-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, PyjI1/xP8BJh4iwzXPxkaEkH1QwU05NED0RG+37J1mOSRqpwJBIJD8KbvMiuwm7i Ws7//3j8nzSBntgTPK53oA== 0000950131-97-002732.txt : 19970423 0000950131-97-002732.hdr.sgml : 19970423 ACCESSION NUMBER: 0000950131-97-002732 CONFORMED SUBMISSION TYPE: 485BPOS PUBLIC DOCUMENT COUNT: 4 FILED AS OF DATE: 19970422 EFFECTIVENESS DATE: 19970422 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E CENTRAL INDEX KEY: 0000804223 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] IRS NUMBER: 350472300 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 485BPOS SEC ACT: 1933 Act SEC FILE NUMBER: 033-26032 FILM NUMBER: 97585237 FILING VALUES: FORM TYPE: 485BPOS SEC ACT: 1940 Act SEC FILE NUMBER: 811-04882 FILM NUMBER: 97585238 BUSINESS ADDRESS: STREET 1: P O BOX 1110 CITY: FORT WAYNE STATE: IN ZIP: 46801 BUSINESS PHONE: 2194273018 MAIL ADDRESS: STREET 1: P O BOX 1110 CITY: FORT WAYNE STATE: IN ZIP: 46801 485BPOS 1 P.E. AMENDMENT NO. 12 TO VA ACCOUNT E As filed with the Securities and Exchange Commission on April 22, 1997 Registration No. 33-26032 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 / / Post-Effective Amendment No. 12 / X / AND REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 / / AMENDMENT NO. 16 / X / LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E ------------------------------------------- (Exact Name of Registrant) THE LINCOLN NATIONAL LIFE INSURANCE COMPANY ------------------------------------------- (Name of Depositor) 1300 South Clinton Street Fort Wayne, Indiana 46802 -------------------------- (Address of Depositor's Principal Executive Offices) Depositor's Telephone Number, including Area Code: (219)455-2000 JACK D. HUNTER, ESQ. 200 East Berry Street Fort Wayne, Indiana 46802 ------------------------- (Name and Address of Agent for Service) Copy to: Susan S. Krawczyk Sutherland, Asbill & Brennan, L.L.P. 1275 Pennsylvania Ave., N.W. Washington, D.C. 20004 --------------------------------------- DECLARATION PURSUANT TO RULE 24F-2 The Registrant has registered an indefinite amount of securities under the Securities Act of 1933 pursuant to Rule 24f-2 of the Investment Company Act of 1940. Pursuant to Rule 24f-2(b)(2), the Registrant filed a Rule 24f-2 Notice for the last fiscal year (1996) on February 28, 1997. It is proposed that this filing will become effective immediately upon filing pursuant to paragraph (b) of Rule 485 --- X On May 2, 1997*, pursuant to paragraph (b) of Rule 485 --- 60 days after filing pursuant to paragraph (a)(1) of Rule 485 --- On April 30, 1997 Pursuant to paragraph (a)(1) of Rule 485 --- *Registrant has requested acceleration to April 30, 1997. LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E CROSS REFERENCE SHEET (PURSUANT TO RULE 495 OF REGULATION C UNDER THE SECURITIES ACT OF 1933) RELATING TO ITEMS REQUIRED BY FORM N-4 (POST-EFFECTIVE AMENDMENT NO. 11)
N-4 ITEM CAPTION IN PROSPECTUS (PART A) - -------- ------------------------------ 1. Cover Page 2. Special terms 3. (a) Expense Table (b) Not Applicable (c) Not Applicable (d) For Your Information (top of page 2) 4. (a) Condensed Financial Information (b) Not Applicable (c) Financial Statements 5. (a) Cover Page; The Lincoln National Life Insurance Company; (b) Variable Annuity Account; Investments of the Variable Annuity Account; Cover Page (c) Investments of the Variable Annuity Account (d) Cover Page (e) Voting Rights (f) Not Applicable 6. (a) For Your Information; Charges and Other Deductions (b) Charges and Other Deductions (c) Charges and Other Deductions (d) Charges and Other Deductions (e) Charges and Other Deductions (f) Charges and Other Deductions (g) Not Applicable 7. (a) The Contracts; Investments of the Variable Annuity Account; Annuity Payouts; Voting Rights; Return Privilege (b) Investments of the Variable Annuity Account; The Contracts; Cover Page (c) The Contracts (d) The Contracts
CROSS REFERENCE SHEET TO ITEMS REQUIRED BY FORM N-4
N-4 ITEM CAPTION IN PROSPECTUS (PART A) - ---------- ------------------------------ 8. (a) Annuity Payouts (b) Annuity Payouts (c) Annuity Payouts (d) Annuity Payouts (e) Cover Page; Annuity Payouts (f) The Contracts; Annuity Payouts 9. (a) The Contracts; Annuity Payouts (b) The Contracts; Annuity Payouts 10. (a) The Contracts; Cover Page; Charges and Other Deductions (b) The Contracts; Investments of the Variable Annuity Account (c) The Contracts (d) Distribution of the Contracts 11. (a) The Contracts (b) Restrictions Under the Texas Optional Retirement Program (c) The Contracts (d) The Contracts (e) Return Privilege 12. (a) Federal Tax Status (b) Cover Page; Federal Tax Status (c) Federal Tax Status 13. Legal Proceedings 14. Table of Contents to the Statement of Additional Information (SAI) for Lincoln National Variable Annuity Account E
N-4 ITEM CAPTION IN STATEMENT OF ADDITIONAL - -------- INFORMATION (PART B) ---------------------------------- 15. Cover Page for Part B 16. Cover Page for Part B 17. (a) Not Applicable (b) Not Applicable (c) General Information and History of The Lincoln National Life Insurance Company Lincoln Life (Lincoln Life)
CROSS REFERENCE SHEET TO ITEMS REQUIRED BY FORM N-4
N-4 ITEM CAPTION IN STATEMENT OF ADDITIONAL - ---------- INFORMATION (PART B) ---------------------------------- 18. (a) Not Applicable (b) Not Applicable (c) Services (d) Not Applicable (e) Not Applicable (f) Not Applicable 19. (a) Purchase of Securities Being Offered (b) Purchase of Securities Being Offered 20. (a) Not Applicable (b) Principal Underwriter (c) Not Applicable (d) Not Applicable 21. Not Applicable 22. Annuity Payouts [Also see that heading in the Prospectus] 23. (a) Financial Statements -- Lincoln National Variable Annuity Account E (b) Consolidated Financial Statements -- The Lincoln National Life Insurance Company
AMERICAN LEGACY LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E INDIVIDUAL VARIABLE ANNUITY CONTRACTS issued by: Lincoln National Life Insurance Co. 1300 South Clinton Street Fort Wayne, Indiana 46802 This Prospectus describes the individual flexible premium deferred variable annuity contract (contract or variable annuity contract) issued by Lincoln Na- tional Life Insurance Co. (Lincoln Life). It is for use with the following re- tirement plans qualified for special tax treatment (qualified plans) under the Internal Revenue Code of 1986, as amended (the code): 1. Public school systems and certain tax-exempt organizations 403(b); 2. Qualified corporate employee pension and profit-sharing trusts and quali- fied annuity plans; 3. Corresponding plans of self-employed individuals (H.R. 10 or Keogh); 4. Individual retirement annuities (IRA); 5. Government deferred compensation plans (457); and 6. Simplified employee pension plans (SEP). Section 403(b) business under number (1.) will normally be accepted only for purchase payments qualifying as 403(b) lump sum transfers or rollovers. The contract described in this Prospectus is also offered to plans established by persons who are not entitled to participate in one of the previously men- tioned plans (nonqualified contracts). The contract offers you the accumulation of contract value and payment of pe- riodic annuity benefits. These benefits may be paid on a variable or fixed ba- sis or a combination of both. Benefits start at an annuity commencement date which you select. If the annuitant dies before the annuity commencement date, the greater of: 1) the contract value; or 2) the guaranteed minimum death ben- efit (GMDB) or, if in effect, the enhanced guaranteed minimum death benefit (EGMDB) will be paid to the beneficiary. (See Death benefit before the annuity commencement date) The minimum initial purchase payment for the contract is: 1. $1,500 for a nonqualified plan and a 403(b) transfer/rollover or 2. $300 for a qualified plan. The minimum subsequent purchase payment for the contract is $25 per payment, subject to a $300 annual minimum. All investments (purchase payments) for benefits on a variable basis will be placed in Lincoln National Variable Annuity Account E (Variable annuity ac- count [VAA]). The VAA is a segregated investment account of Lincoln Life, which is the depositor. Based upon your instructions, the VAA invests purchase payments (at net asset value) in shares of a class of one or more specified funds of the American Variable Insurance Series (series): Global Growth Fund, Growth Fund, International Fund, Growth-Income Fund, Asset Allocation Fund, High-Yield Bond Fund, Bond Fund, U.S. Government/AAA-Rated Securities Fund and Cash Management Fund. (See Description of the series). Both the value of a contract before the annuity commencement date and the amount of payouts after- ward will depend upon the investment performance of the fund(s) selected. In- vestments in these funds are neither insured or guaranteed by the U.S. Govern- ment nor by any other person or entity. Purchase payments for benefits on a fixed basis will be placed in the fixed side of the contract, which is part of our General Account. However, this Pro- spectus deals only with those elements of the contracts relating to the VAA, except where reference to the fixed side is made. THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION (SEC) NOR HAS THE SEC PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. This Prospectus details the information regarding the VAA that you should know before investing. This booklet also includes a current Prospectus of the se- ries. Both should be read carefully before investing and kept for future ref- erence. A statement of additional information (SAI), dated April 30, 1997, concerning the VAA has been filed with the SEC and is incorporated by this reference into this Prospectus. If you would like a free copy, complete and mail the enclosed card, or call 1-800-942-5500. A table of contents for the SAI appears on the last page of this Prospectus. This Prospectus is dated April 30, 1997. TABLE OF CONTENTS
Page - ---------------------------------------------------------------------- Special terms 3 - ---------------------------------------------------------------------- Expense tables 4 - ---------------------------------------------------------------------- Synopsis 6 - ---------------------------------------------------------------------- Condensed financial information for the variable annuity account 8 - ---------------------------------------------------------------------- Financial statements 9 - ---------------------------------------------------------------------- Lincoln National Life Insurance Co. 9 - ---------------------------------------------------------------------- Variable annuity account (VAA) 9 - ---------------------------------------------------------------------- Investments of the variable annuity account 9 - ---------------------------------------------------------------------- Charges and other deductions 11 - ---------------------------------------------------------------------- The contracts 12 - ---------------------------------------------------------------------- Annuity payouts 16
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Page - -------------------------------------------------------------- Federal tax status 17 - -------------------------------------------------------------- Voting rights 19 - -------------------------------------------------------------- Distribution of the contracts 19 - -------------------------------------------------------------- Return privilege 19 - -------------------------------------------------------------- State regulation 19 - -------------------------------------------------------------- Restrictions under the Texas Optional Retirement Program 20 - -------------------------------------------------------------- Records and reports 20 - -------------------------------------------------------------- Other information 20 - -------------------------------------------------------------- Statement of Additional Information table of contents for Separate Account E 20
- -------------------------------------------------------------------------------- 2 SPECIAL TERMS (Throughout this Prospectus, in order to make the following documents more un- derstandable to you, we have italicized the special terms.) Account or variable annuity account (VAA) -- The segregated investment ac- count, Account E, into which Lincoln Life sets aside and invests the assets for the variable side of the contract offered in this Prospectus. Accumulation unit -- A measure used to calculate contract value for the vari- able side of the contract before the annuity commencement date. See The con- tracts. Advisor or investment advisor -- Capital Research and Management Co. (CRMC), which provides investment management services to the series. See Investment advisor. Annuitant -- The person upon whose life the annuity benefit payouts made after the annuity commencement date will be based. Annuity commencement date -- The valuation date when funds are withdrawn or converted into annuity units or fixed dollar payout for payout of annuity ben- efits under the annuity payout option selected. For purposes of determining whether an event occurs before or after the annuity commencement date, the an- nuity commencement date is deemed to begin at close of business on the valua- tion date. Annuity payout option -- An optional form of payout of the annuity available within the contract. See Annuity payouts. Annuity payout -- An amount paid at regular intervals after the annuity com- mencement date under one of several options available to the annuitant and/or any other payee. This amount may be paid on a variable or fixed basis, or a combination of both. Annuity unit -- A measure used to calculate the amount of annuity payouts af- ter the annuity commencement date. See Annuity payouts. Beneficiary -- The person whom you designate to receive the death benefit, if any, in case of the annuitant's death. Cash surrender value -- Upon surrender, the contract value less any applicable charges, fees and taxes. Code -- The Internal Revenue Code of 1986, as amended. Contract (variable annuity contract) -- The agreement between you and us pro- viding a variable annuity. Contractowner (you, your, owner) -- The person who has the ability to exercise the rights within the contract (decides on investment allocations, transfers, payout options; designates the beneficiary, etc.). Usually, but not always, the contractowner is also the annuitant. Contract value -- At a given time, the total value of all accumulation units for a contract plus the value of the fixed side of the contract. Contract year -- Each one-year period starting with the effective date of the contract and starting with each contract anniversary after that. Death benefit -- The amount payable to your designated beneficiary if the an- nuitant dies before the annuity commencement date. See The contracts. Depositor -- Lincoln National Life Insurance Co. Enhanced guaranteed minimum death benefit (EGMDB) -- The EGMDB is the greater of: (1) contract value as of the day on which Lincoln Life approves the pay- ment of a death benefit claim; or (2) the highest contract value on any policy anniversary date (including the inception date) from the time the EGMDB takes effect up to and including the annuitant's age 75. The highest contract value so determined is then increased by purchase payments and decreased by partial withdrawals, partial annuitizations, and any premium taxes made, effected or incurred subsequent to the anniversary date on which the highest contract value is obtained. Flexible premium deferred contract -- An annuity contract with an initial pur- chase payment, allowing additional purchase payments to be made, and with an- nuity payouts beginning at a future date. Fund -- Any of the underlying investment options available in the series in which your purchase payments are invested. Guaranteed minimum death benefit (GMDB) -- The GMDB is equal to the sum of all purchase payments plus any attributable gain, minus any withdrawals, partial annuitizations and premium taxes incurred. We determine the attributable gain separately for each contract year on its seventh anniversary (once its surren- der charge period has expired). See Death benefit before the annuity commence- ment date. Home office -- The headquarters of Lincoln National Life Insurance Co., lo- cated at 1300 South Clinton Street, Fort Wayne, Indiana 46802. Lincoln Life (we, us, our) -- Lincoln National Life Insurance Co. Purchase payments -- Amounts paid into the contract. Series -- American Variable Insurance Series (series), the funds in which pur- chase payments are invested. Statement of additional information (SAI) -- A document required by the SEC to be provided upon request to a prospective purchaser of a contract, you. This free document gives more information about Lincoln Life, the VAA and the vari- able annuity contract. Subaccount -- That portion of the VAA that reflects investments in accumula- tion and annuity units of a class of a particular fund. There is a separate subaccount which corresponds to each class of a fund under the contracts. Surrender -- A contract right that allows you to terminate your contract and receive your cash surrender value. See The contracts. Valuation date -- Each day the New York Stock Exchange (NYSE) is open for trading. Valuation period -- The period starting at the close of trading (currently 4:00 pm New York time) on each day that the NYSE is open for trading (valua- tion date) and ending at the close of such trading on the next valuation date. Withdrawal -- A contract right that allows you to obtain a portion of your cash surrender value. 3 EXPENSE TABLES CONTRACTOWNER TRANSACTION EXPENSES: The maximum contingent deferred sales charge (as a percentage of purchase payments surrendered/withdrawn): 6% The contingent deferred sales charge percentage is reduced over time. The later a redemption occurs, the lower the contingent deferred sales charge with re- spect to that surrender or withdrawal. See Contingent deferred sales charges. (Note: This charge may be waived in certain cases. See Contingent deferred sales charges.) - -------------------------------------------------------------------------------- ANNUAL CONTRACT FEE: $35 This is a single charge assessed against the contract value on the last valua- tion date of each contract year and upon full surrender; it is not a separate charge for each subaccount. - -------------------------------------------------------------------------------- VARIABLE ANNUITY ACCOUNT E ANNUAL EXPENSES (as a percentage of average account value for each subaccount*).
Contracts with EGMDB Contracts without EGMDB Mortality and expense risk fees 1.25% 1.25% EGMDB charge 0.15% -- ----- ----- Total Account E annual expenses 1.40% 1.25%
ANNUAL EXPENSES OF THE FUNDS FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1996 (as a percentage of each fund's average net assets):
Management + Other = Total fees expenses expenses - -------------------------------------------------------------------------- 1. Global Growth** .69% .06% .75% - -------------------------------------------------------------------------- 2. Growth .42 .02 .44 - -------------------------------------------------------------------------- 3. International .61 .08 .69 - -------------------------------------------------------------------------- 4. Growth-Income .39 .02 .41 - -------------------------------------------------------------------------- 5. Asset Allocation .47 .02 .49 - -------------------------------------------------------------------------- 6. High-Yield Bond .50 .03 .53 - -------------------------------------------------------------------------- 7. Bond .51 .01 .52 - -------------------------------------------------------------------------- 8. U.S. Govt./AAA-Rated Securities .51 .02 .53 - -------------------------------------------------------------------------- 9. Cash Management .45 .02 .47
- -------------------------------------------------------------------------------- *The VAA is divided into nine separately-named subaccounts, which are available under the contracts. Each subaccount, in turn, invests purchase payments in its respective fund. **These expenses are estimated amounts for the current fiscal year. 4 EXAMPLES (reflecting expenses both of The American Legacy subaccounts and of the funds): If you surrender your contract at the end of the applicable time period, you would pay the following expenses* on a $1,000 investment, assuming a 5% annual return:
1 year 3 years 5 years 10 years - ------------------------------------------------------------------- 1. Global Growth** $80 $113 $138 $232 - ------------------------------------------------------------------- 2. Growth 77 103 122 199 - ------------------------------------------------------------------- 3. International 80 111 135 226 - ------------------------------------------------------------------- 4. Growth-Income 77 102 120 196 - ------------------------------------------------------------------- 5. Asset Allocation 78 105 124 205 - ------------------------------------------------------------------- 6. High-Yield Bond 78 106 126 209 - ------------------------------------------------------------------- 7. Bond 77 104 123 202 - ------------------------------------------------------------------- 8. U.S. Govt./AAA-Rated Securities 78 106 126 209 - ------------------------------------------------------------------- 9. Cash Management 77 104 123 202
- -------------------------------------------------------------------------------- If you do not surrender your contract, you would pay the following expenses* on a $1,000 investment, assuming a 5% annual return:
1 year 3 years 5 years 10 years - ------------------------------------------------------------------- 1. Global Growth** $20 $63 $108 $232 - ------------------------------------------------------------------- 2. Growth 17 53 92 199 - ------------------------------------------------------------------- 3. International 20 61 105 226 - ------------------------------------------------------------------- 4. Growth-Income 17 52 90 196 - ------------------------------------------------------------------- 5. Asset Allocation 18 55 94 205 - ------------------------------------------------------------------- 6. High-Yield Bond 18 56 96 209 - ------------------------------------------------------------------- 7. Bond 17 54 93 202 - ------------------------------------------------------------------- 8. U.S. Govt./AAA-Rated Securities 18 56 96 209 - ------------------------------------------------------------------- 9. Cash Management 17 54 93 202
- -------------------------------------------------------------------------------- *These expenses, calculated as mandated by the SEC, reflect the annual contract fee as the ratio of the total contract fees collected in the most recent fiscal year to the total average net assets of the account. **These expenses are estimated for the current fiscal year. All of the figures provided under the subheading annual expenses of the funds and part of the data used to produce the figures in the examples were supplied by the underlying portfolio company (series) through the VAA's principal under- writer, American Funds Distributors, Inc. We have not independently verified this information. These examples are provided to assist you in understanding the various costs and expenses that you will bear directly or indirectly. These examples reflect expenses both of the VAA and of the nine funds. These examples reflect expenses assuming that the EGMDB is NOT in effect. If the EGMDB is in effect, these expenses will be higher. For more complete descriptions of the various costs and expenses involved, see Charges and other deductions in this Prospectus, and Fund Organization and Man- agement in the Prospectus for the series. Premium taxes may also be applicable, although they do not appear in the table. THE EXAMPLES SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE MORE OR LESS THAN THOSE SHOWN. These examples are unaudited. 5 SYNOPSIS WHAT TYPE OF CONTRACT AM I BUYING? It is an individual annuity contract issued by Lincoln Life. It may provide for a fixed annuity and/or a variable annuity. This Prospectus is intended to provide disclosure only about the variable por- tion of the contract. See The contracts. WHAT IS THE VARIABLE ANNUITY ACCOUNT (VAA)? It is a segregated asset account established under Indiana insurance law, and registered with the SEC as a unit investment trust. The assets of the VAA are allocated to one or more subaccounts, according to your investment choice. Those assets are not charge- able with liabilities arising out of any other business which Lincoln Life may conduct. See Variable annuity account. WHAT ARE MY INVESTMENT CHOICES? Through its various subaccounts, the VAA uses your purchase payments to purchase series shares, at your direction, in one or more of the following investment funds of the series: Global Growth, Growth, International, Growth-Income, Asset Allocation, High-Yield Bond, Bond, U.S. Government/ AAA-Rated Securities and Cash Management. In turn, each fund holds a portfolio of securities consistent with its own particular investment policy. See Investments of the variable annuity account and Description of the series. WHO INVESTS MY MONEY? The investment advisor for the series is CRMC, Los Ange- les, California. CRMC is a long-established investment management organization, and is registered as an investment advisor with the SEC. See Investments of the variable annuity account and Investment advisor. HOW DOES THE CONTRACT WORK? Once we approve your application, you will be is- sued your individual annuity contract. During the accumulation period, while you are paying in, purchase payments will buy accumulation units under the con- tract. Should you decide to annuitize (that is, change your contract to a pay- out mode rather than an accumulation mode), your accumulation units will be converted to annuity units. Your periodic annuity payout will be based upon the number of annuity units to which you became entitled at the time you decided to annuitize, and the value of each unit on the valuation date. See The contracts. WHAT CHARGES ARE ASSOCIATED WITH THIS CONTRACT? At the end of each contract year and at the time of surrender, we will deduct $35 from your contract value as a maintenance charge. Should you decide to withdraw contract value before your purchase payments have been in your contract for a certain minimum period, you will incur a contingent deferred sales charge of anywhere from 1% to 6%, depending upon how many full contract years those payments have been in the contract. (Note: This sales charge is not assessed upon: the first withdrawal of contract value during a contract year to the extent the withdrawal does not exceed 10% of the purchase payments (this 10% withdrawal exception does not apply to a surrender of the contract); automatic withdrawals, not in excess of 10% of the purchase payments during a contract year, made by non-trustee contractowners who are at least 59 1/2; a surrender of a contract or withdrawal of contract value as a result of the annuitant's permanent and total disability [as defined in Section 22(e)(3) of the code], after the effective date of the contract and before the annuitant's 65th birthday; a surrender of the contract as a result of the death of the annuitant; or annuitization. If your state assesses a premium tax with respect to your contract, then at the time the tax is incurred (or at such other time as we may choose), we will de- duct those amounts from purchase payments or contract value, as applicable. We assess an annual charge in the amount of 1.25% as a mortality and expense risk charge against the daily net asset value of the VAA, including that por- tion of the account attributable to your purchase payments. If the EGMDB is in effect, the aggregate charge against the VAA is 1.40% consisting of a 1.25% mortality and expense risk charge and a 0.15% risk charge for the EGMDB. For a complete discussion of the charges associated with the contract, see Charges and other deductions. The series pays a fee to its investment advisor, CRMC, based upon the average daily net asset value of each fund in the series. (See Investments of the vari- able annuity account-Investment advisor.) In addition, there are other expenses associated with the daily operations of the series. These are more fully de- scribed in the Prospectus for the series. HOW MUCH MUST I PAY, AND HOW OFTEN? Subject to the minimum and maximum payments stated on the first page of the Prospectus, the amount and frequency or your payments are completely flexible. See The contracts--Purchase payments. HOW WILL MY ANNUITY PAYOUTS BE CALCULATED? If you decide to annuitize, you elect an annuity payout option. Once you have done so, your periodic payout will be based upon a number of factors. If you participate in the VAA, the changing values of the funds in which you have invested will be one factor. See Annuity payouts. REMEMBER THAT PARTICIPANTS IN THE VAA BENEFIT FROM ANY GAIN, AND TAKE A RISK OF ANY DROP, IN THE VALUE OF THE SECURITIES IN THE FUNDS' PORT- FOLIOS. WHAT HAPPENS IF I DIE BEFORE I ANNUITIZE? If you are the annuitant and also the contractowner, then the beneficiary whom you designate will receive either the GMDB, or the then current value of the contract, whichever is greater. If the EGMDB is in effect, the beneficiary 6 will receive either the EGMDB or the then current value of the contract, which- ever is greater. Your beneficiary will have certain options for how the money is to be paid out. If a contractowner is not also the annuitant, certain spe- cial rules apply. See The contracts--Death benefit before the annuity commence- ment date and Death of contractowner. MAY I TRANSFER CONTRACT VALUE BETWEEN FUNDS IN THE SERIES? Yes; however, there are limits on how often you may do so. See The contracts--Transfers between subaccounts on or before the annuity commencement date and Transfers after the annuity commencement date. MAY I TRANSFER CONTRACT VALUE FROM THE FIXED TO THE VARIABLE SIDE OF THE CON- TRACT, AND VICE-VERSA? Yes, subject once again to specific restrictions in the contract. See The contracts--Transfers of accumulation units to and from the General Account. MAY I SURRENDER THE CONTRACT OR MAKE A WITHDRAWAL? Yes, subject to contract re- quirements and to restrictions imposed under certain qualified retirement plans for which the contract is purchased. See The contracts--Surrenders and with- drawals. If you surrender the contract or make a withdrawal, certain charges may be as- sessed, as discussed above and under Charges and other deductions. In addition, the Internal Revenue Service (IRS) may assess a 10% premature withdrawal pen- alty tax. A surrender or a withdrawal may be subject to 20% withholding. See Federal tax status and withholding. DO I GET A FREE LOOK AT THIS CONTRACT? Yes. If within 20 days (or a longer pe- riod if required by law) of the date you first receive the contract you return it, postage pre-paid to the home office of Lincoln Life, it will be canceled. However, except in some states, during this period, you assume the risk of a market drop with respect to purchase payments which you allocate to the vari- able side of the contract. See Return privilege. 7 CONDENSED FINANCIAL INFORMATION FOR THE VARIABLE ANNUITY ACCOUNT ACCUMULATION UNIT VALUES (FOR AN ACCUMULATION UNIT OUTSTANDING THROUGHOUT THE PERIOD) The following information relating to accumulation unit values and number of accumulation units for The American Legacy subaccounts for each of the ten years in the period ended December 31, 1996 comes from the VAA's financial statements. It should be read in conjunction with the VAA's financial state- ments and notes which are all included in the SAI.
1987* 1988 1989 1990 1991 1992 1993 1994 1995 1996 - --------------------------------------------------------------------------------------------------------- Growth subaccount Accumulation unit value .Beginning of period $ 1.000 .818 .925 1.200 1.133 1.492 1.632 1.875 1.861 2.450 .End of period $ .818 .925 1.200 1.133 1.492 1.632 1.875 1.861 2.450 2.743 Number of accumulation units .End of period (000's omitted) 28,656 54,124 93,979 99,094 106,335 110,169 111,230 105,312 101,710 90,842 - --------------------------------------------------------------------------------------------------------- International subaccount** Accumulation unit value .Beginning of period $ 1.000 1.001 1.114 .End of period $ 1.001 1.114 1.294 Number of accumulation units .End of period (000's omitted) 27,787 31,592 38,351 - --------------------------------------------------------------------------------------------------------- Growth-Income subaccount Accumulation unit value .Beginning of period $ 1.000 .842 .952 1.180 1.136 1.392 1.484 1.646 1.659 2.180 .End of period $ .842 .952 1.180 1.136 1.392 1.484 1.646 1.659 2.180 2.556 Number of accumulation units .End of period (000's omitted) 58,406 111,918 195,478 199,880 203,868 201,913 199,178 183,608 172,288 158,861 - --------------------------------------------------------------------------------------------------------- Asset Allocation subaccount** Accumulation unit value .Beginning of period $ 1.000 .986 1.262 .End of period $ .986 1.262 1.443 Number of accumulation units .End of period (000's omitted) 3,807 5,168 7,199 - --------------------------------------------------------------------------------------------------------- High-Yield Bond subaccount Accumulation unit value .Beginning of period $ 1.000 .974 1.103 1.204 1.234 1.543 1.714 1.971 1.819 2.188 .End of period $ .974 1.103 1.204 1.234 1.543 1.714 1.971 1.819 2.188 2.447 Number of accumulation units .End of period (000's omitted) 9,304 23,858 34,050 29,430 28,254 27,823 29,951 25,988 23,867 20,767 - --------------------------------------------------------------------------------------------------------- Bond subaccount*** Accumulation unit value .Beginning of period $ 1.000 .End of period $ 1.046 Number of accumulation units .End of period (000's omitted) 1,681 - --------------------------------------------------------------------------------------------------------- U.S. Government/AAA-Rated subaccount Accumulation unit value .Beginning of period $ 1.000 .948 1.012 1.108 1.187 1.359 1.444 1.586 1.498 1.707 .End of period $ .948 1.012 1.108 1.187 1.359 1.444 1.586 1.498 1.707 1.738 Number of accumulation units .End of period (000's omitted) 11,177 26,477 42,915 43,779 44,335 42,291 39,387 31,118 29,062 22,652 - --------------------------------------------------------------------------------------------------------- Cash Management subaccount Accumulation unit value .Beginning of period $ 1.000 1.037 1.097 1.179 1.256 1.309 1.335 1.353 1.388 1.447 .End of period $ 1.037 1.097 1.179 1.256 1.309 1.335 1.353 1.388 1.447 1.502 Number of accumulation units .End of period (000's omitted) 8,749 26,381 31,446 29,312 19,913 21,963 13,982 14,312 10,001 9,605
- -------------------------------------------------------------------------------- *The VAA began operations on March 9, 1987. Therefore, the figures for 1987 represent experience of less than one year. **The International subaccount and Asset Allocation subaccount began operations on January 3, 1994. ***The Bond subaccount began operations on January 2, 1996 so the figures for 1996 represent experience of less than one year. There is a Global Growth subaccount but it is not in the chart because it did not begin activity until 1997. 8 FINANCIAL STATEMENTS The financial statements for the VAA and Lincoln Life are located in the SAI. If you would like a free copy, complete and mail the enclosed card, or call 1- 800-942-5500. LINCOLN NATIONAL LIFE INSURANCE CO. Lincoln Life was founded in 1905 and is organized under Indiana law. We are one of the largest stock life insurance companies in the United States. We are owned by Lincoln National Corp. (LNC) which is also organized under Indiana law. LNC's primary businesses are insurance and financial services. VARIABLE ANNUITY ACCOUNT (VAA) On September 26, 1986, the VAA was established as an insurance company sepa- rate account under Indiana law. It is registered with the SEC as a unit in- vestment trust under the provisions of the Investment Company Act of 1940 (1940 Act). The SEC does not supervise the VAA or Lincoln Life. The VAA is a segregated investment account, meaning that its assets may not be charged with liabilities resulting from any other business that we may conduct. Income, gains and losses, whether realized or not, from assets allocated to the VAA are, in accordance with the applicable annuity contracts, credited to or charged against the VAA. They are credited or charged without regard to any other income, gains or losses of Lincoln Life. The VAA satisfies the defini- tion of separate account under the federal securities laws. We do not guaran- tee the investment performance of the VAA. Any investment gain or loss depends on the investment performance of the funds. YOU ASSUME THE FULL INVESTMENT RISK FOR ALL AMOUNTS PLACED IN THE VAA. INVESTMENTS OF THE VARIABLE ANNUITY ACCOUNT You decide the subaccount(s) to which you allocate purchase payments. There is a separate subaccount which corresponds to each class of each fund in the se- ries. You may change your allocation without penalty or charges. Shares of the funds will be sold at net asset value with no initial sales charge to the VAA in order to fund the contracts. The series is required to redeem fund shares at net asset value upon our request. We reserve the right to add, delete or substitute funds. INVESTMENT ADVISOR The investment advisor for the series is CRMC, 333 South Hope Street, Los An- geles, California 90071. CRMC is one of the nation's largest and oldest in- vestment management organizations. As compensation for its services to the se- ries, the investment advisor receives a fee from the series which is accrued daily and paid monthly. This fee is based on the net assets of each fund, as defined under Purchases and redemptions of shares, in the Prospectus for the series. DESCRIPTION OF THE SERIES The series was organized as a Massachusetts business trust in 1983 and is reg- istered as a diversified, open-end management investment company under the 1940 Act. Diversified means not owning too great a percentage of the securi- ties of any one company. An open-end company is one which, in this case, per- mits Lincoln Life to sell its shares back to the series when you make a with- drawal, surrender the contract or transfer from one fund to another. Manage- ment investment company is the legal term for a mutual fund. These definitions are very general. The precise legal definitions for these terms are contained in the 1940 Act. The series has nine separate portfolios of funds. The series has adopted a plan pursuant to Rule 18f-3 under the 1940 Act to permit the series to estab- lish a multiple class distribution system for all of its portfolios. The se- ries' Board of Trustees may at any time establish additional funds or classes, which may or may not be available to the VAA. Fund assets are segregated and a shareholder's interest is limited to those funds in which the shareholder owns shares. Under the multi-class system adopted by the series, shares of each multi-class fund represent an equal pro rata interest in that fund and, generally, have identical voting, dividend, liquidation and other rights, preferences, powers, restrictions, limitations, qualifications and terms and conditions, except that: (1) each class has a different designation; (2) each class of shares bears its class expenses; (3) each class has exclusive voting rights on any matter submitted to shareholders that relates solely to its distribution ar- rangement; and (4) each class has separate voting rights on any matter submit- ted to shareholders in which the interests of one class differ from the inter- ests of any other class. Expenses currently designated as class expenses by the series' Board of Trustees under the plan pursuant to Rule 18f-3 include, for example, service fees paid under a 12b-1 plan to cover servicing fees paid to dealers selling the contracts. Each fund has two classes of shares, designated as Class 1 and Class 2 shares. Class 1 and 2 differ primarily in that Class 2 but not Class 1 shares are sub- ject to a 12b-1 plan. Only Class 1 shares are available under the contracts. 9 Following are brief summaries of the investment objectives and policies of the funds. Each fund is subject to certain investment policies and restrictions which may not be changed without a majority vote of shareholders of that fund. More detailed information may be obtained from the current Prospectus for the series, which is included in this booklet. PLEASE BE ADVISED THAT THERE IS NO ASSURANCE THAT ANY OF THE FUNDS WILL ACHIEVE THEIR STATED OBJECTIVES. 1. Global Growth Fund--The investment objective is to achieve long-term growth of capital by investing in securities of issuers domiciled around the world. The fund will invest primarily in common stocks but may invest in other se- curities such as preferred stock, debt securities and securities convertible into common stock. PLEASE NOTE: THIS FUND IS NOT YET AVAILABLE IN ALL STATES. PLEASE CONSULT YOUR INVESTMENT DEALER FOR CURRENT INFORMATION ABOUT THE GLOBAL GROWTH FUND'S AVAILABILITY. 2. Growth Fund--This fund seeks to provide growth of capital. Whatever current income is generated by the fund is likely to be incidental to the objective of capital growth. Ordinarily, accomplishment of the fund's objective of capital growth will be sought by investing primarily in common stocks or se- curities with common stock characteristics. 3. International Fund--The investment objective is long-term growth of capital by investing primarily in securities of issuers domiciled outside the United states. 4. Growth-Income Fund--The investment objective is growth of capital and in- come. In the selection of securities for investment, the possibilities of appreciation and potential dividends are given more weight than current yield. Ordinarily, the assets of the Growth-Income Fund consist principally of a diversified group of common stocks, but other types of securities may be held when deemed advisable including preferred stocks and corporate bonds, including convertible bonds. 5. Asset Allocation Fund--This fund seeks total return (including income and capital gains) and preservation of capital over the long-term by investing in a diversified portfolio of securities. These securities can include com- mon stocks and other equity-type securities (such as convertible bonds and preferred stocks), bonds and other intermediate and long-term fixed-income securities and money market instruments. 6. High-Yield Bond Fund--The investment objective is a fully managed, diversi- fied bond portfolio. It seeks high current income and secondarily seeks cap- ital appreciation. This fund will generally be invested substantially in in- termediate-and long-term corporate obligations, with emphasis on higher yielding, higher risk, lower rated or unrated securities. 7. Bond Fund--The fund seeks a high level of current income as is consistent with the preservation of capital by investing in a broad variety of fixed income securities including: marketable corporate debt securities, loan par- ticipations, U.S. Government securities, mortgage-related securities, other asset-backed securities and cash or money market instruments. 8. U.S. Government/AAA-Rated Securities Fund--This fund seeks a high level of current income consistent with prudent investment risk and preservation of capital by investing primarily in a combination of securities guaranteed by the U.S. Government and other debt securities rated AAA or Aaa. 9. Cash Management Fund--The investment objective is high yield while preserv- ing capital by investing in a diversified selection of money market instru- ments. SALE OF FUND SHARES BY THE SERIES We will purchase shares of the funds at net asset value and direct them to the appropriate subaccounts of the VAA. We will redeem sufficient shares of the ap- propriate funds to pay annuity payouts, death benefits, surrender/ withdrawal proceeds or for other purposes described in the contract. If you want to trans- fer all or part of your investment from one subaccount to another, we may redeem shares held in the first and purchase shares of the other. The shares are retired, but they may be reissued later. Shares of the funds are not sold directly to the general public. They are sold to Lincoln Life, and may be sold to other insurance companies, for investment of the assets of the subaccounts established by those insurance companies to fund variable annuity and variable life insurance contracts. When the series sells shares in any of its funds both to variable annuity and to variable life insurance separate accounts, it is said to engage in mixed funding. When the series sells shares in any of its funds to separate accounts of unaffiliated life insurance companies, it is said to engage in shared fund- ing. The series currently engages in mixed and shared funding. Therefore, due to differences in redemption rates or tax treatment, or other considerations, the interests of various contractowners participating in a fund could conflict. The series' Board of Trustees will monitor for the existence of any material con- flicts, and determine what action, if any, should be taken. See the Prospectus for the series. 10 REINVESTMENT OF DIVIDENDS AND CAPITAL GAIN DISTRIBUTIONS All dividend and capital gain distributions of the funds are automatically re- invested in shares of the distributing funds at their net asset value on the date of distribution. Dividends are not paid out to contractowners as addi- tional units, but are reflected in changes in unit values. ADDITION, DELETION OR SUBSTITUTION OF INVESTMENTS We reserve the right, within the law, to make additions, deletions and substi- tutions for the series and/or any funds within the series in which the VAA par- ticipates. (We may substitute shares of other funds for shares already pur- chased, or to be purchased in the future, under the contract. This substitution might occur if shares of a fund should no longer be available, or if investment in any fund's shares should become inappropriate, in the judgment of our man- agement, for the purposes of the contract.) No substitution of the shares at- tributable to your account may take place without notice to you and before ap- proval of the SEC, in accordance with the 1940 Act. CHARGES AND OTHER DEDUCTIONS We will deduct the charges described below to cover our costs and expenses, services provided and risks assumed under the contract. We incur certain costs and expenses for the distribution and administration of the contracts and for providing the benefits payable thereunder. Our administrative services include: processing applications for and issuing the contracts, processing purchases and redemptions of fund shares as required (including dollar cost averaging, cross- reinvestment, and automatic withdrawal services), maintaining records, adminis- tering annuity payouts, furnishing accounting and valuation services (including the calculation and monitoring of daily subaccount values), reconciling and de- positing cash receipts, providing contract confirmations, providing toll-free inquiry services and furnishing telephone fund transfer services. The benefits we provide include death benefits, annuity payout benefits and cash surrender value benefits. The risks we assume include: the risk that the actual life span of persons receiving annuity payouts under contract guarantees will exceed the assumptions reflected in our guaranteed rates (these rates are incorporated in the contract and cannot be changed); the risk that death benefits paid under the EGMDB or GMDB, will exceed actual contract value; the risk that more owners than expected will qualify for waivers of the contingent deferred sales charge; and the risk that our costs in providing the services will exceed our revenues from contract charges (which cannot be changed by us). The amount of a charge may not necessarily correspond to the costs associated with providing the serv- ices or benefits indicated by the designation of the charge or associated with a particular contract. For example, the contingent deferred sales charge col- lected may not fully cover all of the sales and distribution expenses actually incurred by us. MAINTENANCE CHARGE We will deduct a contract maintenance charge of $35 per contract year. This charge will be deducted from the contract value on the last valuation date of each contract year. This charge will also be deducted from the contract value upon surrender. CONTINGENT DEFERRED SALES CHARGE A contingent deferred sales charge applies (except as described below) to sur- renders and withdrawals of purchase payments that have been invested for the periods indicated as follows:
Number of complete contract years that a purchase payment has been invested - --------------------------------------------------------------------------------- Less At than least 2 2 3 4 5 6 7+ Contingent deferred sales charge as a percentage of the surrendered or withdrawn purchase payments 6% 5 4 3 2 1 0
A contingent deferred sales charge does not apply to: 1. A surrender or withdrawal of purchase payments that have been invested at least seven full contract years. 2. The first withdrawal of contract value during a contract year to the extent the withdrawal does not exceed 10% of the purchase payments (this 10% with- drawal exception does not apply to a surrender of a contract); 3. Automatic withdrawals, not in excess of 10% of the purchase payments during a contract year, made by non-trustee contractowners who are at least 59 1/2; 4. A surrender of a contract or withdrawal of contract value as a result of the annuitant's permanent and total disability [as defined in Section 22(e)(3) of the code], after the effective date of the contract and before the annuitant's 65th birthday. 5. A surrender of a contract or withdrawal of contract value of a contract is- sued to employees and registered representatives of any member of the sell- ing group and their spouses and minor children, or to officers, directors, trustees or bona-fide full-time employees of Lincoln National Corp. or The Capital Group, Inc. or their affiliated or managed companies (based upon the contractowner's status at the time the contract was purchased); and 6. A surrender of the contract as a result of the death of the annuitant. However, the contingent deferred sales charge is not waived as a result of the death of a contractowner who is not the annuitant. 11 The contingent deferred sales charge is calculated separately for each con- tract year's purchase payments to which a charge applies. (FOR PURPOSES OF CALCULATING THIS CHARGE, WE ASSUME THAT PURCHASE PAYMENTS ARE WITHDRAWN ON A FIRST IN-FIRST OUT BASIS, AND THAT ALL PURCHASE PAYMENTS ARE WITHDRAWN BEFORE ANY EARNINGS ARE WITHDRAWN.) The contingent deferred sales charges associated with surrender or withdrawal are paid to us to compensate us for the loss we experience on contract distribution costs when contractowners surrender or withdraw before distribution costs have been recovered. DEDUCTIONS FROM THE VAA FOR ASSUMPTION OF MORTALITY AND EXPENSE RISKS We deduct from the VAA an amount, computed daily, which is equal to an annual rate of 1.25% of the daily net asset value as a mortality and expense risk charge. For those contracts which include the EGMDB, the aggregate charge against the VAA is 1.40% consisting of a 1.25% mortality and expense risk charge and a 0.15% risk charge for the EGMDB. DEDUCTIONS FOR PREMIUM TAXES Any premium tax or other tax levied by any governmental entity as a result of the existence of the contracts or the VAA will be deducted from the contract value when incurred, or at another time of our choosing. The applicable premium tax rates that states and other governmental entities impose on the purchase of an annuity are subject to change by legislation, by administrative interpretation or by judicial action. These premium taxes gen- erally depend upon the law of your state of residence. The tax ranges from 0.5% to 4.0%. OTHER CHARGES AND DEDUCTIONS There are deductions from and expenses paid out of the assets of the under- lying series that are described in the Prospectus for the series. ADDITIONAL INFORMATION The administrative and contingent deferred sales charges described previously may be reduced or eliminated for any particular contract. However, these charges will be reduced only to the extent that we anticipate lower distribu- tion and/or administrative expenses, or that we perform fewer sales or admin- istrative services than those originally contemplated in establishing the level of those charges. Lower distribution and administrative expenses may be the result of economies associated with (1) the use of mass enrollment proce- dures, (2) the performance of administrative or sales functions by the employ- er, (3) the use by an employer of automated techniques in submitting deposits or information related to deposits on behalf of its employees or (4) any other circumstances which reduce distribution or administrative expenses. The exact amount of administrative and contingent deferred sales charges applicable to a particular contract will be stated in that contract. THE CONTRACTS PURCHASE OF CONTRACTS If you wish to purchase a contract, you must apply for it through a sales rep- resentative authorized by us. The completed application is sent to us and we decide whether to accept or reject it. If the application is accepted, a con- tract is prepared and executed by our legally authorized officers. The con- tract is then sent to you through your sales representative. See Distribution of the contracts. If a completed application and all other information necessary for processing a purchase order are received, an initial purchase payment will be priced no later than two business days after we receive the order. While attempting to finish an incomplete application, we may hold the initial purchase payment for no more than five business days. If the incomplete application cannot be com- pleted within those five days, you will be informed of the reasons, and the purchase payment will be returned immediately (unless you specifically autho- rize us to keep it until the application is complete). Once the application is complete, the initial purchase payment must be priced within two business days. WHO CAN INVEST? To apply for a contract, you must be of legal age in a state where the con- tracts may be lawfully sold and also be eligible to participate in any of the qualified or nonqualified plans for which the contracts are designed. The an- nuitant cannot be older than age 85 (or older than age 80 in Pennsylvania). PURCHASE PAYMENTS Purchase payments are payable to us at a frequency and in an amount selected by you in the application. The minimum initial purchase payment is $1,500 for nonqualified contracts and Section 403(b) transfers/rollovers; and $300 for qualified contracts. The minimum annual amount for subsequent purchase pay- ments is $300 for nonqualified and qualified contracts, with a minimum of $25 per payment. Purchase payments in total may not exceed $1 million for each an- nuitant. If you stop making purchase payments, the contract will remain in force as a paid-up contract as long as the total contract value is at least $300. Payments may be resumed at any time until the annuity commencement date, the surrender of the contract, the maturity date, the death of the contractowner or the death of the annuitant, whichever comes first. VALUATION DATE Accumulation and annuity units will be valued once daily at the close of trad- ing (currently 4:00 p.m., New York time) on each day the NYSE is open (valua- tion date). On 12 any date other than a valuation date, the accumulation unit value and the annu- ity unit value will not change. ALLOCATION OF PURCHASE PAYMENTS Purchase payments are placed into the VAA's subaccounts, each of which invests in shares of the class of its corresponding fund of the series, according to your instructions. The minimum amount of any purchase payment which can be put into any one subaccount is $20 under the contract. Upon allocation to the appropriate subaccount, purchase payments are converted into accumulation units. The number of accumulation units credited is determined by dividing the amount allocated to each subaccount by the value of an accumulation unit for that subaccount on the valuation date on which the purchase payment is received at the home office if received before 4:00 p.m., New York time. If the purchase payment is re- ceived at or after 4:00 p.m., New York time, we will use the accumulation unit value computed on the next valuation date. The number of accumulation units de- termined in this way shall not be changed by any subsequent change in the value of an accumulation unit. However, the dollar value of an accumulation unit will vary depending not only upon how well the investments perform, but also upon the expenses of the VAA and the underlying funds. VALUATION OF ACCUMULATION UNITS Accumulation units for each subaccount are valued separately. Initially, the value of each accumulation unit was set at $1.00. Thereafter, the value of an accumulation unit in any subaccount on any valuation date equals the value of an accumulation unit in that subaccount as of the preceding valuation date mul- tiplied by the net investment factor of that subaccount for the current valua- tion period. The net investment factor is an index used to measure the investment perfor- mance of a subaccount from one valuation date to the next. The net investment factor for any subaccount for any valuation date reflects the change in the net asset value per share of the fund held in the subaccount from one valuation pe- riod to the next, adjusted for the daily deduction of the mortality and expense risk charge from assets in the subaccount. If any ex-dividend date occurs dur- ing the valuation period, the per share amount of any dividend or capital gain distribution is taken into account. Also, if any taxes need to be reserved, a per share charge or credit for any taxes reserved for, which is determined by us to have resulted from the operations of the subaccount, is taken into ac- count. Because a different daily charge is made for contracts with the EGMDB than for those without, a different net investment factor is calculated for each of the two types of contracts, resulting in different corresponding accumulation unit values on any given day. TRANSFERS BETWEEN SUBACCOUNTS ON OR BEFORE THE ANNUITY COMMENCEMENT DATE You may transfer all or a portion of your investment from one subaccount to an- other. A transfer involves the surrender of accumulation units in one subaccount and the purchase of accumulation units in the other subaccount. A transfer will be done using the respective accumulation unit values as of the valuation date we receive your request provided that your request is received by 4 p.m. New York time. If your request is received after 4 p.m. New York time, the transfer will be done using the accumulation unit values as of the next valuation date. Transfers between subaccounts are restricted to six times every contract year. We reserve the right to waive this six-time limit. This limit does not apply to transfers made under a dollar cost averaging or cross-reinvestment program elected on forms available from us. The minimum amount which may be transferred between subaccounts is $300 (or the entire amount in the subaccount, if less than $300). If the transfer from a subaccount would leave you with less than $300 in the subaccount, we may transfer the total balance of the subaccount. A transfer may be made by writing to the home office or, if a telephone ex- change authorization form (available from us) is on file with us, by a toll- free telephone call. In order to prevent unauthorized or fraudulent telephone transfers, we may require the caller to provide certain identifying information before we will act upon their instructions. We may also assign the contract- owner a Personal Identification Number (PIN) to serve as identification. We will not be liable for following telephone instructions we reasonably believe are genuine. Telephone requests may be recorded and written confirmation of all transfer requests will be mailed to the contractowner on the next valuation date. Telephone transfers will be processed on the valuation date that they are received when they are received at our customer service center before 4 p.m. New York time. When thinking about a transfer of contract value, you should consider the in- herent risk involved. Frequent transfers based on short-term expectations may increase the risk that a transfer will be made at an inopportune time. TRANSFERS TO AND FROM THE GENERAL ACCOUNT ON OR BEFORE THE ANNUITY COMMENCEMENT DATE You may transfer all or any part of the contract value from the subaccount(s) to the fixed side of the contract. These transfers cannot be elected more than six times every contract year. We reserve the right to waive this six-time lim- it. The minimum amount which can be transferred to the fixed side is $300 or the total 13 amount in the subaccount, if less than $300. However, if a transfer from a subaccount would leave you with less than $300 in the subaccount, we may transfer the total amount to the fixed side. You may also transfer all or any part of the contract value from the fixed side of your contract to the various subaccount(s) subject to the following restrictions: (1) the sum of the percentages of fixed value transferred is limited to 25% of the value of the fixed side in any 12 month period; (2) the minimum amount which can be transferred is $300 or the amount in the fixed ac- count; and (3) a transfer cannot be made during the first 30 days after the issue date of the contract. These transfers cannot be elected more than six times every contract year. We reserve the right to waive these restrictions. These restrictions do not apply to transfers made under a dollar cost averaging or cross-reinvestment program elected on forms available from us. TRANSFERS AFTER THE ANNUITY COMMENCEMENT DATE You may transfer all or a portion of your investment in one subaccount to an- other subaccount or to the fixed side of the contract. Those transfers will be limited to three times per contract year. However, no transfers are allowed from the fixed side of the contract to the subaccounts. DEATH BENEFIT BEFORE THE ANNUITY COMMENCEMENT DATE You may designate a beneficiary during the life of the annuitant and change the beneficiary by filing a written request with the home office. Each change of beneficiary revokes any previous designation. We reserve the right to re- quest that you send us the contract for endorsement of a change of beneficia- ry. If the annuitant dies before the annuity commencement date, a death benefit equal to the greater of: (1) the GMDB or, if elected, the EGMDB; or (2) the current value of the contract, will be paid to your designated beneficiary. The value of the death benefit will be determined as of the date on which the death claim is approved for payment. This payment will occur upon receipt of: (1) Proof, satisfactory to us, of the death of the annuitant; (2) Written au- thorization for payment; and (3) Our receipt of all required claim forms, fully completed. The GMDB is equal to the sum of all purchase payments plus any attributable gain, minus any withdrawals, partial annuitizations and premium taxes in- curred. We determine the attributable gain separately for each contract year on its seventh anniversary (once its surrender charge period has expired). The attributable gain consists of the earnings on a contract year's net purchase payment(s) [purchase payment(s) minus any withdrawals and partial annuitizations, applied on a first-in-first-out basis] as of the valuation date just before its seventh anniversary. This amount will then be included in the GMDB calculation. If contract conditions are met, the GMDB will be increased automatically by us according to the prescribed formula based upon the contract's internal rate of return. For this to occur, the annuitant, as of the seventh anniversary of each eligible contract year, must still be living and must be less than 81 years of age. For more information about GMDB calculations, please refer to the SAI. The EGMDB is an alternative to the GMDB for owners of nonqualified contracts or contracts used under an IRA plan. Under the EGMDB, the death benefit pay- able is the amount equal to the greater of: (1) contract value as of the day on which Lincoln Life approves the payment of the claim; or (2) the highest contract value which the contract attains on any policy anniversary date (in- cluding the inception date) from the time the EGMDB takes effect up to and in- cluding the annuitant's age up to and including 75. The highest contract value so determined is then increased by purchase payments and decreased by partial withdrawals, partial annuitizations and any premium taxes made, effected or incurred subsequent to the anniversary date on which the highest contract value is obtained. You can elect the EGMDB during a limited period ending six months after the benefit is approved in your state or ending December 31, 1997, whichever is later. Please see your investment dealer for assistance. If you elect the EGMDB during this limited period, the benefit will take ef- fect as of the valuation time on the next policy anniversary date following our receipt of the election of this benefit, and we will begin deducting the charge for the EGMDB as of that date. If we receive an election for this bene- fit on a policy anniversary date, the EGMDB will take effect and we will begin deducting the charge for the benefit at the valuation time on that date. If you elect the EGMDB, you may discontinue the benefit at any time by sending a written request to Lincoln Life. The benefit will be discontinued effective at the valuation time on the next policy anniversary date after we receive the request, and we will cease deducting the charge for the benefit as of that date. If the benefit is discontinued on the policy anniversary date, the bene- fit and the charge will terminate at the valuation time on that date. If you discontinue the benefit, it cannot be reinstated. If you do not elect the EGMDB or you discontinue the benefit after electing it, the GMDB will apply instead and will determine what death benefit is payable. If the death benefit becomes payable, the beneficiary may elect to receive payment either in the form of a lump-sum settlement or an annuity payout. Fed- eral tax law requires that an annuity election be made no later than 60 days after we receive satisfactory notice of death as discussed previously. If a lump-sum settlement is requested, the proceeds will be mailed within seven days of receipt of satisfactory claim documentation as discussed previ- ously, sub- 14 ject to the laws and regulations governing payment of death benefits. If an election has not been made by the end of the 60-day period, a lump-sum settle- ment will be made to the beneficiary at that time. This payment may be post- poned as permitted by the 1940 Act. Payment will be made in accordance with applicable laws and regulations gov- erning payment of death benefits. Unless otherwise provided in the beneficiary designation, one of the following procedures will take place on the death of a beneficiary: 1. If any beneficiary dies before the annuitant, that beneficiary's interest will go to any other beneficiaries named, according to their respective in- terests (There are no restrictions on the beneficiary's use of the pro- ceeds.); and/or 2. If no beneficiary survives the annuitant, the proceeds will be paid to the contractowner or to his/her estate, as applicable. JOINT/CONTINGENT OWNERSHIP If a joint owner is named in the application, the joint owners shall be treated as having equal undivided interests in the contract. Either owner, in- dependently of the other, may exercise any ownership rights in this contract. A contingent owner may exercise ownership rights in this contract only after the contractowner dies. DEATH OF CONTRACTOWNER If the contractowner of a nonqualified contract dies before the annuity com- mencement date, then, in compliance with the code, the cash surrender value of the contract will be paid as follows: 1. Upon the death of a non-annuitant contractowner, the cash surrender value shall be paid to any surviving joint or contingent owner(s). If no joint or contingent owner has been named, then the cash surrender value shall be paid to the annuitant named in the contract; and 2. Upon the death of a contractowner, who is also the annuitant, the death will be treated as death of the annuitant and the provisions of this con- tract regarding death of annuitant will control. If the beneficiary is the surviving spouse of the contractowner, the contract may be continued in the name of that spouse as the new contractowner. If the surviving spouse elects to continue the contract, the contract will continue as though no death benefit had been payable. The code requires that any distribution be paid within five years of the death of the contractowner unless the beneficiary begins receiving, within one year of the contractowner's death, the distribution in the form of a life annuity or an annuity for a designated period not exceeding the beneficiary's life ex- pectancy. SURRENDERS AND WITHDRAWALS Before the annuity commencement date, we will allow the surrender of the con- tract or a withdrawal of the contract value upon your written request, subject to the rules discussed below. Surrender or withdrawal rights after the annuity commencement date depend upon the annuity payout option you select. Special restrictions on surrenders/withdrawals apply if your contract is pur- chased as part of a retirement plan of a public school system or 501(c)(3) or- ganization under Section 403(b) of the code. Beginning January 1, 1989, in or- der for a contract to retain its tax-qualified status, Section 403(b) prohib- its a withdrawal from a 403(b) contract of post-1988 contributions (and earn- ings on those contributions) pursuant to a salary reduction agreement. Howev- er, this restriction does not apply if the annuitant (a) attains age 59 1/2, (b) separates from service, (c) dies, (d) becomes totally and permanently dis- abled and/or (e) experiences financial hardship (in which event the income at- tributable to those contributions may not be withdrawn). Pre-1989 contributions and earnings through December 31, 1988, are not subject to the previously stated restriction. Funds transferred to the contract from a 403(b)(7) custodial account will be subject to the restrictions. The contract value available upon surrender/withdrawal is the cash surrender value of the contract at the end of the valuation period during which the written request for surrender/withdrawal is received at the home office. Un- less a request for withdrawal specifies otherwise, withdrawals will be made from all subaccounts within the VAA and from the General Account in the same proportion that the amount of withdrawal bears to the total contract value. The minimum amount which can be withdrawn is $300, and the remaining contract value must be at least $300. Unless prohibited, surrender/withdrawal payments will be mailed within seven days after we receive a valid written request at the home office. The payment may be postponed as permitted by the 1940 Act. There are charges associated with the surrender of a contract or withdrawal of contract value. You may specify whether these charges are deducted from the amount you request to be withdrawn or from the remaining contract value. See Charges and other deductions. The tax consequences of a surrender/withdrawal are discussed later in this booklet. See Federal tax status. Participants in the Texas Optional Retirement Program should refer to Restric- tions under the Texas Optional Retirement Program, later in this Prospectus booklet. If the total contract value is less than $300, and if no purchase payments have been made for at least two years, we reserve the right to terminate the contract. 15 REINVESTMENT PRIVILEGE You may elect to make a reinvestment purchase with any part of the proceeds of a surrender/withdrawal, and we will recredit the surrender/withdrawal charges previously deducted. This election must be made within 30 days of the date of the surrender/withdrawal, and the repurchase must be of a contract covered by this Prospectus. A representation must be made that the proceeds being used to make the purchase have retained their tax-favored status under an arrangement for which the contracts offered by this Prospectus are designed. The number of accumulation units which will be credited when the proceeds are reinvested will be based on the value of the accumulation unit(s) on the next valuation date. This computation will occur following receipt of the proceeds and re- quest for reinvestment at the home office. You may utilize the reinvestment privilege only once. For tax reporting purposes, we will treat a surrender/withdrawal and a subsequent reinvestment purchase as separate trans- actions. You should consult a tax advisor before you request a surrender/withdrawal or subsequent reinvestment purchase. AMENDMENT OF CONTRACT We reserve the right to amend the contract to meet the requirements of the 1940 Act or other applicable federal or state laws or regulations. You will be notified in writing of any changes, modifications or waivers. COMMISSIONS The maximum commission which will be paid to dealers is equal to 4.0% of each purchase payment; plus an annual continuing commission equal to 0.25% of the value of contract purchase payments invested for at least 15 months; plus an annual persistency bonus equal to 0.40% of each contract year's increased GMDB (regardless of whether or not the EGMDB is in effect), paid over a period of eight years. At times, additional sales incentives (up to 0.30% of purchase payments and up to 0.05% of the contract value in the VAA while the EGMDB is in effect) may be provided to dealers maintaining certain sales volume levels. In addition, the equivalent of 4.0% of contract value can be paid to dealers upon annuitization. These commissions are not deducted from purchase payments or contract value; they are paid by us. OWNERSHIP As contractowner, you have all rights under the contract. According to Indiana law, the assets of the VAA are held for the exclusive benefit of all contractowners and their designated beneficiaries. The assets of the VAA are not chargeable with liabilities arising from any other business that we may conduct. Qualified contracts may not be assigned or transferred except as per- mitted by the Employee Retirement Income Security Act (ERISA) of 1974 and upon written notification to us. We assume no responsibility for the validity or effect of any assignment. Consult your tax advisor about the tax consequences of an assignment. CONTRACTOWNER QUESTIONS The obligations to purchasers under the contracts are those of Lincoln Life. Questions about your contract should be directed to us at 1-800-942-5500. ANNUITY PAYOUTS When you apply for a contract, you may select any annuity commencement date permitted by law. (PLEASE NOTE THE FOLLOWING EXCEPTION: Contracts issued under qualified employee pension and profit-sharing trusts [described in Section 401(a) and tax exempt under Section 501(a) of the code] and qualified annuity plans [described in Section 403(a) of the code], including H.R.10 trusts and plans covering self-employed individuals and their employees, provide for an- nuity payouts to start at the date and under the option specified in the plan.) The contract provides optional forms of payouts of annuities (annuity op- tions), each of which is payable on a variable basis, a fixed basis or a com- bination of both. The contract provides that all or part of the contract value may be used to purchase an annuity. You may elect annuity payouts in monthly, quarterly, semiannual or annual in- stallments. If the payouts from any subaccount would be or become less than $50, we have the right to reduce their frequency until the payouts are at least $50 each. Following are explanations of the annuity options available: ANNUITY OPTIONS LIFE ANNUITY. This option offers a periodic payout during the lifetime of the annuitant and ends with the last payout before the death of the annuitant. This option offers the highest periodic payout since there is no guarantee of a minimum number of payouts or provision for a death benefit for beneficia- ries. HOWEVER, THERE IS THE RISK UNDER THIS OPTION THAT THE ANNUITANT WOULD RECEIVE NO PAYOUTS IF HE/SHE DIES BEFORE THE DATE SET FOR THE FIRST PAYOUT; ONLY ONE PAYOUT IF DEATH OCCURS BEFORE THE SECOND SCHEDULED PAYOUT, AND SO ON. LIFE INCOME WITH PAYOUTS GUARANTEED FOR DESIGNATED PERIOD. This option guaran- tees periodic payouts during a designated period, usually 10 or 20 years, and then continues throughout the lifetime of the annuitant. The designated period is selected by the contractowner. JOINT LIFE ANNUITY. This option offers a periodic payout during the joint lifetime of the annuitant and a designated joint annuitant. The payouts con- tinue during the lifetime of the survivor. JOINT LIFE ANNUITY WITH GUARANTEED PERIOD. This option guarantees periodic payouts during a designated period, usually 10 or 20 years, and continues dur- ing the joint lifetime of the annuitant and a designated 16 joint annuitant. The payouts continue during the lifetime of the survivor. The designated period is selected by the contractowner. JOINT-AND-TWO-THIRDS SURVIVOR ANNUITY. This option provides a periodic payout during the joint lifetime of the annuitant and a designated joint annuitant. When one of the joint annuitants dies, the survivor receives two thirds of the periodic payout made when both were alive. UNIT REFUND LIFE ANNUITY. This option offers a periodic payout during the lifetime of the annuitant with the guarantee that upon death a payout will be made of the value of the number of annuity units (see Variable annuity payouts) equal to the excess, if any, of: (a) the total amount applied under this option divided by the annuity unit value for the date payouts begin, di- vided by (b) the annuity units represented by each payout to the annuitant multiplied by the number of payouts paid before death. The value of the number of annuity units is computed on the date the death claim is approved for pay- ment by the home office. GENERAL INFORMATION None of the options listed above currently provide withdrawal features, per- mitting the contractowner to withdraw commuted values as a lump sum payment. Other options, with or without withdrawal features, may be made available by us. Options are only available to the extent they are consistent with the re- quirements of the contract as well as Sections 72(s) and 401(a)(9) of the code, if applicable. The mortality and expense risk charge will be assessed on all variable annuity payouts, including options that may be offered that do not have a life contingency and therefore no mortality risk. The annuity commencement date is usually on or before the annuitant's 85th birthday. You may change the annuity commencement date, change the annuity op- tion or change the allocation of the investment among subaccounts up to 30 days before the scheduled annuity commencement date, upon written notice to the home office. You must give us at least 30 days notice before the date on which you want payouts to begin. If proceeds become available to a beneficiary in a lump sum, the beneficiary may choose any annuity payout option. Unless you select another option, the contract automatically provides for a life annuity with annuity payouts guaranteed for 10 years (on a fixed, vari- able or combination fixed and variable basis, in proportion to the account al- locations at the time of annuitization) except when a joint life payout is re- quired by law. Under any option providing for guaranteed payouts, the number of payouts which remain unpaid at the date of the annuitant's death (or sur- viving annuitant's death in case of a joint life annuity) will be paid to your beneficiary as payouts become due. VARIABLE ANNUITY PAYOUTS Variable annuity payouts will be determined using: 1. The contract value on the annuity commencement date; 2. The annuity tables contained in the contract; 3. The annuity option selected; and 4. The investment performance of the fund(s) selected. To determine the amount of payouts, we make this calculation: 1. Determine the dollar amount of the first periodic payout; then 2. Credit the contract with a fixed number of annuity units equal to the first periodic payout divided by the annuity unit value; and 3. Calculate the value of the annuity units each period thereafter. We assume an investment return of 4% per year, as applied to the applicable mortality table. The amount of each payout after the initial payout will de- pend upon how the underlying fund(s) perform, relative to the 4% assumed rate. There is a more complete explanation of this calculation in the SAI. FEDERAL TAX STATUS This section is a discussion of the Federal income tax rules applicable to the contracts as of the date of this Prospectus. More information is provided in the SAI. THESE DISCUSSIONS AND THOSE IN THE SAI ARE NOT INTENDED AS TAX AD- VICE. This section does not discuss the Federal tax consequences resulting from every possible situation. No attempt has been made to consider any appli- cable state, local or foreign tax law, other than the imposition of any state premium taxes (See Deductions for premium taxes). If you are concerned about the tax implications with respect to the contracts, you should consult a tax advisor. The following discussion is based upon our understanding of the pres- ent Federal income tax laws as they are currently interpreted by the IRS. No representation is made about the likelihood of continuation of the present Federal income tax laws or their current interpretations by the IRS. TAXATION OF NONQUALIFIED CONTRACTS You are generally not taxed on increases in the value of your contract until a distribution occurs. This distribution can be in the form of a lump sum payout received by requesting all or part of the cash surrender value (i.e. surrenders/withdrawals) or as annuity payouts. For this purpose, the assign- ment or pledge of, or the agreement to assign or pledge, any portion of the value of a contract will be treated as a distribution. A transfer of ownership of a contract, or designation of an annuitant (or 17 other beneficiary) who is not also the contractowner, may also result in tax consequences. The taxable portion of a distribution (in the form of a lump sum payout or an annuity) is taxed as ordinary income. For purchase payments made after February 28, 1986, a contractowner who is not a natural person (for ex- ample, a corporation), subject to limited exceptions, will be taxed on any in- crease in the contract's cash value over the investment in the contract during the taxable year, even if no distribution occurs. [See Section 72(u) of the code.] The next discussion applies to contracts owned by natural persons. In the case of a surrender under the contract or withdrawal of contract value, generally amounts received are first treated as taxable income to the extent that the cash value of the contract immediately before the surrender exceeds the investment in the contract at that time. Any additional amount withdrawn is not taxable. The investment in the contract generally equals the portion, if any, of any purchase payment paid by or on behalf of an individual under a contract which is not excluded from the individual's gross income. Even though the tax consequences may vary depending on the form of annuity payout selected under the contract, the contractowner of an annuity payout generally is taxed on the portion of such payout that exceeds the investment in the contract. For variable annuity payouts, the taxable portion is deter- mined by a formula that establishes a specific dollar amount of each payout that is not taxed. The dollar amount is determined by dividing the investment in the contract by the total number of expected periodic payouts. For fixed annuity payouts, there generally is no tax on the portion of each payout that represents the same ratio that the investment in the contract bears to the to- tal expected value of payouts for the term of the annuity; the remainder of each payout is taxable. For individuals whose annuity starting date is after December 31, 1986, the entire distribution (whether fixed or variable) will be fully taxable once the recipient is deemed to have recovered the dollar amount of the investment in the contract. There may be imposed a penalty tax on distributions equal to 10% of the amount treated as taxable income. The penalty tax is not imposed in certain circum- stances, which generally are distributions: 1. Received on or after the contractowner attaining age 59 1/2; 2. Made as a result of death or disability of the contractowner; 3. Received in substantially equal periodic payments such as a life annuity (subject to special recapture rules if the series of payouts is subse- quently modified); 4. Under a qualified funding asset in a structured settlement; 5. Under an immediate annuity contract as defined in the code; 6. Under a contract purchased in connection with the termination of certain retirement plans. TAXATION OF QUALIFIED CONTRACTS The contracts may be purchased in connection with the following types of tax- favored retirement plans: 1. Contracts purchased for employees of public school systems and certain tax- exempt organizations, qualified under Section 403(b) of the code (normally for transfers or rollovers only); 2. Pension and profit-sharing plans of self-employed individuals (H.R. 10 or Keogh plans) or corporations, qualified under Section 401(a) or 403(a) of the code; 3. IRAs, qualified under Section 408 of the code; 4. Deferred compensation plans of state or local governments, qualified under Section 457 of the code; and/or 5. SEPs, qualified under Section 408(k) of the code. The tax rules applicable to these plans, including restrictions on contribu- tions and benefits, taxation of distributions and any tax penalties, vary ac- cording to the type of plan and its terms and conditions. Participants under such plans, as well as contractowners, annuitants and beneficiaries, should be aware that the rights of any person to any benefits under such plans may be subject to the terms and conditions of the plans themselves, regardless of the terms and conditions of the contracts. Purchasers of contracts for use with any qualified plan, as well as plan participants, should consult counsel and other advisors as to the suitability of the contracts to their specific needs, and as to applicable code limitations and tax consequences. MULTIPLE CONTRACTS All contracts entered into after October 21, 1988, and issued by the same in- surance company (or its affiliates) to the same contractowner during any cal- endar year will be treated as a single contract for tax purposes. INVESTOR CONTROL The Treasury Department has indicated that guidelines may be issued under which a variable annuity contract will not be treated as an annuity contract for tax purposes if the contractowner has excessive control over the invest- ments underlying the contract. They may consider the number of investment op- tions or the number of transfer opportunities available between options as relevant when determining excessive control. The issuance of those guidelines may require us to impose limitations on your right to control the investment. We do not know whether any such guidelines would have a retroactive effect. Section 817(h) of the code and the related regulations that the Treasury De- partment has adopted require that 18 assets underlying a variable annuity contract be adequately diversified. The regulations provide that a variable annuity contract which does not satisfy the diversification standards will not be treated as an annuity contract, un- less the failure to satisfy the regulations was inadvertent, the failure is corrected, and the contractowner or we pay an amount to the IRS. The amount will be based on the tax that would have been paid by the contractowner if the income, for the period the contract was not diversified, had been received by the contractowner. If the failure to diversify is not corrected in this man- ner, the contractowner of an annuity contract will be deemed to be the owner of the underlying securities and will be taxed on the earnings of his or her account. We believe, under our interpretation of the code and regulations thereunder, that the investments underlying this contract meet these diversi- fication standards. WITHHOLDING Generally, pension and annuity distributions are subject to withholding for the recipient's Federal income tax liability at rates that vary according to the type of distribution and the recipient's tax status. Recipients, however, generally are provided the opportunity to elect not to have tax withheld from distributions. Under the Unemployment Compensation Amendments of 1992 (UCA), 20% income tax withholding may apply to eligible rollover distributions. All taxable distributions from qualified plans (except IRAs) and Section 403(b) annuities are eligible rollover distributions, except (1) annuities paid out over life or life expectancy, (2) installments paid for a period spanning 10 years or more, and (3) required minimum distributions. The UCA imposes a man- datory 20% income tax withholding on any eligible rollover distribution that the contractowner does not elect to have paid in a direct rollover to another qualified plan, Section 403(b) annuity or individual retirement account. Dis- tributions from Section 457 plans are subject to the general wage withholding rules. VOTING RIGHTS As required by law, we will vote the series shares held in the VAA at meetings of the shareholders of the series. The voting will be done according to the instructions of contractowners who have interests in any subaccounts which in- vest in funds of the series. If the 1940 Act or any regulation under it should be amended or if present interpretations should change, and if as a result we determine that we are permitted to vote the series shares in our own right, we may elect to do so. The number of votes which you have the right to cast will be determined by ap- plying your percentage interest in a subaccount to the total number of votes attributable to the subaccount. In determining the number of votes, fractional shares will be recognized. After the annuity commencement date, the votes at- tributable to a contract will decrease. Series shares of a class held in a subaccount for which no timely instructions are received will be voted by us in proportion to the voting instructions which are received for all contracts participating in that subaccount. Voting instructions to abstain on any item to be voted on will be applied on a pro- rata basis to reduce the number of votes eligible to be cast. Whenever a shareholder's meeting is called, each person having a voting inter- est in a subaccount will receive proxy voting material, reports and other ma- terials relating to the series. Since the series engages in shared funding, other persons or entities beside Lincoln Life may vote series shares. See Sale of fund shares by the series. DISTRIBUTION OF THE CONTRACTS American Funds Distributors, Inc. (AFD), 333 South Hope Street, Los Angeles, Ca 90071, is the distributor and principal underwriter of the contracts. They will be sold by properly licensed registered representatives of independent broker-dealers which in turn have selling agreements with AFD and have been licensed by state insurance departments to represent us. AFD is registered with the SEC under the Securities Exchange Act of 1934 as a broker-dealer and is a member of the National Association of Securities Dealers (NASD). Lincoln Life will offer contracts in all states where it is licensed to do business. RETURN PRIVILEGE Within the free-look period after you receive the contract, you may cancel it for any reason by delivering or mailing it postage pre-paid, to the home of- fice at P.O. Box 2348, 1300 South Clinton Street, Fort Wayne, Indiana, 46801. A contract canceled under this provision will be void. With respect to the fixed portion of a contract, we will return purchase payments. With respect to the VAA, except as explained in the following paragraph, we will return the contract value as of the date of receipt of the cancellation, plus any con- tract maintenance and administrative fees and any premium taxes which had been deducted. No contingent deferred sales charge will be assessed. A purchaser who participates in the VAA is subject to the risk of a market loss during the free-look period. For contracts written in those states whose laws require that we assume this market risk during the free-look period, a contract may be canceled, subject to the conditions explained before, except that we will return only the pur- chase payment(s). STATE REGULATION As a life insurance company organized and operated under Indiana law, we are subject to provisions governing 19 life insurers and to regulation by the Indiana Commissioner of Insurance. Our books and accounts are subject to review and examination by the Indiana Insurance Department at all times. A full examination of our operations is conducted by that Department at least every five years. RESTRICTIONS UNDER THE TEXAS OPTIONAL RETIREMENT PROGRAM Title 8, Section 830.105 of the Texas Government Code, consistent with prior interpretations of the Attorney General of the State of Texas, permits partic- ipants in the Texas Optional Retirement Program (ORP) to redeem their interest in a variable annuity contract issued under the ORP only upon: 1. Termination of employment in all institutions of higher education as de- fined in Texas law; 2. Retirement; or 3. Death. Accordingly, participants in the ORP will be required to obtain a certificate of termination from their employer(s) before accounts can be redeemed. STATEMENT OF ADDITIONAL INFORMATION TABLE OF CONTENTS FOR SEPARATE ACCOUNT E
Item - ----------------------------------------- General information and history of Lincoln Life - ----------------------------------------- Special terms - ----------------------------------------- Services - ----------------------------------------- Principal underwriter - ----------------------------------------- Purchase of securities being offered - -----------------------------------------
For a free copy of the SAI please see page one of this booklet. RECORDS AND REPORTS As presently required by the 1940 Act and applicable regulations, we are re- sponsible for maintaining all records and accounts relating to the VAA. We have entered into an agreement with the Delaware Management Company, 2005 Mar- ket Street, Philadelphia, PA 19203, to provide accounting services, to the VAA. We will mail to you, at your last known address of record at the home of- fice, at least semiannually after the first contract year, reports containing information required by the 1940 Act or any other applicable law or regula- tion. OTHER INFORMATION A Registration Statement has been filed with the SEC, under the Securities Act of 1933 as amended, for the contracts being offered here. This Prospectus does not contain all the information in the Registration Statement, its amendments and exhibits. Please refer to the Registration Statement for further informa- tion about the VAA, Lincoln Life and the contracts offered. Statements in this Prospectus about the content of contracts and other legal instruments are summaries. For the complete text of those con- tracts and instruments, please refer to those documents as filed with the SEC. Lincoln National Variable Annuity Account H and Lincoln National Flexible Pre- mium Variable Life Accounts F, G and J (all registered as investment companies under the 1940 Act) and Lincoln National Flexible Premium Group Variable Annu- ity Accounts 50, 51 and 52 are all segregated investment accounts of Lincoln Life which also invest in the series. The series also offers shares of the funds to other segregated investment accounts.
Item - ------------------------------------------------- Annuity payouts - ------------------------------------------------- Federal tax status - ------------------------------------------------- Automatic increase in the guaranteed minimum death benefit - ------------------------------------------------- Financial statements - -------------------------------------------------
20 THE AMERICAN LEGACY LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E (REGISTRANT) LINCOLN NATIONAL LIFE INSURANCE CO. (DEPOSITOR) STATEMENT OF ADDITIONAL INFORMATION (SAI) This SAI should be read in conjunction with the Prospectus of Lincoln National Variable Annuity Account E dated April 30, 1997. You may obtain a copy of the Account E Prospectus on request and without charge. Please write American Leg- acy Customer Service, Lincoln National Life Insurance Co., P.O. Box 2348, Fort Wayne, Indiana 46801 or call 1-800-942-5500. TABLE OF CONTENTS
Page - ------------------------------------------ GENERAL INFORMATION AND HISTORY OF LINCOLN LIFE B-2 - ------------------------------------------ SPECIAL TERMS B-2 - ------------------------------------------ SERVICES B-2 - ------------------------------------------ PRINCIPAL UNDERWRITER B-2 - ------------------------------------------ PURCHASE OF SECURITIES BEING OFFERED B-2 - ------------------------------------------
Page - ANNUITY PAYOUTS B-2 - FEDERAL TAX STATUS B-3 - AUTOMATIC INCREASE IN THE GUARANTEED MINIMUM DEATH BENEFIT B-6 - FINANCIAL STATEMENTS B-6 -
THIS SAI IS NOT A PROSPECTUS. SPECIAL NOTICE TO CONTRACTOWNERS ABOUT THIS YEAR'S LINCOLN LIFE FINANCIAL STATEMENTS. Each year Lincoln Life is required by law to prepare financial statements for different purposes. Two of the most important purposes are fil- ing with state insurance departments and for inclusion in the securities regis- tration statements for our variable products, like this one. In the past we have interpreted the prevailing regulations as requiring presentation of these statements according to two different sets of accounting principles--one for the insurance regulators (known as Statutory Accounting Principles, or STAP) and one for the SEC (known as Generally Accepted Accounting Principles, or GAAP). When we create two sets of financial statements for the same insurer it re- quires nearly double the time commitment of our internal accounting staff, and two separate audits by our independent auditors. In an effort to control costs and eliminate duplication of effort, we have reviewed the SEC's requirements for the mode of presentation of the insurer's financial statements in this reg- istration statement. As a result of our review, and on advice of counsel, we shall now begin to use the STAP-basis statements (which we call Statutory Statements) exclusively, both for the insurance regulators and for our securi- ties registration statements. We believe that both Statutory and GAAP statements fairly present the financial position of Lincoln Life for the periods indicated, in accordance with those respective accounting principles. However, between the two there are some im- portant differences in accounting theory and financial statement presentation. FOR THAT REASON, IN THIS TRANSITION YEAR WE INCLUDE HERE BOTH STATUTORY AND GAAP STATEMENTS. This should permit you to evaluate the financial position of Lincoln Life from both points of view, and should help you understand the dif- ferences between Statutory and GAAP statements. BEGINNING NEXT YEAR WE SHALL PRESENT ONLY THE STATUTORY STATEMENTS. The date of this SAI is April 30, 1997. GENERAL INFORMATION AND HISTORY OF LINCOLN NATIONAL LIFE INSURANCE CO. (LINCOLN LIFE) The prior Depositor of the Account, Lincoln National Pension Insurance Compa- ny, was merged into Lincoln Life, effective January 1, 1989. Lincoln Life, or- ganized in 1905, is an Indiana stock insurance corporation, engaged primarily in the direct issuance of annuities and life and health insurance contracts, and is also a professional reinsurer. Lincoln Life is wholly owned by Lincoln National Corporation (LNC), a publicly held insurance holding company domi- ciled in Indiana. SPECIAL TERMS The special terms used in this SAI are the ones defined in the Prospectus. In connection with the term, valuation date, the NYSE is currently closed on weekends and on these holidays: New Year's Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. If any of these holidays occurs on a weekend day, the Exchange may also be closed on the business day occurring just before or just after the holiday. SERVICES INDEPENDENT AUDITORS The financial statements of the variable annuity account (VAA) and the finan- cial statements and schedules of Lincoln Life appearing in this SAI and regis- tration statement have been audited by Ernst & Young LLP, independent audi- tors, as set forth in their reports which also appear elsewhere in this docu- ment and in the Registration Statement. The financial statements and schedules audited by Ernst & Young, LLP have been included in this document in reliance on their report given on their authority as experts in accounting and audit- ing. KEEPER OF RECORDS All accounts, books, records and other documents which are required to be maintained for the VAA are maintained by Lincoln Life or by third parties re- sponsible to Lincoln Life. We have entered into an agreement with the Delaware Management Company, 2005 Market Street, Philadelphia, PA 19203, to provide accounting services to the VAA. No separate charge against the assets of the VAA is made by Lincoln Life for this service. PRINCIPAL UNDERWRITER Lincoln Life has contracted with American Funds Distributors, Inc. (AFD), 333 South Hope St., Los Angeles, California 90071, a licensed broker-dealer, to distribute the contracts through certain legally authorized sales persons and organizations (brokers). AFD and its brokers are compensated under a standard compensation schedule. PURCHASE OF SECURITIES BEING OFFERED The contracts are no longer being offered. Although there are no special pur- chase plans for any class of prospectus buyers, the contingent deferred sales charge normally assessed upon surrender or withdrawal of contract value will be waived for officers, directors or bona fide full time employees of the LNC, the Capital Group, Inc., their affiliated or managed companies and certain other persons. See Contingent deferred sales charges in the Prospectus. Both before and after the annuity commencement date, there are exchange privi- leges between subaccounts, and from the VAA to the General Account, subject to restrictions set out in the Prospectus. See The contracts, in the Prospectus. No exchanges are permitted between the VAA and other separate accounts. ANNUITY PAYOUTS VARIABLE ANNUITY PAYOUTS Variable annuity payouts will be determined on the basis of: (1) the dollar value of the contract before the annuity commencement date; (2) the annuity tables contained in the contract; (3) the type of annuity option selected; and (4) the investment results of the fund(s) selected. In order to determine the amount of variable annuity payouts, Lincoln Life makes the following calcula- tion: first, it determines the dollar amount of the first payout; second, it credits the contract with a fixed number of annuity units based on the amount of the first payout; and third, it calculates the value of the annuity units each period thereafter. These steps are explained as follows. The dollar amount of the first periodic variable annuity payout is determined by applying the total value of the accumulation units credited under the con- tract valued as of the annuity commencement date (less any premium taxes) to the annuity tables contained in the contract. The first variable annuity pay- out will be paid 14 days after the annuity commencement date. This day of the month will become the day on which all future annuity payouts will be paid. Amounts shown in the tables are based on B-2 the 1971 Individual Annuity Mortality Tables, modified, with an assumed invest- ment return at the rate of 4% per annum. The first annuity payout is determined by multiplying the benefit per $1,000 of value shown in the contract tables by the number of thousands of dollars of value accumulated under the contract. These annuity tables vary according to the form of annuity selected and the age of the annuitant at the annuity commencement date. The 4% interest rate stated above is the measuring point for subsequent annuity payouts. If the actual net investment rate (annualized) exceeds 4%, the payout will increase at a rate equal to the amount of such excess. Conversely, if the actual rate is less than 4%, annuity payouts will decrease. If the assumed rate of interest were to be increased, annuity payouts would start at a higher level but would decrease more rapidly or increase more slowly. Lincoln Life may use sex distinct annuity tables in contracts that are not as- sociated with employer sponsored plans and where not prohibited by law. At the annuity commencement date, the contract is credited with annuity units for each subaccount on which variable annuity payouts are based. The number of annuity units to be credited is determined by dividing the amount of the first periodic payout by the value of an annuity unit in each subaccount selected. Although the number of annuity units is fixed by this process, the value of such units will vary with the value of the underlying fund. The amount of the second and subsequent annuity payouts is determined by multiplying the contractowner's fixed number of annuity units in each subaccount by the appro- priate annuity unit value for the valuation date ending 14 days before the date that payout is due. The value of each subaccount's annuity unit will be set initially at $1.00. The annuity unit value for each subaccount at the end of any valuation date is de- termined by multiplying the subaccount annuity unit value for the immediately preceding valuation date by the product of: a. The net investment factor of the subaccount for the valuation period for which the annuity unit value is being determined, and b. A factor to neutralize the assumed investment return in the annuity table. The value of the annuity units is determined as of a valuation date 14 days be- fore the payout date in order to permit calculation of amounts of annuity payouts and mailing of checks in advance of their due dates. Such checks will normally be issued and mailed at least three days before the due date. PROOF OF AGE, SEX AND SURVIVAL Lincoln Life may require proof of age, sex or survival of any payee upon whose age, sex or survival payouts depend. FEDERAL TAX STATUS GENERAL The operations of the VAA form a part of, and are taxed with, the operations of Lincoln Life under the Internal Revenue Code of 1986, as amended (the code). Investment income and realized net capital gains on the assets of the VAA are reinvested and taken into account in determining the accumulation and annuity unit values. As a result, such investment income and realized net capital gain are automatically retained as part of the reserves under the contract. Under existing federal income tax law, Lincoln Life believes that the VAA investment income and realized net capital gain are not taxed to the extent they are re- tained as part of the reserves under the contract. Accordingly, Lincoln Life does not anticipate that it will incur any federal income tax liability attrib- utable to the VAA, and therefore it does not intend to make any provision for such taxes. However, if changes in the federal tax laws or interpretations thereof result in Lincoln Life's being taxed on income or gain attributable to the VAA, then Lincoln Life may impose a charge against the VAA (with respect to some or all contracts) in order to make provision for payment of such taxes. TAX STATUS OF NONQUALIFIED CONTRACTS Section 817(h) of the code provides that separate account investments (or the investments of a mutual fund the shares of which are owned by separate accounts of insurance companies) underlying the contract be adequately diversified in accordance with Treasury regulations in order for the contract to qualify as an annuity contract under Section 72 of the code. The VAA, through each of the funds, intends to comply with the diversification requirements prescribed in regulations, which affect how the assets in each of the funds in which the VAA invests may be invested. Capital Research and Management Company is not affili- ated with Lincoln Life and Lincoln Life does not have control over the series or its investments. However, Lincoln Life believes that each fund in which the VAA owns shares will meet the diversification requirements and that therefore the contracts will be treated as annuities under the code. The regulations relating to diversification requirements do not provide guid- ance concerning the extent to which contractowners may direct their investments to particular subaccounts of a separate account. When guidance is provided, the contract may need to be modified to comply with that guidance. For these rea- sons, Lincoln Life reserves the right to modify the contract as necessary to prevent the contractowner from being considered the owner of the assets of the VAA. In addition, Section 72(s) of the code provides that contracts issued after January 18, 1995, will not be treated B-3 as annuity contracts for purposes of Section 72 unless the contract provides that (1) if any contractowner dies on or after the annuity starting date be- fore the time the entire interest in the contract has been distributed, the remaining portion of such interest must be distributed at least as rapidly as under the method of distribution in effect at the time of the contractowner's death; and (2) if any contractowner dies before the annuity starting date, the entire interest must be distributed within five years after the death of the contractowner. These requirements are considered satisfied if any portion of the contractowner's interest that is payable to or for the benefit of a desig- nated beneficiary is distributed over that designated beneficiary's life, or a period not extending beyond the designated beneficiary's life expectancy, and if that distribution begins within one year of the contractowner's death. The designated beneficiary must be a natural person. However, the contract may be continued in the name of the contractowner's surviving spouse as the contractowner. Contracts issued after January 18, 1995, contain provisions in- tended to comply with these code requirements. No regulations interpreting these requirements have yet been issued. Thus, no assurance can be given that the provisions contained in contracts issued after January 18, 1995 satisfy all such code requirements. However, Lincoln Life believes that such provi- sions in such contracts meet these requirements. Lincoln Life intends to re- view such provisions and modify them as necessary to assure that they comply with the requirements of Section 72(s) when clarified by regulation or other- wise. TAX STATUS OF CONTRACTS USED WITH CERTAIN PLANS The rules governing the tax treatment of contributions and distributions under qualified plans, as set forth in the code and applicable rulings and regula- tions, are complex and subject to change. These rules also vary according to the type of plan and the terms and conditions of the plan itself. Therefore, no attempt is made herein to provide more than general information about the use of contracts with the various types of plans, based on Lincoln Life's un- derstanding of the current federal tax laws as interpreted by the IRS. Pur- chasers of contracts for use with such a plan and plan participants should consult counsel and other competent advisors as to the suitability of the plan and the contract to their specific needs, and as to applicable code limita- tions and tax consequences. Participants under such plans, as well as contractowners, annuitants and beneficiaries, should also be aware that the rights of any person to any benefits under such plans may be subject to the terms and conditions of the plans themselves regardless of the terms and con- ditions of the contract. Following are brief descriptions of the various types of plans and of the use of contracts in connection therewith. PUBLIC SCHOOL SYSTEMS AND 501(C)(3) ORGANIZATIONS [SECTION 403(B) PLANS] Payments made to purchase annuity contracts by public school systems or 501(c)(3) organizations for their employees are excludable from the gross in- come of the employee to the extent that aggregate payments for the employee do not exceed the exclusion allowance provided by Section 403(b) of the code, the over-all limits for excludable contributions of Section 415 of the code or the limit on elective contributions. Furthermore, the investment results of the fund credited to the account are not taxable until benefits are received ei- ther in the form of annuity payments, in a single sum, or a withdrawal. If an employee's individual account is surrendered, usually the full amount received would be includable in income for that year at ordinary rates. QUALIFIED CORPORATE EMPLOYEE'S PENSION AND PROFIT-SHARING TRUSTS AND QUALIFIED ANNUITY PLANS Payments made by a corporate employer and the increments on all payments for qualified corporate plans are not taxable as income to the employee until dis- tributed. However, the employee may be required to include these amounts in gross income before distribution if the qualified plan or trust loses its qualification. Corporate plans qualified under Section 401(a) or 403(a) of the code are subject to extensive rules, including limitations on maximum contri- butions or benefits. For plan years beginning after December 31, 1996, tax ex- empt organizations, except state and local governments, may have 401(k) plans. Distributions of amounts in excess of nondeductible employee contributions are generally taxable as ordinary income. If an employee or beneficiary receives a lump-sum distribution, that is, if the employee or beneficiary receives in a single tax year the total amounts payable with respect to that employee, and the benefits are paid as a result of the employee's death or separation from service or after the employee attains 59 1/2, taxable gain may be eligible for special lump sum averaging treatment. These special tax rules are not avail- able in all cases. SELF-EMPLOYED INDIVIDUALS (H.R. 10 OR KEOGH) Under code provisions, self-employed individuals may establish plans commonly known as H.R. 10 or Keogh plans for themselves and their employees. The tax consequences to participants under such plans depend upon the plan itself. Such plans are subject to special B-4 rules in addition to those applicable to qualified corporate plans, although certain of these rules have been repealed or modified effective in 1984. Pur- chasers of the contracts for use with H.R. 10 plans should seek competent ad- vice as to suitability of plan documents and the funding contracts. INDIVIDUAL RETIREMENT ANNUITIES (IRA) Under Section 408 of the code, individuals may participate in a retirement program known as individual retirement annuity (IRA). An individual may make an annual IRA contribution of up to the lesser of $2,000 (or $4,000 if IRAs are maintained for both the individual and his nonworking spouse) or 100% of compensation. However, IRA contributions may be nondeductible in whole or in part if (1) the individual or his spouse is an active participant in certain other retirement programs and (2) the income of the individual (or of the in- dividual and his spouse) exceeds a specified amount. Distributions from cer- tain other IRA plans or qualified plans may be rolled over to an IRA on a tax deferred basis without regard to the limit on contributions, provided certain requirements are met. Distributions from IRA's are subject to certain restric- tions. Deductible IRA contributions and all IRA earnings will be taxed as or- dinary income when distributed. The failure to satisfy certain code require- ments with respect to an IRA may result in adverse tax consequences. DEFERRED COMPENSATION PLANS (SECTION 457 PLANS) Under the code provisions, employees and independent contractors (partici- pants) performing services for state and local governments and tax-exempt or- ganizations may establish deferred compensation plans. While participants in such plans may be permitted to specify the form of investment in which their plan accounts will participate, all such investments are owned by the sponsor- ing employer and are subject to the claims of its creditors. Plans of state or local governments established on August 20, 1996, or later, must hold all as- sets and income in trust (or custodial accounts or an annuity contract) for the exclusive benefit of participants and their beneficiaries. Section 457 plans that were in existence before August 20, 1996 are allowed until January 1, 1999 to meet this requirement. The amounts deferred under a plan which meet the requirements of Section 457 of the code are not taxable as income to the participant until paid or otherwise made available to the participant or bene- ficiary. Deferrals are taxed as compensation from the employer when they are actually or constructively received by the employee. As a general rule, the maximum amount which can be deferred in any one year is the lesser of $7,500 or 33 1/3% of the participant's includable compensation. However, in the lim- ited circumstances, up to $15,000 may be deferred in each of the last three years before retirement. SIMPLIFIED EMPLOYEE PENSION PLANS [SECTION 408(K)] An employer may make contributions on behalf of employees to a simplified em- ployee pension plan (SEP) as provided by Section 408(k) of the code. The con- tributions and distribution dates are limited by the code provisions. All dis- tributions from the plan will be taxed as ordinary income. Any distribution before the employee attains age 59 1/2 (except in the event of death or dis- ability) or the failure to satisfy certain other code requirements may result in adverse tax consequences. For tax years after 1996, salary reductions SEPs (SAR/SEP) may no longer be established. However, SAR/SEPs in existence before January 1, 1997 may continue to receive contributions. TAX ON DISTRIBUTIONS FROM QUALIFIED CONTRACTS The following rules generally apply to distributions from contracts purchased in connection with the plans discussed above, other than 457 Plans. The portion, if any, of any contribution under a contract made by or on behalf of an individual which is not excluded from the employee's gross income (gen- erally, the employee's own nondeductible contributions) constitutes his in- vestment in the contract. If a distribution is made in the form of annuity payouts, the employee's investment in the contract (adjusted for certain re- fund provisions) divided by his life expectancy (or other period for which an- nuity payouts are expected to be made) constitutes a tax-free return of capi- tal each year. The dollar amount of annuity payouts received in any year in excess of such return is taxable as ordinary income. However, for employees whose annuity starting date is after December 31, 1986, all distributions will be fully taxable once the employee is deemed to have recovered the dollar amount of his investment in the contract. Notwithstanding the above, if the employee's annuity starting date was on or before July 1, 1986 and if his in- vestment in the contract will be recovered within three years of his annuity starting date, no amount is included in income until he has fully recovered such investment. For amounts distributed after 1986, new rules generally pro- vide that all distributions which are not received as an annuity will be taxed as a pro rata distribution of taxable and nontaxable amounts (rather than as a distribution first of nontaxable amounts). If a surrender of or withdrawal from the contract is effected and a distribu- tion is made in a single payout, the proceeds may qualify for special lump-sum distribution treatment under certain qualified plans, as discussed previously. Otherwise, the amount by which the payout exceeds the investment in the con- tract (adjusted for any prior withdrawals) allocated to that payout, if any, will be taxed as ordinary income in the year of receipt. B-5 Distributions from qualified plans, 403(b) plans and IRAs will be subject to (1) a 10% penalty tax if made before age 59 1/2 unless certain other excep- tions apply, and (2) except during 1997, 1998, and 1999, a 15% penalty tax on combined annual distributions in excess of $150,000 (as indexed), subject to various special rules. Failure to meet certain minimum distribution require- ments for the above plans, as well as for Section 457 plans, will result in a 50% excise tax. Various other adverse tax consequences may also be potentially applicable in certain circumstances to these types of plans. Upon an annuitant's death, the taxation of benefits payable to his beneficiary generally follow these same principles, subject to a variety of special rules. OTHER CONSIDERATIONS It should be understood that the foregoing comments about the federal tax con- sequences under these contracts are not exhaustive and that special rules are provided with respect to other tax situations not discussed herein. Further, the foregoing discussion does not address any applicable state, local or for- eign tax laws. In recent years, numerous changes have been made in the federal income tax treatment of contracts and retirement plans, which are not fully discussed above. Before an investment is made in any of the above plans, a tax advisor should be consulted. AUTOMATIC INCREASE IN THE GUARANTEED MINIMUM DEATH BENEFIT Subject to the following terms and conditions, once a contract has been in force for a certain period, Lincoln Life will automatically increase the guar- anteed minimum death benefit (GMDB): Lincoln Life will automatically increase the GMDB, separately for each con- tract year's purchase payment(s), effective upon the seventh anniversary of each eligible contract year in which those payments were made (as the contin- gent deferred sales charge expires on those payments). The attributable gain (AG), used to increase the GMDB, will be calculated based on the contract value at the close of business on the last valuation date preceding the seventh anniversary of the contract year for which the in- crease is made. The AG will be the amount which results from allocating the total appreciation in the contract to each contract year's purchase payments adjusted by withdrawals on a first-in-first out (FIFO) basis based on Lincoln Life's internal rate of return (IRR) calculation (as described below). If a single purchase payment was deposited or multiple deposits were made in the first contract year only, then, upon adjustment, the increased GMDB will be the contract value on the seventh contract anniversary. However, if con- tract value is less than net purchase payments, the GMDB will not be adjusted. If purchase payments have been deposited in multiple contract years, then, upon adjustment, the increased GMDB will be the sum of all purchase payments plus any attributable gain, as calculated for each contract year which has reached its seventh anniversary, minus any withdrawals, partial annuitizations and premium taxes incurred. The IRR is the level compound rate of return, calculated by Lincoln Life, at which purchase payments less withdrawals will accumulate to the contract value on the contract anniversary beginning with the seventh anniversary. The appli- cation of the IRR methodology to any particular contract year could allocate gain, if any, in a manner which does not precisely correlate with the con- tract's actual investment experience for a particular contract year or subaccount. The calculation of the IRR assumes all purchase payments and with- drawals occur at the beginning of the contract year in which they were made. Once the IRR has been determined, the gain attributable to each contract year is calculated by applying the IRR to the purchase payments, less any withdraw- als applied on a FIFO basis. FINANCIAL STATEMENTS Financial statements for the VAA and Lincoln Life appear on the following pages. For more information about the financial statements for the company provided in this SAI, please see the cover page of this SAI. B-6 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E STATEMENT OF ASSETS AND LIABILITY DECEMBER 31, 1996
Percent Growth- of net Income Growth assets Combined Account Account - -------------------------------------------------------------------------------- ASSETS Investments in American Variable Insurance Series at net asset value: . Growth-Income Fund-12,446,752 shares at $32.66 per share (cost-$283,664,387) 49.5% $406,510,918 $406,510,918 ------------------------------- . Growth Fund-6,295,349 shares at $39.63 per share (cost- $179,838,168) 30.4 249,484,681 $249,484,681 ------------------------------- . Asset Allocation Fund-746,484 shares at $13.93 per share (cost-$9,657,035) 1.2 10,398,524 ------------------------------- . High-Yield Bond Fund- 3,535,059 shares at $14.39 per share (cost-$47,451,596) 6.2 50,869,501 ------------------------------- . U.S. Government/AAA-Rated Securities Fund-3,596,342 shares at $10.96 per share (cost-$39,358,899) 4.8 39,415,910 ------------------------------- . Cash Management Fund- 1,309,510 shares at $11.03 per share (cost-$14,498,159) 1.8 14,443,897 ------------------------------- . International Fund-3,291,616 shares at $15.09 per share (cost-$45,215,974) 6.0 49,670,482 ------------------------------- . Bond Fund-173,049 shares at $10.17 per share (cost- $1,725,773) 0.2 1,759,909 ------------------------------- ----- ------------ ------------ ------------ TOTAL INVESTMENTS AND TOTAL ASSETS (Cost-$621,409,991) 100.1 822,553,822 406,510,918 249,484,681 - -------------------------------- LIABILITY--Payable to The Lincoln National Life Insurance Company 0.1 879,859 433,442 270,157 - -------------------------------- ----- ------------ ------------ ------------ NET ASSETS 100.0% $821,673,963 $406,077,476 $249,214,524 ===== ============ ============ ============ Net assets are represented by: . Units in accumulation period 158,120,316 90,423,607 ------------------------------- . Annuity reserves units 740,811 418,652 ------------------------------- . Unit value $ 2.556 $ 2.743 ------------------------------- . Value in accumulation period $404,183,830 $248,066,005 ------------------------------- . Annuity reserves 1,893,646 1,148,519 ------------------------------- ------------ ------------ $406,077,476 $249,214,524 ============ ============
See accompanying notes. 7
U.S. Government/ Asset High-Yield AAA-Rated Cash Allocation Bond Securities Management International Bond Account Account Account Account Account Account - ------------------------------------------------------------------------- $10,398,524 $50,869,501 $39,415,910 $14,443,897 $49,670,482 $1,759,909 ----------- ----------- ----------- ----------- ----------- ---------- 10,398,524 50,869,501 39,415,910 14,443,897 49,670,482 1,759,909 10,973 53,986 42,158 15,715 51,642 1,786 ----------- ----------- ----------- ----------- ----------- ---------- $10,387,551 $50,815,515 $39,373,752 $14,428,182 $49,618,840 $1,758,123 =========== =========== =========== =========== =========== ========== 7,142,428 20,689,339 22,582,034 9,516,683 38,228,510 1,681,128 56,316 78,040 69,610 88,311 122,802 $ 1.443 $ 2.447 $ 1.738 $ 1.502 $ 1.294 $ 1.046 $10,306,289 $50,624,559 $39,252,754 $14,295,525 $49,459,959 $1,758,123 81,262 190,956 120,998 132,657 158,881 ----------- ----------- ----------- ----------- ----------- ---------- $10,387,551 $50,815,515 $39,373,752 $14,428,182 $49,618,840 $1,758,123 =========== =========== =========== =========== =========== ==========
8 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E Statement of operations YEAR ENDED DECEMBER 31, 1996
Growth- Asset Income Growth Allocation Combined Account Account Account - -------------------------------------------------------------------------------- Net Investment Income: .Dividends from investment income $ 19,716,480 $ 8,571,709 $ 1,496,317 $ 335,744 - --------------------------- .Dividends from net realized gains on investments 49,785,004 29,380,575 17,775,320 671,389 - --------------------------- .Mortality and expense guarantees (10,027,910) (4,890,859) (3,103,832) (109,329) - --------------------------- ------------ ----------- ----------- ---------- NET INVESTMENT INCOME 59,473,574 33,061,425 16,167,805 897,804 - --------------------------- Net realized and unrealized gain (loss) on investments: .Net realized gain (loss) on investments 29,343,024 14,407,411 13,669,140 183,214 - --------------------------- .Net change in unrealized appreciation or depreciation on investments 15,593,387 14,952,347 (2,339,414) 111,594 - --------------------------- ------------ ----------- ----------- ---------- NET GAIN (LOSS) ON INVESTMENTS 44,936,411 29,359,758 11,329,726 294,808 - --------------------------- ------------ ----------- ----------- ---------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $104,409,985 $62,421,183 $27,497,531 $1,192,612 - --------------------------- ============ =========== =========== ==========
See accompanying notes. B-9
U.S. Government/ High-Yield AAA-Rated Cash Bond Securities Management International Bond Account Account Account Account Account - ----------------------------------------------------------------- $4,540,433 $ 3,192,222 $ 687,412 $ 844,032 $ 48,611 -- -- -- 1,957,720 -- (637,732) (545,379) (185,765) (543,994) (11,020) ---------- ----------- --------- ---------- -------- 3,902,701 2,646,843 501,647 2,257,758 37,591 546,963 196,545 33,734 307,274 (1,257) 1,230,568 (2,286,249) 15,487 3,874,918 34,136 ---------- ----------- --------- ---------- -------- 1,777,531 (2,089,704) 49,221 4,182,192 32,879 ---------- ----------- --------- ---------- -------- $5,680,232 $ 557,139 $ 550,868 $6,439,950 $ 70,470 ========== =========== ========= ========== ========
B-10 Lincoln National Variable Annuity Account E Statements of changes in net assets YEARS ENDED DECEMBER 31, 1996 AND 1995
Growth- Asset Income Growth Allocation Combined Account Account Account - --------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 1995 $648,369,033 $305,800,046 $196,928,380 $ 3,753,419 Changes from operations: . Net investment income 48,606,930 19,503,304 19,708,146 368,386 - -------------------------- . Net realized gain (loss) on investments 16,886,466 7,744,287 8,831,210 56,260 - -------------------------- . Net change in unrealized appreciation or depreciation on investments 108,448,509 65,673,514 31,746,506 792,203 - -------------------------- ------------ ------------ ------------ ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 173,941,905 92,921,105 60,285,862 1,216,849 - -------------------------- Net increase (decrease) from unit transactions (36,424,502) (21,712,701) (6,950,539) 1,643,517 - -------------------------- ------------ ------------ ------------ ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 137,517,403 71,208,404 53,335,323 2,860,366 - -------------------------- ------------ ------------ ------------ ----------- NET ASSETS AT DECEMBER 31, 1995 785,886,436 377,008,450 250,263,703 6,613,785 - -------------------------- Changes from operations: . Net investment income 59,473,574 33,061,425 16,167,805 897,804 - -------------------------- . Net realized gain (loss) on investments 29,343,024 14,407,411 13,669,140 183,214 - -------------------------- . Net change in unrealized appreciation or depreciation on investments 15,593,387 14,952,347 (2,339,414) 111,594 - -------------------------- ------------ ------------ ------------ ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 104,409,985 62,421,183 27,497,531 1,192,612 - -------------------------- Net increase (decrease) from unit transactions (68,622,458) (33,352,157) (28,546,710) 2,581,154 - -------------------------- ------------ ------------ ------------ ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 35,787,527 29,069,026 (1,049,179) 3,773,766 - -------------------------- ------------ ------------ ------------ ----------- NET ASSETS AT DECEMBER 31, 1996 $821,673,963 $406,077,476 $249,214,524 $10,387,551 - -------------------------- ============ ============ ============ ===========
See accompanying notes. B-11
U.S. Government/ High-Yield AAA-Rated Cash Bond Securities Management International Bond Account Account Account Account Account - ---------------------------------------------------------------------- $47,422,084 $46,699,048 $19,932,319 $27,833,737 -- 4,204,576 2,935,858 768,596 1,118,064 -- 113,481 207,403 61,583 (127,758) -- 4,891,023 3,176,299 (89,864) 2,258,828 -- ----------- ----------- ----------- ----------- ---------- 9,209,080 6,319,560 740,315 3,249,134 -- (4,308,160) (3,328,157) (5,901,188) 4,132,726 -- ----------- ----------- ----------- ----------- ---------- 4,900,920 2,991,403 (5,160,873) 7,381,860 -- ----------- ----------- ----------- ----------- ---------- 52,323,004 49,690,451 14,771,446 35,215,597 -- 3,902,701 2,646,843 501,647 2,257,758 $ 37,591 546,963 196,545 33,734 307,274 (1,257) 1,230,568 (2,286,249) 15,487 3,874,918 34,136 ----------- ----------- ----------- ----------- ---------- 5,680,232 557,139 550,868 6,439,950 70,470 (7,187,721) (10,873,838) (894,132) 7,963,293 1,687,653 ----------- ----------- ----------- ----------- ---------- (1,507,489) (10,316,699) (343,264) 14,403,243 1,758,123 ----------- ----------- ----------- ----------- ---------- $50,815,515 $39,373,752 $14,428,182 $49,618,840 $1,758,123 =========== =========== =========== =========== ==========
B-12 [THIS PAGE INTENTIONALLY LEFT BLANK] B-13 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E NOTES TO FINANCIAL STATEMENTS 1. ACCOUNTING POLICIES THE ACCOUNT: Lincoln National Variable Annuity Account E (the Variable Ac- count) is a segregated investment account of The Lincoln National Life Insur- ance Company (the Company) and is registered under the Investment Company Act of 1940, as amended, as a unit investment trust INVESTMENTS: The Variable Account invests in the American Variable Insurance Series (AVIS) which consists of eight funds: Growth-Income Fund, Growth Fund, Asset Allocation Fund, High-Yield Bond Fund, U.S. Government/AAA-Rated Securi- ties Fund, Cash Management Fund, International Fund, and Bond Fund (the Funds). Investments in the Funds are stated at the closing net asset value per share on December 31, 1996. AVIS is registered as an open-ended management in- vestment company. Investment transactions are accounted for on a trade date basis and dividend income is recorded on the ex-dividend date. The cost of investments sold is determined by the average cost method. DIVIDENDS: Dividends paid to the Variable Account are automatically reinvested in shares of the Funds on the payable date. FEDERAL INCOME TAXES: Operations of the Variable Account form a part of and are taxed with operations of the Company, which is taxed as a "life insurance company" under the Internal Revenue Code. Using current law, no federal income taxes are payable with respect to the Variable Account's net investment income and the net realized gain on investments. ANNUITY RESERVES: Reserves on contracts not involving life contingencies are calculated using an assumed investment rate of 4%. Reserves on contracts in- volving life contingencies are calculated using a modification of the 1971 In- dividual Annuitant Mortality Table and an assumed investment rate of 4%. 2. MORTALITY AND EXPENSE GUARANTEES AND OTHER TRANSACTIONS WITH AFFILIATE Amounts are paid to the Company for mortality and expense guarantees at the rate of .0034247% of the current value of the Variable Account per day (1.25% on an annual basis). In addition, amounts retained by the Company from the proceeds of the sales of annuity contracts for contract charges and surrender charges were as follows during 1996: Growth-Income Account $373,768 - -------------------------------------------- Growth Account 238,383 - -------------------------------------------- Asset Allocation Account 7,127 - -------------------------------------------- High-Yield Bond Account 49,543 - -------------------------------------------- U.S. Government/AAA-Rated Securities Account 46,182 - -------------------------------------------- Cash Management Account 15,386 - -------------------------------------------- International Account 34,337 - -------------------------------------------- Bond Account 1,068 - -------------------------------------------- -------- $765,794 ========
Accordingly, the Company is responsible for all sales, general, and adminis- trative expenses applicable to the Variable Account. B-14 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E NOTES TO FINANCIAL STATEMENTS CONTINUED 3. NET ASSETS Net Assets at December 31, 1996 consisted of the following:
Growth- Asset Income Growth Allocation Combined Account Account Account - ------------------------------------------------------------------------------- Unit Transactions: Accumulation units $273,760,728 $121,491,495 $74,330,674 $7,931,940 - --------------------------- Annuity reserves 1,502,642 750,252 261,421 64,572 - --------------------------- ------------ ------------ ------------ ----------- 275,263,370 122,241,747 74,592,095 7,996,512 Accumulated net investment income 252,517,824 123,426,154 55,795,093 1,423,951 - --------------------------- Accumulated net realized gain (loss) on investments 92,748,938 37,563,044 49,180,823 225,599 - --------------------------- Net unrealized appreciation (depreciation) on investments 201,143,831 122,846,531 69,646,513 741,489 - --------------------------- ------------ ------------ ------------ ----------- $821,673,963 $406,077,476 $249,214,524 $10,387,551 ============ ============ ============ ===========
4. SUMMARY OF CHANGES FROM UNIT TRANSACTIONS
Year Ended December 31 1996 1995 Units Amount Units Amount - ------------------------------------------------------------------------------- GROWTH-INCOME ACCOUNT Accumulation Units: Contract purchases 10,540,136 $24,373,803 10,350,639 $19,179,957 - -------------------------- Terminated contracts and transfers to annuity reserves (24,707,912) (57,905,158) (21,670,603) (40,844,430) - -------------------------- ----------- ----------- ----------- ----------- (14,167,776) (33,531,355) (11,319,964) (21,664,473) Annuity Reserves: Transfers from accumulation units and between accounts 216,750 490,036 88,577 150,159 - -------------------------- Annuity payments (106,398) (214,250) (98,991) (176,847) - -------------------------- Reimbursement of mortality guarantee adjustment (38,281) (96,588) (14,741) (21,540) - -------------------------- ----------- ----------- ----------- ----------- 72,071 179,198 (25,155) (48,228) GROWTH ACCOUNT Accumulation Units: Contract purchases 12,024,738 30,187,898 16,181,841 35,859,071 - -------------------------- Terminated contracts and transfers to annuity reserves (23,311,473) (58,691,504) (19,783,367) (42,659,766) - -------------------------- ----------- ----------- ----------- ----------- (11,286,735) (28,503,606) (3,601,526) (6,800,695) Annuity Reserves: Transfers from accumulation units and between accounts 45,043 118,037 2,485 5,000 - -------------------------- Annuity payments (60,964) (162,288) (65,160) (143,670) - -------------------------- Receipt (reimbursement) of mortality guarantee adjustment 415 1,147 (7,161) (11,174) - -------------------------- ----------- ----------- ----------- ----------- (15,506) (43,104) (69,836) (149,844)
B-15
U.S. Government/ High-Yield AAA-Rated Cash Bond Securities Management International Bond Account Account Account Account Account - -------------------------------------------------------------- $13,055,461 $10,610,043 $ 4,203,228 $40,450,234 $1,687,653 92,804 75,267 110,467 147,859 -- - ----------- ----------- ----------- ----------- ---------- 13,148,265 10,685,310 4,313,695 40,598,093 1,687,653 32,371,380 26,081,011 8,967,799 4,414,845 37,591 1,877,965 2,550,420 1,200,950 151,394 (1,257) 3,417,905 57,011 (54,262) 4,454,508 34,136 - ----------- ----------- ----------- ----------- ---------- $50,815,515 $39,373,752 $14,428,182 $49,618,840 $1,758,123 =========== =========== =========== =========== ==========
B-16 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E NOTES TO FINANCIAL STATEMENTS CONTINUED 4. SUMMARY OF CHANGES FROM UNIT TRANSACTIONS CONTINUED
Year Ended December 31 1996 1995 Units Amount Units Amount - ------------------------------------------------------------------------------- ASSET ALLOCATION ACCOUNT Accumulation Units: Contract purchases 3,807,410 5,011,478 2,443,961 2,707,631 - ----------------------------- Terminated contracts and transfers to annuity reserves (1,832,754) (2,404,180) (1,083,237) (1,154,830) - ----------------------------- ---------- ----------- ---------- ---------- 1,974,656 2,607,298 1,360,724 1,552,801 Annuity Reserves: Transfers from accumulation units and between accounts 8,829 11,835 100,509 123,405 - ----------------------------- Annuity payments (26,398) (37,979) (26,624) (32,689) - ----------------------------- ---------- ----------- ---------- ---------- (17,569) (26,144) 73,885 90,716 HIGH-YIELD BOND ACCOUNT Accumulation Units: Contract purchases 1,860,645 4,292,963 2,410,971 4,632,252 - ----------------------------- Terminated contracts and transfers to annuity reserves (5,038,600) (11,563,870) (4,531,465) (8,875,942) - ----------------------------- ---------- ----------- ---------- ---------- (3,177,955) (7,270,907) (2,120,494) (4,243,690) Annuity Reserves: Transfers from accumulation units and between accounts 64,776 150,749 -- -- - ----------------------------- Annuity payments (23,781) (55,464) (18,239) (36,636) - ----------------------------- Reimbursement of mortality guarantee adjustment (4,983) (12,099) (15,310) (27,834) - ----------------------------- ---------- ----------- ---------- ---------- 36,012 83,186 (33,549) (64,470) U.S. GOVERNMENT/AAA-RATED SECURITIES ACCOUNT Accumulation Units: Contract purchases 2,518,074 4,157,391 3,825,554 5,935,150 - ----------------------------- Terminated contracts and transfers to annuity reserves (8,997,754) (15,068,410) (5,882,054) (9,245,078) - ----------------------------- ---------- ----------- ---------- ---------- (6,479,680) (10,911,019) (2,056,500) (3,309,928) Annuity Reserves: Transfers from accumulation units and between accounts 35,915 61,658 8,141 12,653 - ----------------------------- Annuity payments (11,047) (19,166) (20,620) (32,615) - ----------------------------- Receipt (reimbursement) of mortality guarantee adjustment (3,051) (5,311) 1,063 1,733 - ----------------------------- ---------- ----------- ---------- ---------- 21,817 37,181 (11,416) (18,229)
B-17 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E NOTES TO FINANCIAL STATEMENTS CONTINUED
Year Ended December 31 1996 1995 Units Amount Units Amount - ------------------------------------------------------------------------------- CASH MANAGEMENT ACCOUNT Accumulation Units: Contract purchases 12,030,851 17,751,903 9,800,227 13,417,006 - ------------------------ Terminated contracts and transfers to annuity reserves (12,515,148) (18,474,236) (14,111,045) (19,548,592) - ------------------------ ----------- ------------ ----------- ------------ (484,297) (722,333) (4,310,818) (6,131,586) Annuity Reserves: Transfers from accumulation units and between accounts (79,045) (116,265) 246,973 325,992 - ------------------------ Annuity payments (37,345) (55,673) (87,414) (97,028) - ------------------------ Receipt of mortality guarantee adjustment 92 139 1,022 1,434 - ------------------------ ----------- ------------ ----------- ------------ (116,298) (171,799) 160,581 230,398 INTERNATIONAL ACCOUNT Accumulation Units: Contract purchases 14,756,117 17,417,127 11,574,971 12,049,232 - ------------------------ Terminated contracts and transfers to annuity reserves (8,119,189) (9,595,403) (7,770,768) (7,916,260) - ------------------------ ----------- ------------ ----------- ------------ 6,636,928 7,821,724 3,804,203 4,132,972 Annuity Reserves: Transfers from accumulation units and between accounts 143,251 166,145 -- -- - ------------------------ Annuity payments (25,552) (23,120) (746) (780) - ------------------------ Receipt (reimbursement) of mortality guarantee adjustment (1,171) (1,456) 534 534 - ------------------------ ----------- ------------ ----------- ------------ 116,528 141,569 (212) (246) BOND ACCOUNT Accumulation Units: Contract purchases 1,989,096 2,042,272 -- -- - ------------------------ Terminated contracts and transfers to annuity reserves (307,968) (354,619) -- -- - ------------------------ ----------- ------------ ----------- ------------ 1,681,128 1,687,653 -- -- Annuity Reserves: Transfers from accumulation units and between accounts -- -- -- -- - ------------------------ Annuity payments -- -- -- -- - ------------------------ Receipt (reimbursement) of mortality guarantee adjustment -- -- -- -- - ------------------------ ----------- ------------ ----------- ------------ -- -- -- -- NET DECREASE FROM UNIT TRANSACTIONS ($68,622,458) ($36,424,502) ============ ============
B-18 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E NOTES TO FINANCIAL STATEMENTS CONTINUED 5. PURCHASES AND SALES OF SECURITIES The aggregate cost of investments purchased and the aggregate proceeds from investments sold were as follows for 1996.
Aggregate Aggregate Cost of Proceeds Purchases from Sales - ----------------------------------------------------------------------- Growth-Income Account $ 43,244,884 $ 43,502,552 - -------------------------------------------- Growth Account 33,315,400 45,690,512 - -------------------------------------------- Asset Allocation Account 5,138,494 1,655,512 - -------------------------------------------- High-Yield Bond Account 6,630,147 9,916,395 - -------------------------------------------- U.S. Government/AAA-Rated Securities Account 5,829,459 14,066,769 - -------------------------------------------- Cash Management Account 14,560,605 14,953,101 - -------------------------------------------- International Account 14,295,926 4,059,930 - -------------------------------------------- Bond Account 1,933,861 206,831 - -------------------------------------------- ------------ ------------ $124,948,776 $134,051,602 ============ ============
6. NEW INVESTMENT FUND Effective January 1, 1996, the AVIS Bond Fund became available as an investment option for Variable Account contract owners. 7. DAILY VALUATION CALCULATIONS Effective October 1996, the daily unit value calculation process was transferred from the Company to the Delaware Group, an affiliate of the Company. Costs associated with the calculation of the unit value are paid by the Company. B-19 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Board of Directors of The Lincoln National Life Insurance Company and Contract Owners of Lincoln National Variable Annuity Account E We have audited the accompanying statement of assets and liability of Lincoln National Variable Annuity Account E (Variable Account) as of December 31, 1996, and the related statement of operations for the year then ended, and the state- ments of changes in net assets for each of the two years in the period then ended. These financial statements are the responsibility of the Variable Ac- count's management. Our responsibility is to express an opinion on these finan- cial statements based on our audits. We conducted our audits in accordance with generally accepted auditing stan- dards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of mate- rial misstatement. An audit includes examining, on a test basis, evidence sup- porting the amounts and disclosures in the financial statements. Our procedures included confirmation of securities owned as of December 31, 1996, by corre- spondence with the custodian. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evalu- ating 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 financial position of Lincoln National Variable An- nuity Account E at December 31, 1996, the results of its operations for the year then ended, and the changes in its net assets for each of the two years in the period then ended in conformity with generally accepted accounting princi- ples. Fort Wayne, Indiana March 18, 1997 B-20 LINCOLN NATIONAL LIFE INSURANCE CO. AUDITED FINANCIAL STATEMENTS Prior to 1996, management of The Lincoln National Life Insurance Company (Company) prepared annual financial statements of the Company using two different types of accounting principles. Pursuant to insurance regulatory requirements in several states, management prepared financial statements in accordance with statutory accounting principles (STAP), which were subject to audit by the Company's independent auditors. Additionally, solely for purposes of inclusion in the registration statements of separate account products requiring registration and periodic reporting to the Securities and Exchange Commission (SEC), management also prepared financial statements of the Company in accordance with generally accepted accounting principles (GAAP), which were also subject to audit. In an attempt to reduce costs associated with the preparation and audits of both GAAP and STAP-bases financial statements, commencing with the registrations in 1997, management will prepare and have audited only STAP-basis financial statements. The STAP-basis financial statements included in this registration statement have been prepared in conformity with accounting practices prescribed or permitted by the Indiana Department of Insurance, which is an "other comprehensive basis of accounting" as that term is defined by the American Institute of Certified Public Accountants (see notes 1 and 2 to the enclosed audited STAP-basis financial statements for information on such prescribed and permitted practices). Because 1996 is the initial year for which STAP-basis financial statements are used for purposes of these separate account product filings with the SEC, management has included the following financial statements of the Company to allow for comparability between years: . Section 1 contains the STAP-basis balance sheets of the Company as of Decem- ber 31, 1996 and 1995 and the related STAP-basis statements of income, changes in capital and surplus, and cash flows for the three years in the pe- riod ended December 31, 1996. . Section 2 contains the GAAP-basis balance sheets of the Company as of Decem- ber 31, 1995 and 1994 and the related consolidated statements of income, shareholder's equity, and cash flows for each of the three years in the pe- riod ended December 31, 1995. G-1 LINCOLN NATIONAL LIFE INSURANCE CO. CONSOLIDATED BALANCE SHEETS
December 31 1995 1994 ----------- ----------- (000's omitted) ----------------------- ASSETS INVESTMENTS: Securities available-for-sale, at fair value: . Fixed maturity (cost: 1995 -- $18,852,837; 1994 -- $18,193,928) $20,414,785 $17,692,214 - ---------------------------------------------------- . Equity (cost: 1995 -- $480,261; 1994 -- $416,351) 598,435 456,333 - ---------------------------------------------------- Mortgage loans on real estate 3,147,783 2,795,914 - ---------------------------------------------------- Real estate 746,023 679,512 - ---------------------------------------------------- Policy loans 565,325 528,731 - ---------------------------------------------------- Other investments 241,219 158,196 - ---------------------------------------------------- ----------- ----------- Total investments 25,713,570 22,310,900 - ---------------------------------------------------- Cash and invested cash 802,743 990,880 - ---------------------------------------------------- Property and equipment 53,830 54,989 - ---------------------------------------------------- Deferred acquisition costs 953,834 1,736,526 - ---------------------------------------------------- Premiums and fees receivable 117,634 123,494 - ---------------------------------------------------- Accrued investment income 352,301 367,370 - ---------------------------------------------------- Assets held in separate accounts 18,461,629 13,000,540 - ---------------------------------------------------- Federal income taxes -- 134,463 - ---------------------------------------------------- Amounts recoverable from reinsurers 2,940,976 2,069,292 - ---------------------------------------------------- Goodwill 5,149 3,385 - ---------------------------------------------------- Other assets 185,398 233,708 - ---------------------------------------------------- ----------- ----------- Total assets $49,587,064 $41,025,547 - ---------------------------------------------------- =========== =========== LIABILITIES AND SHAREHOLDER'S EQUITY LIABILITIES: Policy liabilities and accruals: . Future policy benefits, claims and claims expenses $ 8,435,019 $ 7,540,772 - ---------------------------------------------------- . Unearned premiums 55,174 61,472 - ---------------------------------------------------- ----------- ----------- Total policy liabilities and accruals 8,490,193 7,602,244 - ---------------------------------------------------- Contractholder funds 18,171,822 17,028,628 - ---------------------------------------------------- Liabilities related to separate accounts 18,461,629 13,000,540 - ---------------------------------------------------- Federal income taxes 166,430 -- - ---------------------------------------------------- Short-term debt 124,783 153,656 - ---------------------------------------------------- Long-term debt 40,827 54,794 - ---------------------------------------------------- Other liabilities 1,412,534 1,264,730 - ---------------------------------------------------- ----------- ----------- Total liabilities 46,868,218 39,104,592 - ---------------------------------------------------- SHAREHOLDER'S EQUITY: Common stock, $2.50 par value: . Authorized, issued and outstanding shares -- 10 million (owned by Lincoln National Corp.) 25,000 25,000 - ---------------------------------------------------- Additional paid-in capital 809,557 791,605 - ---------------------------------------------------- Retained earnings 1,440,994 1,428,969 - ---------------------------------------------------- Net unrealized gain (loss) on securities available- for-sale 443,295 (324,619) - ---------------------------------------------------- ----------- ----------- Total shareholder's equity 2,718,846 1,920,955 - ---------------------------------------------------- ----------- ----------- Total liabilities and shareholder's equity $49,587,064 $41,025,547 - ---------------------------------------------------- =========== ===========
See accompanying notes. G-2 LINCOLN NATIONAL LIFE INSURANCE CO. CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31 1995 1994 1993 --------------------------------- (000's omitted) --------------------------------- REVENUE Insurance premiums $ 846,873 $1,099,480 $1,972,630 - ------------------------------------------ Insurance fees 450,423 390,384 425,083 - ------------------------------------------ Net investment income 1,899,630 1,673,981 1,823,459 - ------------------------------------------ Realized gain (loss) on investments 136,195 (138,522) 92,150 - ------------------------------------------ Gain (loss) on sale of affiliates -- 68,954 (98,500) - ------------------------------------------ Other 3,405 20,946 35,781 - ------------------------------------------ ---------- ---------- ---------- Total revenue 3,336,526 3,115,223 4,250,603 - ------------------------------------------ BENEFITS AND EXPENSES Benefits and settlement expenses 2,122,616 2,194,047 3,033,139 - ------------------------------------------ Underwriting, acquisition, insurance and other expenses 764,346 660,363 881,703 - ------------------------------------------ Interest expense 67 615 96 - ------------------------------------------ ---------- ---------- ---------- Total benefits and expenses 2,887,029 2,855,025 3,914,938 - ------------------------------------------ ---------- ---------- ---------- Income before federal income taxes and cumulative effect of accounting change 449,497 260,198 335,665 - ------------------------------------------ Federal income taxes 127,472 40,400 142,544 - ------------------------------------------ Income before cumulative effect of accounting change 322,025 219,798 193,121 - ------------------------------------------ ---------- ---------- ---------- Cumulative effect of accounting change (postretirement benefits) -- -- 45,582 - ------------------------------------------ ---------- ---------- ---------- Net income $ 322,025 $ 219,798 $ 147,539 - ------------------------------------------ ========== ========== ========== EARNINGS PER SHARE Income before cumulative effect of accounting change $32.20 $21.98 $19.31 - ------------------------------------------ Cumulative effect of accounting change (postretirement benefits) -- -- (4.56) - ------------------------------------------ ---------- ---------- ---------- Net income $32.20 $21.98 $14.75 - ------------------------------------------ ========== ========== ==========
See accompanying notes. G-3 LINCOLN NATIONAL LIFE INSURANCE CO. CONSOLIDATED STATEMENTS OF SHAREHOLDER'S EQUITY
Year ended December 31 1995 1994 1993 ------------------------------ (000's omitted) ---------------------------------- Common stock -- balance at beginning and end of year $ 25,000 $ 25,000 $ 25,000 - ----------------------------------------- ADDITIONAL PAID-IN CAPITAL: Balance at beginning of year 791,605 791,444 791,223 - ----------------------------------------- Contribution from Lincoln National Corp. 17,952 161 221 - ----------------------------------------- ---------- ---------- ---------- Balance at end of year 809,557 791,605 791,444 - ----------------------------------------- RETAINED EARNINGS: Balance at beginning of year 1,428,969 1,334,171 1,198,632 - ----------------------------------------- Net income 322,025 219,798 147,539 - ----------------------------------------- Dividends declared (310,000) (125,000) (12,000) - ----------------------------------------- ---------- ---------- ---------- Balance at end of year 1,440,994 1,428,969 1,334,171 - ----------------------------------------- NET UNREALIZED GAIN (LOSS) ON SECURITIES AVAILABLE-FOR-SALE: Balance at beginning of year (324,619) 621,161 47,303 - ----------------------------------------- Cumulative effect of accounting change -- -- 564,153 - ----------------------------------------- Other change during year 767,914 (945,780) 9,705 - ----------------------------------------- ---------- ---------- ---------- Balance at end of year 443,295 (324,619) 621,161 - ----------------------------------------- ---------- ---------- ---------- Total shareholder's equity at end of year $2,718,846 $1,920,955 $2,771,776 - ----------------------------------------- ========== ========== ==========
See accompanying notes. G-4 LINCOLN NATIONAL LIFE INSURANCE CO. CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31 1995 1994 1993 ----------- ----------- ---------- (000's omitted) ------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 322,025 $ 219,798 $ 147,539 - ---------------------------------------- Adjustments to reconcile net income to net cash provided by operating activities: . Deferred acquisition costs 124,526 (171,063) (92,183) - ---------------------------------------- . Premiums and fees receivable 6,082 10,755 80,582 - ---------------------------------------- . Accrued investment income 15,069 (54,434) (18,827) - ---------------------------------------- . Policy liabilities and accruals 621,603 114,038 345,142 - ---------------------------------------- . Contractholder funds 1,335,625 1,769,240 1,248,058 - ---------------------------------------- . Amounts recoverable from reinsurers (883,425) (884,388) (700,622) - ---------------------------------------- . Federal income taxes 95,745 8,364 (130,308) - ---------------------------------------- . Provisions for depreciation 39,089 38,870 41,516 - ---------------------------------------- . Amortization of discount and premium (86,653) 7,928 (100,274) - ---------------------------------------- . Realized loss (gain) on investments (244,995) 219,682 (115,881) - ---------------------------------------- . Loss (gain) on sale of affiliates -- (68,954) 98,500 - ---------------------------------------- . Cumulative effect of accounting change -- -- 45,582 - ---------------------------------------- . Other 458,542 (4,599) 51,369 - ---------------------------------------- ----------- ----------- ---------- Net adjustments 1,481,208 985,439 752,654 - ---------------------------------------- ----------- ----------- ---------- Net cash provided by operating activities 1,803,233 1,205,237 900,193 - ---------------------------------------- CASH FLOWS FROM INVESTING ACTIVITIES Securities available-for-sale: . Purchases (13,549,807) (12,100,213) (7,171,684) - ---------------------------------------- . Sales 12,163,673 9,326,809 7,139,781 - ---------------------------------------- . Maturities 929,018 958,065 42,707 - ---------------------------------------- Fixed maturity securities held for investment: . Purchases -- -- (5,903,805) - ---------------------------------------- . Sales -- -- 2,805,980 - ---------------------------------------- . Maturities -- -- 1,639,739 - ---------------------------------------- Purchases of other investments (1,711,427) (1,421,321) (1,936,013) - ---------------------------------------- Sale or maturity of other investments 1,198,536 1,457,157 1,142,872 - ---------------------------------------- Sale of affiliates -- 520,340 -- - ---------------------------------------- Decrease in cash collateral on loaned securities (39,681) (163,872) (40,454) - ---------------------------------------- Other (213,708) (37,606) 83,751 - ---------------------------------------- ----------- ----------- ---------- Net cash used in investing activities (1,223,396) (1,460,641) (2,197,126) - ---------------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on long-term debt (13,967) (200) (1,138) - ---------------------------------------- Issuance of long-term debt -- -- 10,314 - ---------------------------------------- Net increase (decrease) in short-term debt (28,873) 3,629 13,047 - ---------------------------------------- Universal life and investment contract deposits 1,716,239 2,381,829 2,418,037 - ---------------------------------------- Universal life and investment contract withdrawals (2,149,325) (1,604,450) (1,503,105) - ---------------------------------------- Capital contribution from Lincoln National Corp. 17,952 161 221 - ---------------------------------------- Dividends paid to shareholder (310,000) (125,000) (12,000) - ---------------------------------------- ----------- ----------- ---------- Net cash provided by (used in) financing activities (767,974) 655,969 925,376 - ---------------------------------------- ----------- ----------- ----------
Net increase (decrease) in cash (188,137) 400,565 (371,557) - ------------------------------- Cash at beginning of year 990,880 590,315 961,872 - ------------------------------- -------- -------- -------- Cash at end of year $802,743 $990,880 $590,315 - ------------------------------- ======== ======== ========
See accompanying notes. G-5 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1995 1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of presentation The accompanying consolidated financial statements include Lincoln National Life Insurance Co. ("Lincoln Life") and its majority owned subsidiaries. Lincoln Life and its subsidiaries operate multiple insurance businesses. Operations are divided into two business segments (see Note 9). These con- solidated financial statements have been prepared in conformity with gener- ally accepted accounting principles. Use of estimates The nature of the insurance business requires management to make estimates and assumptions that affect the amounts reported in the consolidated finan- cial statements and accompanying notes. Actual results could differ from those estimates. Investments Lincoln Life classifies its fixed maturity securities and equity securities (common and non-redeemable preferred stocks) as available-for-sale and, ac- cordingly, such securities are carried at fair value. The cost of fixed ma- turity securities is adjusted for amortization of premiums and discounts. The cost of fixed maturity and equity securities is adjusted for declines in value that are other than temporary. For the mortgage-backed securities portion of the fixed maturity securities portfolio, Lincoln Life recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the se- curities. When estimates of prepayments change, the effective yield is re- calculated to reflect actual payments to date and anticipated future pay- ments. The net investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied since the ac- quisition of the securities. This adjustment is reflected in net investment income. Mortgage loans on real estate are carried at outstanding principal balances less unaccrued discounts and net of reserves for declines that are other than temporary. Investment real estate is carried at cost less allowances for depreciation. Such real estate is carried net of reserves for declines in value that are other than temporary. Real estate acquired through foreclosure proceedings is re- corded at fair value on the settlement date which establishes a new cost basis. If a subsequent periodic review of a foreclosed property indicates the fair value, less estimated costs to sell, is lower than the carrying value at the settlement date, the carrying value is adjusted to the lower amount. Policy loans are carried at the aggregate unpaid balances. Any changes to the reserves for mortgage loans on real estate and real estate are reported as a realized gain (loss) on investments. Cash and invested cash are carried at cost and include all highly liquid debt instruments purchased with a maturity of three months or less, includ- ing participation in a short-term investment pool administered by Lincoln National Corp. (LNC), the Lincoln Life's parent. Realized gain (loss) on investments is recognized in net income, net of re- lated amortization of deferred acquisition costs, using the specific iden- tification method. Changes in the fair values of securities carried at fair value are reflected directly in shareholder's equity after deductions for related adjustments for deferred acquisition costs and amounts required to satisfy policyholder commitments that would have been recorded if these se- curities would have been sold at their fair value, and after deferred taxes or credits to the extent deemed recoverable. Derivatives Lincoln Life hedges certain portions of its exposure to interest rate fluc- tuations, the widening of bond yield spreads over comparable maturity U.S. Government obligations and foreign exchange risk by entering into deriva- tive transactions. A description of Lincoln Life's accounting for its hedge of such risks is discussed in the following two paragraphs. The premium paid for interest rate caps is deferred and amortized to net investment income on a straight-line basis over the term of the interest rate cap. Any settlement received in accordance with the terms of the in- terest rate caps is recorded as investment income. Spread-lock agreements, interest rate swaps and financial futures, which hedge fixed maturity secu- rities available-for-sale, are carried at fair value with the change in fair value reflected directly in shareholder's equity. Realized gain (loss) from the settlement of such derivatives is deferred and amortized over the life of the hedged assets as an adjustment to the yield. Foreign exchange forward contracts, foreign currency options and foreign currency swaps, which hedge some of the foreign exchange risk of investments in fixed matu- rity securities denominated in foreign currencies, are carried at fair value with the change in fair value reflected in earnings. Realized G-6 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONTINUED gain (loss) from the settlement of such derivatives is also zreflected in earnings. Hedge accounting is applied as indicated above after Lincoln Life deter- mines that the items to be hedged expose Lincoln Life to interest rate fluctuations, the widening of bond yield spreads over comparable maturity U.S. Government obligations and foreign exchange risk; and the derivatives used are designated as a hedge and reduce the indicated risk by having a high correlation of changes in the value of the derivatives and the items being hedged at both the inception of the hedge and throughout the hedge period. Should such criteria not be met, the change in value of the deriva- tives is included in net income. Property and equipment Property and equipment owned for Lincoln Life use is carried at cost less allowances for depreciation. Premiums and fees Revenue for universal life and other interest-sensitive life insurance pol- icies consists of policy charges for cost of insurance, policy initiation and administration, and surrender charges that have been assessed. Tradi- tional individual life-health and annuity premiums are recognized as reve- nue over the premium-paying period of the policies. Group health premiums are prorated over the contract term of the policies. Assets held in separate accounts/ liabilities related to separate accounts These assets and liabilities represent segregated funds administered and invested by Lincoln Life for the exclusive benefit of pension and variable life and annuity contractholders. The fees received by Lincoln Life for ad- ministrative and contractholder maintenance services performed for these separate accounts are included in Lincoln Life's consolidated statements of income. Deferred acquisition costs Commissions and other costs of acquiring universal life insurance, variable universal life insurance, traditional life insurance, annuities and group health insurance which vary with and are primarily related to the produc- tion of new business, have been deferred to the extent recoverable. Acqui- sition costs for universal and variable universal life insurance policies are being amortized over the lives of the policies in relation to the inci- dence of estimated gross profits from surrender charges and investment, mortality and expense margins, and actual realized gain (loss) on invest- ments. That amortization is adjusted retrospectively when estimates of cur- rent or future gross profits to be realized from a group of policies are revised. The traditional life-health and annuity acquisition costs are am- ortized over the premium-paying period of the related policies using as- sumptions consistent with those used in computing policy reserves. Expenses Expenses for universal and variable universal life insurance policies in- clude interest credited to policy account balances and benefit claims in- curred during the period in excess of policy account balances. Interest crediting rates associated with funds invested in Lincoln Life's general account during 1993 through 1995 ranged from 6.1% to 8.25%. Goodwill The cost of acquired subsidiaries in excess of the fair value of net assets (goodwill) is amortized using the straight-line method over periods that generally correspond with the benefits expected to be derived from the ac- quisitions. Goodwill is amortized over 40 years. The carrying value of goodwill is reviewed periodically for indicators of impairment in value. Policy liabilities and accruals The liabilities for future policy benefits and expenses for universal and variable universal life insurance policies consist of policy account bal- ances that accrue to the benefit of the policyholders, excluding surrender charges. The liabilities for future policy benefits and expenses for tradi- tional life policies and immediate and deferred paid-up annuities are com- puted using a net level premium method and assumptions for investment yields, mortality and withdrawals based principally on Lincoln Life experi- ence projected at the time of policy issue, with provision for possible ad- verse deviations. Interest assumptions for traditional direct individual life reserves for all policies range from 2.3% to 11.7% graded to 5.7% af- ter 30 years depending on time of policy issue. Interest rate assumptions for reinsurance reserves range from 5.0% to 11.0% graded to 8.0% after 20 years. The interest assumptions for immediate and deferred paid-up annui- ties range from 4.5% to 8.0%. With respect to its policy liabilities and accruals, Lincoln Life carries on a continuing review of its 1) overall reserve position, 2) reserving techniques G-7 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONTINUED and 3) reinsurance arrangements, and as experience develops and new infor- mation becomes known, liabilities are adjusted as deemed necessary. The ef- fects of changes in estimates are included in the operating results for the period in which such estimates occur. Reinsurance Lincoln Life enters into reinsurance agreements with other companies in the normal course of their business. Lincoln Life may assume reinsurance from unaffiliated companies and/or cede reinsurance to such companies. Assets/liabilities and premiums/benefits from certain reinsurance contracts which grant statutory surplus to other insurance companies have been netted on the balance sheets and income statements, respectively, since there is a right of offset. All other reinsurance agreements are reported on a gross basis. Depreciation Provisions for depreciation of investment real estate and property and equipment owned for Lincoln Life use are computed principally on the straight-line method over the estimated useful lives of the assets. Postretirement medical and life insurance benefits Lincoln Life accounts for its postretirement medical and life insurance benefits using the full accrual method. Income taxes Lincoln Life and eligible subsidiaries have elected to file consolidated Federal and state income tax returns with their parent, LNC. Pursuant to an intercompany tax sharing agreement with LNC, Lincoln Life and its eligible subsidiaries provide for income taxes on a separate return filing basis. The tax sharing agreement also provides that Lincoln Life and eligible sub- sidiaries will receive benefit for net operating losses, capital losses and tax credits which are not usable on a separate return basis to the extent such items may be utilized in the consolidated income tax returns of LNC. Lincoln Life uses the liability method of accounting for income taxes. De- ferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax return purposes. Lincoln Life establishes a valuation allowance for any portion of its deferred tax assets which are unlikely to be realized. 2.CHANGES IN ACCOUNTING PRINCIPLES AND CHANGES IN ESTIMATES Postretirement benefits other than pensions Effective January 1, 1993, Lincoln Life changed its method of accounting for postretirement medical and life insurance benefits for its eligible em- ployees and agents from a pay-as-you-go method to a full accrual method in accordance with Financial Accounting Standards No. 106 entitled "Employers' Accounting for Postretirement Benefits Other Than Pensions" ("FAS 106"). This full accrual method recognizes the estimated obligation for retired employees and agents and active employees and agents who are expected to retire in the future. The effect of the change was to increase net periodic postretirement benefit cost by $7,800,000 and decrease income before cumu- lative effect of accounting change by $5,100,000 ($0.51 per share). The im- plementation of FAS 106 resulted in a one-time charge to the first quarter 1993 net income of $45,600,000 or $4.56 per share ($69,000,000 pre-tax) for the cumulative effect of the accounting change. See Note 6 for additional disclosures regarding postretirement benefits other than pensions. Accounting by creditors for impairment of a loan Financial Accounting Standards No. 114 entitled "Accounting by Creditors for Impairment of a Loan" ("FAS 114") issued in May 1993, was adopted by Lincoln Life effective January 1, 1993. FAS 114 requires that if an im- paired mortgage loan's fair value as described in Note 3 is less than the recorded investment in the loan, the difference is recorded in the mortgage loan allowance for losses account. The adoption of FAS 114 resulted in ad- ditions to the mortgage loan allowance for losses account and reduced first quarter 1993 income before cumulative effect of accounting change and net income by $37,700,000, or $3.77 per share ($57,200,000 pre-tax). See Note 3 for further mortgage loan disclosures. Most of the effect of this change in accounting was within the Life Insurance and Annuities business segment. Accounting for certain investments in debt and equity securities Financial Accounting Standards No. 115 entitled "Accounting for Certain In- vestments in Debt and Equity Securities" ("FAS 115") issued in May 1993, was adopted by Lincoln Life as of December 31, 1993. In accordance with the rules, the G-8 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 2. CHANGES IN ACCOUNTING PRINCIPLESAND CHANGES IN ESTIMATES CONTINUED prior year financial statements have not been restated to reflect the change in accounting principle. Under FAS 115, securities can be classified as available-for-sale, trading or held-to-maturity according to the hold- er's intent. Lincoln Life classified its entire fixed maturity securities portfolio as "available-for-sale." Securities classified as available-for- sale are carried at fair value and unrealized gains and losses on such se- curities are carried as a separate component of shareholder's equity. The ending balance of shareholder's equity at December 31, 1993 was increased by $564,200,000 (net of $377,500,000 of related adjustments to deferred ac- quisition costs, $50,700,000 of policyholder commitments and $303,700,000 in deferred income taxes, all of which would have been recognized if those securities would have been sold at their fair value, net of amounts appli- cable to Security-Connecticut Corp.) to reflect the net unrealized gain on fixed maturity securities classified as available-for-sale previously car- ried at amortized cost. Prior to the adoption of FAS 115, Lincoln Life car- ried a portion of its fixed maturity securities at fair value with unrealized gains and losses carried as a separate component of sharehold- er's equity. The remainder of such securities were carried at amortized cost. Change in estimate for net investment income related to mortgage-backed securities At December 31, 1993, Lincoln Life had $5,942,100,000 invested in mortgage- backed securities. As indicated in Note 1, Lincoln Life recognizes income on these securities using a constant effective yield based on anticipated prepayments. With the implementation of new investment software in December 1993, Lincoln Life was able to significantly refine its estimate of the ef- fective yield on such securities to better reflect actual prepayments and estimates of future prepayments. This resulted in an increase in the amor- tization of purchase discount on these securities of $58,000,000 and, after related amortization of deferred acquisition costs ($18,300,000) and income taxes ($14,300,000), increased 1993's income before cumulative effect of accounting change and net income by $25,500,000 or $2.55 per share. Most of the effect of this change in estimate was within the Life Insurance and Annuities business segment. Change in estimate for disability income reserves During the fourth quarter of 1993, income before cumulative effect of ac- counting change and net income decreased by $15,500,000 or $1.55 per share as the result of strengthening reinsurance disability income reserves by $23,900,000. The need for this reserve increase within the Reinsurance seg- ment was identified as the result of management's assessment of current ex- pectations for morbidity trends and the impact of lower investment income due to lower interest rates. During the fourth quarter of 1995, Lincoln Life completed an in-depth re- view of the experience of its disability income business. As a result of this study, and based on the assumption that recent experience will con- tinue in the future, income before cumulative effect of accounting change and net income decreased by $33,500,000 or $3.35 per share ($51,500,000 pre-tax) as a result of strengthening disability income reserves by $15,200,000 and writing-off deferred acquisition costs of $36,300,000 in the Reinsurance segment. G-9 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 3.INVESTMENTS The major categories of net investment income are as follows:
Year ended December 31 1995 1994 1993 ---------- (in millions) -------------------------- Fixed maturity securities $1,549.4 $1,357.4 $1,497.6 ----------------------------- Equity securities 8.9 7.4 4.3 ----------------------------- Mortgage loans on real estate 268.3 271.3 294.2 ----------------------------- Real estate 110.0 97.8 75.2 ----------------------------- Policy loans 35.4 32.7 36.0 ----------------------------- Invested cash 55.4 46.4 24.8 ----------------------------- Other investments 15.8 7.3 8.0 ----------------------------- -------- -------- -------- Investment revenue 2,043.2 1,820.3 1,940.1 ----------------------------- Investment expenses 143.6 146.3 116.6 ----------------------------- -------- -------- -------- Net investment income $1,899.6 $1,674.0 $1,823.5 ----------------------------- ======== ======== ========
The realized gain (loss) on investments is as follows:
Year ended December 31 1995 1994 1993 -------------------------- (in millions) ------------------------ Fixed maturity securities available-for-sale: . Gross gain $239.6 $ 69.6 $ 91.1 ------------------------------------------------ . Gross loss (87.8) (294.1) (8.4) ------------------------------------------------ Equity securities available-for-sale: . Gross gain 82.3 50.2 88.3 ------------------------------------------------ . Gross loss (31.3) (50.5) (33.7) ------------------------------------------------ Fixed maturity securities held for investment: . Gross gain -- -- 209.9 ------------------------------------------------ . Gross loss -- -- (69.5) ------------------------------------------------ Other investments 42.2 5.1 (161.8) ------------------------------------------------ Related restoration or amortization of deferred acquisition costs and provision for policyholder commitments (108.8) 81.2 (23.7) ------------------------------------------------ ------ ------- ------- $136.2 $(138.5) $ 92.2 ====== ======= =======
Provisions (credits) for write-downs and net changes in pro- visions for losses, which are included in realized gain (loss) on investments shown above, are as follows:
Year ended December 31 1995 1994 1993 (in millions) ------------------- Fixed maturity securities $10.4 $14.2 $ 55.6 ----------------------------- Equity securities 3.3 6.8 -- ----------------------------- Mortgage loans on real estate 14.7 19.5 136.7 ----------------------------- Real estate (7.2) 13.0 21.8 ----------------------------- Other long-term investments (1.5) .3 3.9 ----------------------------- Guarantees (2.2) 4.3 1.7 ----------------------------- ----- ----- ------ $17.5 $58.1 $219.7 ===== ===== ======
G-10 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 3.INVESTMENTS CONTINUED The change in unrealized appreciation (depreciation) on in- vestments in fixed maturity and equity securities is as fol- lows:
Year ended December 31 1995 1994 1993 ------------------------------ (in millions) ---------------------------- Fixed maturity securities available-for-sale $2,063.7 $(1,903.7) $1,387.1 --------------------------------------------- Equity securities available-for-sale 78.1 (26.0) 9.2 --------------------------------------------- Fixed maturity securities held for investment -- -- (959.7) --------------------------------------------- -------- --------- -------- $2,141.8 $(1,929.7) $ 436.6 ======== ========= ========
The cost, gross unrealized gain and loss and fair value of securities available-for-sale are as follows:
Year ended December 31, 1995 ----------------------------------- Gross unrealized --------------- Fair Cost Gain Loss value ---------------------------------------- (in millions) ----------------------------------- Corporate bonds $12,412.1 $1,141.0 $ 28.7 $13,524.4 ------------------------------------- U.S. Government bonds 569.6 83.9 .1 653.4 ------------------------------------- Foreign government bonds 927.9 70.3 .6 997.6 ------------------------------------- Mortgage-backed securities: . Mortgage pass-through securities 1,072.5 41.0 3.2 1,110.3 ------------------------------------- . Collateralized mortgage obligations 3,816.3 262.5 7.4 4,071.4 ------------------------------------- . Other mortgage-backed securities 2.8 .3 -- 3.1 ------------------------------------- State and municipal bonds 12.3 .1 -- 12.4 ------------------------------------- Redeemable preferred stocks 39.3 2.9 -- 42.2 ------------------------------------- --------- -------- ------ --------- Total fixed maturity securities 18,852.8 1,602.0 40.0 20,414.8 ------------------------------------- Equity securities 480.3 123.6 5.5 598.4 ------------------------------------- --------- -------- ------ --------- $19,333.1 $1,725.6 $ 45.5 $21,013.2 ========= ======== ====== ========= Year ended December 31, 1994 ----------------------------------- Gross unrealized --------------- Fair Cost Gain Loss value ---------------------------------------- (in millions) ----------------------------------- Corporate bonds $11,519.3 $ 143.3 $514.4 $11,148.2 ------------------------------------- U.S. Government bonds 1,048.4 6.9 25.5 1,029.8 ------------------------------------- Foreign governments bonds 541.2 4.7 12.5 533.4 ------------------------------------- Mortgage-backed securities: . Mortgage pass-through securities 1,176.8 3.0 44.1 1,135.7 ------------------------------------- . Collateralized mortgage obligations 3,835.5 85.8 148.6 3,772.7 ------------------------------------- . Other mortgage-backed securities 5.0 .1 .1 5.0 ------------------------------------- State and municipal bonds 16.3 .4 -- 16.7 ------------------------------------- Redeemable preferred stocks 51.4 .2 .9 50.7 ------------------------------------- --------- -------- ------ --------- Total fixed maturity securities 18,193.9 244.4 746.1 17,692.2 ------------------------------------- Equity securities 416.3 56.4 16.4 456.3 ------------------------------------- --------- -------- ------ --------- $18,610.2 $ 300.8 $762.5 $18,148.5 ========= ======== ====== =========
G-11 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 3.INVESTMENTS CONTINUED Future maturities of fixed maturity securities available- for-sale are as follows:
December 31, 1995 ------------------- Fair Cost value --------- --------- (in millions) ------------------- Due in one year or less $ 278.4 $ 282.6 -------------------------------------- Due after one year through five years 2,955.7 3,102.1 -------------------------------------- Due after five years through ten years 4,918.2 5,265.9 -------------------------------------- Due after ten years 5,808.9 6,579.4 -------------------------------------- --------- --------- 13,961.2 15,230.0 Mortgage-backed securities 4,891.6 5,184.8 -------------------------------------- --------- --------- $18,852.8 $20,414.8 ========= =========
The foregoing data is based on stated maturities. Actual maturities will differ in some cases because borrowers may have the right to call or pre-pay obligations. At December 31, 1995, the current par, amortized cost and estimated fair value of investments in mortgage-backed securities summarized by interest rates of the underlying collateral are as follows:
December 31, 1995 ------------------------------- Current Par Cost Fair value ----------- -------- ---------- (in millions) ------------------------------- Below 7% $ 292.6 $ 290.5 $ 293.6 -------- 7%-8% 1,302.8 1,276.9 1,318.2 -------- 8%-9% 1,607.0 1,564.7 1,669.8 -------- Above 9% 1,810.5 1,759.5 1,903.2 -------- -------- -------- -------- $5,012.9 $4,891.6 $5,184.8 ======== ======== ========
The quality ratings of fixed maturity securities available- for-sale are as follows:
December 31, 1995 ----------------- Treasuries and AAA 34.1% ------------------ AA 8.0 ------------------ A 25.9 ------------------ BBB 24.5 ------------------ BB 3.9 ------------------ Less than BB 3.6 ------------------ ------ 100.0% ======
Mortgage loans on real estate are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When Lincoln Life determines that a loan is impaired, a provision for loss is established for the difference between the carrying value of the mortgage loan and the estimated value. Estimated value is based on either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's observable market price or the fair value of the collateral. The provision for losses is reported as realized gain (loss) on investments. Mortgage loans deemed to be uncollectible are charged against the provision for losses and subsequent recoveries, if any, are credited to the provision for losses. G-12 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 3.INVESTMENTS CONTINUED The provision for losses is maintained at a level believed adequate by management to absorb estimated probable credit losses. Management's periodic evaluation of the adequacy of the provision for losses is based on the Company's 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. This evaluation is inherently subjective as it requires estimating the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. Impaired loans along with the related allowance for losses are as follows:
December 31 1995 1994 ------ ------ (in millions) -------------- Impaired loans with allowance for losses $144.7 $246.0 ------------------------------------------- Allowance for losses (28.5) (56.6) ------------------------------------------- Impaired loans with no allowance for losses 2.1 2.2 ------------------------------------------- ------ ------ Net impaired loans $118.3 $191.6 ------------------------------------------- ====== ======
Impaired loans with no allowance for losses are a result of direct write-downs or for collateral dependent loans where the fair value of the collateral is greater than the re- corded investment in such loans. A reconciliation of the mortgage loan allowance for losses for these impaired mortgage loans is as follows:
Year ended December 31 1995 1994 1993 ------ ------- ------ (in millions) ----------------------- Balance at beginning of year $ 56.6 $ 220.7 $129.1 --------------------------------- Provisions for losses 14.7 19.5 79.5 --------------------------------- Provision for adoption of FAS 114 -- -- 57.2 --------------------------------- Releases due to write-downs (12.0) -- -- --------------------------------- Releases due to sales (15.9) (164.7) (12.2) --------------------------------- Releases due to foreclosures (14.9) (18.9) (32.9) --------------------------------- ------ ------- ------ Balance at end of year $ 28.5 $ 56.6 $220.7 --------------------------------- ====== ======= ======
G-13 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 3.INVESTMENTS CONTINUED The average recorded investment in impaired loans and the interest income recognized on impaired loans were as fol- lows:
Year ended December 31 1995 1994 1993 ------ ------ ------ (in millions) -------------------- Average recorded investment in impaired loans $181.7 $467.5 $703.6 --------------------------------------------- Interest income recognized on impaired loans 16.6 36.1 47.3 ---------------------------------------------
All interest income on impaired loans was recognized on the cash basis of income recognition. As of December 31, 1995 and 1994, Lincoln Life had restruc- tured loans of $62,500,000 and $36,200,000, respectively. Lincoln Life recorded $6,300,000 and $800,000 interest income on these restructured loans in 1995 and 1994, respectively. Interest income in the amount of $6,600,000 and $3,900,000 would have been recorded on these loans according to their original terms in 1995 and 1994, respectively. As of December 31, 1995 and 1994, Lincoln Life had no outstanding commit- ments to lend funds on restructured loans. As of December 31, 1995, the Company's investment commit- ments for fixed maturity securities (primarily private placements), mortgage loans on real estate and real estate were $543,100,000. Fixed maturity securities available-for-sale, mortgage loans on real estate and real estate with a combined carrying value at December 31, 1995 of $1,300,000 were non-income producing for the year ended December 31, 1995. The cost information for mortgage loans on real estate, real estate and other long-term investments are net of allowances for losses. The balance sheet account for other liabilities includes a reserve for guarantees of third-party debt. The amount of allowances and a reserve for such items is as fol- lows:
December 31 1995 1994 ----- ----- (in millions) ----------- Mortgage loans on real estate $28.5 $56.6 ----------------------------- Real estate 46.6 65.2 ----------------------------- Other long-term investments 11.8 13.5 -----------------------------
Details underlying the balance sheet caption "Net Unrealized Gain (loss) on Securities Available-for-Sale," are as fol- lows:
December 31 1995 1994 --------- --------- (in millions) -------------------- Fair value of securities available-for-sale $21,013.2 $18,148.5 ---------------------------------------------------- Cost of securities available-for-sale 19,333.1 18,610.2 ---------------------------------------------------- --------- --------- Unrealized gain (loss) 1,680.1 (461.7) ---------------------------------------------------- Adjustments to deferred acquisition costs (492.1) 158.2 ---------------------------------------------------- Amounts required to satisfy policyholder commitments (510.1) 8.6 ---------------------------------------------------- Deferred income credits (taxes) (234.6) 105.9 ---------------------------------------------------- Valuation allowance for deferred tax assets -- (135.6) ---------------------------------------------------- --------- --------- Net unrealized gain (loss) on securities available- for-sale $ 443.3 $ (324.6) ---------------------------------------------------- ========= =========
G-14 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 3.INVESTMENTS CONTINUED Adjustments to Deferred acquisition costs and amounts re- quired to satisfy policyholder commitments are netted against the Deferred acquisition costs asset account and in- cluded with the Future policy benefits, claims and claims expense liability on the balance sheet, respectively. 4.FEDERAL INCOME TAXES The Federal income tax expense (benefit) before cumulative effect of accounting change is as follows:
Year ended December 31 1995 1994 1993 (in millions) ---------------------- Current $172.5 $(93.4) $261.3 -------- Deferred (45.0) 133.8 (118.8) -------- ------ ------ ------ $127.5 $ 40.4 $142.5 ====== ====== ======
Cash paid for Federal income taxes in 1995, 1994 and 1993 was $27,500,000, $41,400,000 and $272,600,000, respectively. The cash paid in 1995 is net of a $146,900,000 cash refund related to the carryback of 1994 capital losses to prior years. The effective tax rate on pre-tax income before cumulative effect of accounting change is lower than the prevailing corporate Federal income tax rate. A reconciliation of this difference is as follows:
Year ended December 31 1995 1994 1993 --------- (in millions) --------------------- Tax rate times pre-tax income $157.3 $91.1 $117.5 ------------------------------------ Effect of: . Tax-exempt investment income (22.0) (21.5) (16.2) ------------------------------------ . Participating policyholders' share 5.4 3.4 4.1 ------------------------------------ . Loss (gain) on sale of affiliates -- (24.1) 34.5 ------------------------------------ . Other items (13.2) (8.5) 2.6 ------------------------------------ ------ ----- ------ Provision for income taxes $127.5 $40.4 $142.5 ------------------------------------ ====== ===== ====== Effective tax rate 28.4% 15.5% 42.5% ------------------------------------ ====== ===== ======
The Federal income tax recoverable (liability) is as follows:
December 31 1995 1994 ------- ------ (in millions) --------------- Current $ (25.0) $118.2 -------- Deferred (141.4) 16.3 -------- ------- ------ $(166.4) $134.5 ======= ======
G-15 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 4.FEDERAL INCOME TAXES CONTINUED Significant components of Lincoln Life's net deferred tax asset (liability) are as follows:
December 31 1995 1994 ------- ------- (in millions) ---------------- Deferred tax assets: . Policy liabilities and accruals and contractholder funds $ 694.5 $ 430.9 ------------------------ . Loss on investments -- 16.8 ------------------------ . Net unrealized loss on securities available- for-sale -- 161.6 ------------------------ . Postretirement benefits other than pensions 25.3 24.2 ------------------------ . Other 39.5 34.6 ------------------------ ------- ------- Total deferred tax assets 759.3 668.1 ------------------------ Valuation allowance for deferred tax assets -- (135.6) ------------------------ ------- ------- Net deferred tax assets 759.3 532.5 ------------------------ Deferred tax liabilities: . Deferred acquisition costs 218.8 475.5 ------------------------ . Net unrealized gain on securities available- for-sale 579.6 -- ------------------------ . Gain on investments 7.7 -- ------------------------ . Other 94.6 40.7 ------------------------ ------- ------- Total deferred tax liabilities 900.7 516.2 ------------------------ ------- ------- Net deferred tax (liability) asset $(141.4) $ 16.3 ------------------------ ======= =======
Lincoln Life is required to establish a "valuation allow- ance" for any portion of its deferred tax assets which are unlikely to be realized. At December 31, 1994, $161,600,000 of deferred tax assets relating to net unrealized capital losses on fixed maturity and equity securities available- for-sale were available to be recorded in shareholder's eq- uity before considering a valuation allowance. For Federal income tax purposes, capital losses may only be used to off- set capital gains in the current year or during a three-year carryback and five-year carryforward period. Due to these restrictions, and the uncertainty at that time of future capital gains, these deferred tax assets were substantially offset by a valuation allowance of $135,600,000. By December 31, 1995, the fair values of fixed maturity and equity secu- rities available-for-sale were greater than the cost basis resulting in unrealized capital gains. Accordingly, no valu- ation allowance was established as of December 31, 1995 since management believes it is more likely than not that Lincoln Life will realize the benefit of its deferred tax assets. Prior to 1984, a portion of the life companies' current income was not subject to current income tax, but was accumulated for income tax purposes in a memorandum account designated as "policyholders' surplus." The total of the life companies' balances in their respective "policyholders' surplus" accounts at December 31, 1983 of $204,800,000 was "frozen" by the Tax Reform Act of 1984 and, accordingly, there have been no additions to the accounts after that date. That portion of current income on which income taxes have been paid will continue to be accumulated in a memorandum account designated as "shareholder surplus," and is available for dividends to the shareholder without additional payment of tax. The December 31, 1995 total of the life companies' account balances for their "shareholder surplus" was $1,554,000,000. Should dividends to the shareholder for each life company exceed its respective "shareholder surplus," amounts would need to be transferred from its respective "policyholders' surplus" and would be subject to Federal income tax at that time. In connection with the 1993 sale of a life insurance affiliate (see Note 10), $8,800,000 was transferred from policyholders' surplus G-16 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 4.FEDERAL INCOME TAXES CONTINUED to shareholder surplus and current income tax of $3,100,000 was paid. Under existing or foreseeable circumstances, Lincoln Life neither expects nor intends that distributions will be made from the remaining balance in "policyholders' surplus" of $196,000,000 that will result in any such tax. Accordingly, no provision for deferred income taxes has been provided by Lincoln Life on its "policyholders' surplus" account. In the event that such excess distributions are made, it is estimated that income taxes of approximately $68,600,000 would be due. 5.SUPPLEMENTAL FINANCIAL DATA The balance sheet captions, "Real estate," "Other investments" and "Property and equipment," are shown net of allowances for depreciation as follows:
December 31 1995 1994 ------ ------ (in millions) ------------- Real estate $ 51.6 $ 37.0 ---------------------- Other investments 14.6 12.2 ---------------------- Property and equipment 100.7 104.7 ----------------------
Details underlying the balance sheet caption, "Contractholder funds," are as follows:
December 31 1995 1994 --------- --------- (in millions) ------------------- Premium deposit funds $17,886.9 $16,770.3 ------------------------------------------------ Undistributed earnings on participating business 91.9 63.6 ------------------------------------------------ Other 193.0 194.7 ------------------------------------------------ --------- --------- $18,171.8 $17,028.6 ========= =========
Details underlying the balance sheet captions, "Short-term and Long-term Debt," are as follows:
December 31 1995 1994 ------ ------ (in millions) ------------- Short-term debt: --------------------------------------- . Short-term notes $123.5 $150.8 --------------------------------------- . Current portion of long-term debt 1.3 2.9 --------------------------------------- ------ ------ Total short-term debt $124.8 $153.7 --------------------------------------- ====== ====== Long-term debt less current portion: --------------------------------------- . 7% mortgage note payable, due 1996 $ -- $ 4.9 --------------------------------------- . 9.48% mortgage note payable, due 1996 -- 7.7 --------------------------------------- . 12% mortgage note payable, due 1996 -- .2 --------------------------------------- . 8.42% mortgage note payable, due 1997 7.0 7.2 --------------------------------------- . 8.25% mortgage note payable, due 1997 10.1 10.2 --------------------------------------- . 8% mortgage note payable, due 1997 2.1 -- --------------------------------------- . 8.75% mortgage note payable, due 1998 18.4 18.8 --------------------------------------- . 9.75% mortgage note payable, due 2002 3.2 5.8 --------------------------------------- ------ ------ Total long-term debt $ 40.8 $ 54.8 --------------------------------------- ====== ======
G-17 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 5.SUPPLEMENTAL FINANCIAL DATA CONTINUED Fixed maturities of long-term debt are as follows (in mil- lions): 1996 -- $ 1.31998 -- $18.42000 -- $ -- 1997 -- 19.21999 -- --Thereafter -- 3.2 Cash paid for interest for 1995, 1994 and 1993 was $67,000, $615,000 and $96,000, respectively. Reinsurance transactions included in the income statement caption, "Insurance premiums," are as follows:
Year ended December 31 1995 1994 1993 ------ ------ ------ (in millions) -------------------- Insurance assumed $777.6 $910.8 $807.5 ------------------------ Insurance ceded 441.7 716.7 568.6 ------------------------ ------ ------ ------ Net reinsurance premiums $335.9 $194.1 $238.9 ------------------------ ====== ====== ======
The income statement caption, "Benefits and settlement ex- penses," is net of reinsurance recoveries of $456,000, $524,000 and $438,000 for the years ended December 31, 1995, 1994 and 1993, respectively. The income statement caption, "Underwriting, acquisition, insurance and other Expenses," includes amortization of de- ferred acquisition costs of $399,700,000, $115,200,000 and $241,000,000 for the years ended December 31, 1995, 1994 and 1993, respectively. An additional $(85,200,000), $81,200,000 and ($23,700,000) of deferred acquisition costs was restored (amortized) and netted against "Realized gain (loss) on in- vestments" for the years ended December 31, 1995, 1994 and 1993, respectively. 6.EMPLOYEE BENEFIT PLANS Pension plans LNC maintains funded defined benefit pension plans for most of its employees and, prior to January 1, 1995, full-time agents. The benefits for employees are based on total years of service and the highest 60 months of compensation during the last 10 years of employment. The benefits for agents were based on a percentage of each agent's yearly earnings. The plans are funded by contributions to tax-exempt trusts. Lincoln Life's funding policy is consistent with the funding requirements of Federal laws and regulations. Contributions are intended to provide not only the benefits attributed to service to date, but also those expected to be earned in the future. Plan assets consist principally of listed equity se- curities and corporate obligations and government bonds. All benefits applicable to the funded defined benefit plan for agents were frozen as of December 31, 1994. The curtail- ment of this plan did not have a significant effect on net pension cost for 1994. Effective January 1, 1995, pension benefits for agents have been provided by a new defined con- tribution plan. Contributions to this plan will be based on 2.3% of an agent's earnings up to the social security wage base and 4.6% of any excess. LNC also administers two types of unfunded, nonqualified, defined benefit plans for certain employees and agents. A supplemental retirement plan provides defined benefit pen- sion benefits in excess of limits imposed by federal tax law. A salary continuation plan provides certain officers of Lincoln Life defined pension benefits based on years of service and final monthly salary upon death or retirement. G-18 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 6.EMPLOYEE BENEFIT PLANS CONTINUED The status of the funded defined benefit pension plans and the amounts recognized on the balance sheets are as follows:
December 31 1995 1994 ------- ------- (in millions) ---------------- Actuarial present value of benefit obligation: . Vested benefits $(162.1) $(130.5) ------------------------------------------------------ . Nonvested benefits (9.2) (7.3) ------------------------------------------------------ ------- ------- Accumulated benefit obligation (171.3) (137.8) ------------------------------------------------------ Effect of projected future compensation increases (37.2) (24.3) ------------------------------------------------------ ------- ------- Projected benefit obligation (208.5) (162.1) ------------------------------------------------------ Plan assets at fair value 196.4 159.3 ------------------------------------------------------ ------- ------- Projected benefit obligations in excess of plan assets (12.1) (2.8) ------------------------------------------------------ Unrecognized net loss (gain) 12.6 (.5) ------------------------------------------------------ Unrecognized prior service cost 1.2 1.1 ------------------------------------------------------ ------- ------- Prepaid (accrued) pension cost included in other liabilities $ 1.7 $ (2.2) ------------------------------------------------------ ======= =======
The status of the unfunded defined benefit pension plans and the amounts recognized on the balance sheets are as follows:
December 31 1995 1994 ------ ----- (in millions) ------------- Actuarial present value of benefit obligation: . Vested benefits $ (7.0) $(5.4) --------------------------------------------------- . Nonvested benefits (1.5) (1.0) --------------------------------------------------- ------ ----- Accumulated benefit obligation (8.5) (6.4) --------------------------------------------------- Effect of projected future compensation increases (2.4) (2.5) --------------------------------------------------- ------ ----- Projected benefit obligation (10.9) (8.9) --------------------------------------------------- Unrecognized transition obligation -- -- --------------------------------------------------- Unrecognized net loss (gain) 1.0 (.3) --------------------------------------------------- Unrecognized prior service cost .8 .8 --------------------------------------------------- ------ ----- Accrued pension costs included in other liabilities $ (9.1) $(8.4) --------------------------------------------------- ====== =====
The determination of the projected benefits obligation for the defined benefit plans was based on the following assump- tions:
1995 1994 1993 ------------ Weighted-average discount rate 7.0% 8.0% 7.0% ------------------------------------------------ Rate of increase in compensation: . Salary continuation plan 6.0 6.5 6.0 ------------------------------------------------ . All other plans 5.0 5.0 5.0 ------------------------------------------------ Expected long-term rate of return on plan assets 9.0 9.0 9.0 ------------------------------------------------
G-19 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 6.EMPLOYEE BENEFIT PLANS CONTINUED The components of net pension cost for the defined benefit pension plans are as follows:
Year ended December 31 1995 1994 1993 ------------------- (in millions) ------------------- Service cost--benefits earned during the year $ 5.0 $ 8.9 $ 8.5 --------------------------------------------- Interest cost on projected benefit obligation 13.2 12.9 12.4 --------------------------------------------- Actual return on plan assets (36.3) 4.7 (20.1) --------------------------------------------- Net amortization (deferral) 22.9 (18.6) 6.1 --------------------------------------------- ------ ------ ------ Net pension cost $ 4.8 $ 7.9 $ 6.9 --------------------------------------------- ====== ====== ======
401(k) LNC and Lincoln Life sponsor contributory defined contribu- tion plans for eligible employees and agents. Lincoln Life's contributions to the plans are equal to each participant's pre-tax contribution, not to exceed 6% of base pay, multi- plied by a percentage, ranging from 25% to 150%, which var- ies according to certain incentive criteria as determined by LNC's Board of Directors. Expense for these plans amounted to $8,000,000, $13,200,000 and $11,800,000 in 1995, 1994 and 1993, respectively. Postretirement medical and life insurance benefit plans LNC sponsors unfunded defined benefit plans that provide postretirement medical and life insurance benefits to full- time employees and agents who, depending on the plan, have worked for Lincoln Life 10 to 15 years and attained age 55 to 60. Medical benefits are also available to spouses and other dependents of employees and agents. For medical bene- fits, limited contributions are required from individuals retired prior to November 1, 1988; contributions for later retirees, which can be adjusted annually, are based on such items as years of service at retirement and age at retire- ment. The life insurance benefits are noncontributory, al- though participants can elect supplemental contributory ben- efits. The status of the postretirement medical and life insurance benefit plans and the amounts recognized on the balance sheets are as follows:
December 31 1995 1994 -- (in millions) -- Accumulated postretirement benefit obligation: . Retirees $(39.8) $(34.9) ----------------------------------------------- . Fully eligible active plan participants (9.9) (7.0) ----------------------------------------------- . Other active plan participants (20.8) (15.0) ----------------------------------------------- ------ ------ Accumulated postretirement benefit obligation (70.5) (56.9) ----------------------------------------------- Unrecognized net gain (.8) (5.5) ----------------------------------------------- ------ ------ Accrued plan cost included in other liabilities $(71.3) $(62.4) ----------------------------------------------- ====== ======
G-20 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 6.EMPLOYEE BENEFIT PLANS CONTINUED The components of periodic postretirement benefit cost are as follows:
Year ended December 31 1995 1994 1993 -- (in millions) -- Service cost $1.5 $1.7 $2.6 ---------------------------------------- Interest cost 4.4 4.2 4.6 ---------------------------------------- Amortization cost (credit) (.8) .1 -- ---------------------------------------- ---- ---- ---- Net periodic postretirement benefit cost $5.1 $6.0 $7.2 ---------------------------------------- ==== ==== ====
The calculation of the accumulated postretirement benefit obligation assumes a weighted-average annual rate of in- crease in the per capita cost of covered benefits (i.e., health care cost trend rate) of 9.5% for 1996 gradually de- creasing to 5.5% by 2004 and remaining at that level there- after. The health care cost trend rate assumption has a sig- nificant effect on the amounts reported. For example, in- creasing the assumed health care cost trend rates by one percentage point each year would increase the accumulated postretirement benefit obligation as of December 1995 and 1994 by $5,100,000 and $4,100,000, respectively, and the ag- gregate of the estimated service and interest cost compo- nents of net periodic postretirement benefit cost for the year ended December 31, 1995 by $488,000. The calculation assumes a long-term rate of increase in compensation of 5.0% for both December 31, 1995 and 1994. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.0% and 8.0% at De- cember 31, 1995 and 1994, respectively. 7. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES Shareholder's equity restrictions Net income as determined in accordance with statutory accounting practices for Lincoln Life and its insurance subsidiaries in 1995, 1994 and 1993 was $284,500,000, $366,700,000 and $237,000,000, respectively. Lincoln Life's shareholder's equity as determined in accordance with statutory accounting practices at December 31, 1995 and 1994 was $1,732,900,000 and $1,679,700,000, respectively. Lincoln Life is subject to certain insurance department regulatory restric- tions as to the transfer of funds and payments of dividends to LNC. In 1996, Lincoln Life can transfer up to $284,500,000 without seeking prior approval from the insurance regulators. Disability income claims The liability for disability income claims net of the related asset for amounts recoverable from reinsurers at December 31, 1995 and 1994 is a net liability of $602,600,000 and $441,700,000, respectively, excluding de- ferred acquisition costs. The bulk of the increase to this liability re- lates to the assumption of a large block of disability claim reserves and related assets during the third quarter of 1995. In addition, as indicated in Note 2, Lincoln Life strengthened its disability income reserves and wrote off certain related deferred acquisition costs in the fourth quarter of 1995. The reserves were established on the assumption that the recent experience will continue in the future. If incidence levels or claim termi- nation rates vary significantly from these assumptions, further adjustments to reserves may be required in the future. It is not possible to provide a meaningful estimate of a range of possible outcomes at this time. Lincoln Life reviews and updates the level of these reserves on an on-going basis. Compliance of qualified annuity plans Tax authorities continue to focus on compliance of qualified annuity plans marketed by insurance companies. If sponsoring em- ployers cannot demonstrate compliance and the insurance company is held re- sponsible due to its marketing efforts, Lincoln Life and other insurers may be subject to potential liability. It is not possi- ble to provide a meaningful estimate of the range of potential liability at this time. Management continues to monitor this matter and to take steps to minimize any potential liability. Group pension annuities The liabilities for guaranteed interest and group pension annuity con- tracts, which are no longer be- G-21 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 7. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES CONTINUED ing sold, are supported by a single portfolio of assets which attempts to match the duration of these liabilities. Due to the very long-term nature of group pension annuities and the resulting inability to exactly match cash flows, a risk exists that future cash flows from investments will not be reinvested at rates as high as currently earned by the portfolio. This situation could cause losses which would be recognized at some future time. Leases Lincoln Life and certain of its subsidiaries lease their home office prop- erties 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 Lincoln Life with the right of first refusal to purchase the properties during the term of the lease, in- cluding renewal periods, at a price as defined in the agreements. In addi- tion, Lincoln Life has 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 pe- riods. Total rental expense under operating leases in 1995, 1994 and 1993 was $24,400,000, $21,700,000 and $27,100,000. Future minimum rental commitments are as follows (in millions): 1996 $ 20.9 ---------- 1997 19.5 ---------- 1998 18.3 ---------- 1999 18.3 ---------- 2000 17.7 ---------- Thereafter 172.4 ---------- ------ $267.1 ======
Insurance ceded and assumed Lincoln Life cedes insurance to other companies, including certain affili- ates. That portion of risks exceeding each company's retention limit is re- insured with other insurers. Lincoln Life seeks reinsurance coverage within the business segment that sells life insurance that limits its liabilities on an individual insured to $3,000,000. To cover products other than life insurance, Lincoln Life acquires other insurance coverages with retentions and limits which management believes are appropriate for the circumstances. The accompanying financial statements reflect premiums, benefits and set- tlement expenses and deferred acquisition costs, net of insurance ceded (see Note 5). Lincoln Life and its subsidiaries remain liable if their re- insurers are unable to meet their contractual obligations under the appli- cable reinsurance agreements. Lincoln Life assumes insurance from other companies, including certain af- filiates. At December 31, 1995, Lincoln Life has provided $92,700,000 of statutory surplus relief to other insurance companies under reinsurance transactions. Generally, such amounts are offset by corresponding receiv- ables from the ceding company, which are secured by future profits on the reinsured business. However, Lincoln Life is subject to the risk that the ceding company may become insolvent and the right of offset would not be permitted. Vulnerability from concentrations At December 31, 1995, Lincoln Life did not have a material concentration of financial instruments in a single investee, industry or geographic location. Also at December 31, 1995, Lincoln Life did not have a concentration of 1) business transactions with a particular customer, lender or distributor, 2) revenues from a par- ticular product or service, 3) sources of supply of labor or services used in the business or 4) 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 se- vere impact to Lincoln Life's financial condition. Other contingency matters Lincoln Life and its subsidiaries are involved in various pending or threatened legal proceedings arising from the conduct of their business. In some instances, these proceedings include claims for punitive damages and similar types of relief in unspecified or substantial amounts, in addition to amounts for alleged contractual liability or requests for equitable re- lief. After consultation with counsel and a review of available facts, it is management's opinion that these proceedings ultimately will be resolved without materially affecting the consolidated financial statements of Lin- coln Life. The number of insurance companies that are under regulatory supervision has resulted, and is expected to continue to result, in assessments by state guaranty funds to cover losses to policyholders of insolvent or rehabili- tated companies. Mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. Lincoln Life has accrued for expected assessments net of estimated future premium tax deductions. G-22 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 7.RESTRICTIONS, COMMITMENTS AND CONTINGENCIES CONTINUED Guarantees Lincoln Life has guarantees with off-balance-sheet risks whose contractual amounts represent credit exposure. Out- standing guarantees with off-balance-sheet risks, shown in notional or contract amounts, are as follows:
Notional or contract amounts ----------- December 31 1995 1994 --------------- (in millions) ----------- Real estate partnerships $ 3.3 $17.6 --------------------------------------- Mortgage loan pass-through certificates 63.6 78.2 --------------------------------------- ----- ----- $66.9 $95.8 ===== =====
Lincoln Life has invested in real estate partnerships that use conventional mortgage loans. In some cases, the terms of these arrangements involve guarantees by each of the part- ners to indemnify the mortgagor in the event a partner is unable to pay its principal and interest payments. In addi- tion, Lincoln Life has sold commercial mortgage loans through grantor trusts which issued pass-through certifi- cates. Lincoln Life has agreed to repurchase any mortgage loans which remain delinquent for 90 days at a repurchase price substantially equal to the outstanding principal bal- ance plus accrued interest thereon to the date of repur- chase. 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 Lincoln Life. Accordingly, both the carrying value and fair value of these guarantees is zero at December 31, 1995 and 1994. G-23 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 7.RESTRICTIONS, COMMITMENTS AND CONTINGENCIES CONTINUED Derivatives Lincoln Life has derivatives with off-balance-sheet risks whose notional or contract amounts exceed the credit expo- sure. Lincoln Life has entered into derivative transactions to reduce its exposure to fluctuations in interest rates, the widening of bond yield spreads over comparable maturity U.S. Government obligations and foreign exchange risks. In addition, Lincoln Life is subject to the risks associated with changes in the value of its derivatives; however, such changes in the value generally are offset by changes in the value of the items being hedged by such contracts. Outstand- ing derivatives with off-balance-sheet risks, shown in notional or contract amounts along with their carrying value and estimated fair values, are as follows:
Assets (Liabilities) ------------------------------ Notional or Carrying Fair Carrying Fair contract amounts value value value value ----------------- -------- ----- -------- ----- December 31 December 31 December 31 1995 1994 1995 1995 1994 1994 -------- -------- -------- ----- -------- ----- (in millions) ------------------------------------------------ Interest rate derivatives: Interest rate cap agreements $5,110.0 $4,400.0 $22.7 $5.3 $23.3 $34.4 ------------------------ Spread-lock agreements 600.0 1,300.0 (.9) (.9) 3.2 3.2 ------------------------ Financial futures contracts -- 382.5 -- -- (7.5) (7.5) ------------------------ Interest rate swaps 5.0 5.0 .2 .2 .2 .2 ------------------------ -------- -------- ----- ---- ----- ----- 5,715.0 6,087.5 22.0 4.6 19.2 30.3 Foreign currency derivatives: Foreign exchange forward contracts 15.7 21.2 (.6) (.6) .2 .2 ------------------------ Foreign currency options 99.2 -- 1.9 1.4 -- -- ------------------------ Foreign currency swaps 15.0 -- .4 .4 -- -- ------------------------ -------- -------- ----- ---- ----- ----- 129.9 21.2 1.7 1.2 .2 .2 -------- -------- ----- ---- ----- ----- $5,844.9 $6,108.7 $23.7 $5.8 $19.4 $30.5 ======== ======== ===== ==== ===== =====
A reconciliation and discussion of the notional or contract amounts for the significant programs using derivative agree- ments and contracts is as follows:
Interest rate caps Spread locks ----------------- ------------------- December 31 December 31 1995 1994 1995 1994 -------- -------- --------- -------- (in millions) ------------------------------------- Balance at beginning of year $4,400.0 $3,800.0 $ 1,300.0 $1,700.0 ---------------------------- New contracts 710.0 600.0 800.0 -- ---------------------------- Terminations and maturities -- -- (1,500.0) (400.0) ---------------------------- -------- -------- --------- -------- Balance at end of year $5,110.0 $4,400.0 $ 600.0 $1,300.0 ---------------------------- ======== ======== ========= ========
G-24 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 7.RESTRICTIONS, COMMITMENTS AND CONTINGENCIES CONTINUED
Financial futures ------------------------------------- Contracts Options 1995 1994 1995 1994 --------- -------- ------- ------- (in millions) ------------------------------------- Balance at beginning of year $ 382.5 $ 33.1 $ -- $ -- ---------------------------- New contracts 810.5 1,087.7 181.6 308.0 ---------------------------- Terminations and maturities (1,193.0) (738.3) (181.6) (308.0) ---------------------------- --------- -------- ------- ------- Balance at end of year $ -- $ 382.5 $ -- $ -- ---------------------------- ========= ======== ======= =======
Foreign currency derivatives ----------------------------------------- Foreign exchange Foreign Foreign forward currency currency contracts options swaps 1995 1994 1995 1994 1995 1994 ------- ------ ------- ---- ----- ---- (in millions) ----------------------------------------- Balance at beginning of year $ 21.2 $ -- $ -- $ -- $ -- $ -- ---------------------------- New contracts 131.2 38.5 356.6 -- 15.0 -- ---------------------------- Terminations and maturities (136.7) (17.3) (257.4) -- -- -- ---------------------------- ------- ------ ------- ---- ----- ---- Balance at end of year $ 15.7 $ 21.2 $ 99.2 $ -- $15.0 $ -- ---------------------------- ======= ====== ======= ==== ===== ====
Interest rate caps The interest rate cap agreements, which expire in 1997 through 2003, entitle Lincoln Life to receive payments from the counterparties on specified future reset dates, contin- gent 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 times the notional amount divided by four. The purpose of Lincoln Life's interest rate cap agreement program is to protect its annuity line of business from the effect of fluctuating in- terest rates. The premium paid for the interest rate caps is included in other assets ($22,700,000 and $23,400,000 as of December 31, 1995 and 1994, respectively) and is being amor- tized over the terms of the agreements and is included in net investment income. Spread locks Spread-lock agreements in effect at December 31, 1995 all expire in 2005. Spread-lock agreements provide for a lump sum payment to or by Lincoln Life depending on whether the spread between the swap rate and a specified U.S. Treasury note is larger or smaller than a contractually specified spread. Cash payments are based on the product of the notional amount, the spread between the swap rate and the yield of an equivalent maturity U.S. Treasury security and the price sensitivity of the swap at that time, expressed in dollars per basis point. The purpose of Lincoln Life's spread-lock program is to protect a portion of its fixed ma- turity securities against widening of spreads. G-25 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED Lincoln Life is exposed to credit loss in the event of nonperformance by counterparties on interest rate cap agreements, spread-lock agreements, in- terest rate swaps, foreign exchange forward contracts, foreign currency op- tions and foreign currency swaps, but Lincoln Life does not anticipate non- performance by any of these counterparties. The credit risk associated with such agreements is minimized by purchasing such agreements from financial institutions with long-standing, superior performance records. The amount of such exposure is essentially the net replacement cost or market value for such agreements with each counterparty if the net market value is in Lincoln Life's favor. At December 31, 1995, the exposure was $6,900,000. 8.FAIR VALUE OF FINANCIAL INSTRUMENTS The following discussion outlines the methodologies and assumptions used to determine the estimated fair value of Lincoln Life's financial instruments. Considerable judgment is required to develop these fair values and, accord- ingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one time, current market exchange of all of Lincoln Life's financial instruments. Fixed maturity and equity securities Fair values for fixed maturity securities are based on quoted market pric- es, where available. For fixed maturity securities not actively traded, fair values are estimated using values obtained from independent pricing services or, in the case of private placements, are estimated by discount- ing expected future cash flows using a current market rate applicable to the coupon rate, credit quality and maturity of the investments. The fair values for equity securities are based on quoted market prices. Mortgage loans on real estate The estimated fair value of mortgage loans on real estate was established using a discounted cash flow method based on credit rating, maturity and future income when compared to the expected yield for mortgages having sim- ilar characteristics. The rating for mortgages in good standing are based on property type, location, market conditions, occupancy, debt service cov- erage, loan to value, caliber of tenancy, borrower and payment record. Fair values for impaired mortgage loans are measured based either on the present value of expected future cash flows discounted at the loan's effective in- terest rate, at the loan's market price or the fair value of the collateral if the loan is collateral dependent. 7.RESTRICTIONS, COMMITMENTS AND CONTINGENCIES CONTINUED Financial futures Lincoln Life uses exchange-traded financial futures contracts and options on those financial futures to hedge against interest rate risks and to man- age duration of a portion of its fixed maturity securities. Financial futures contracts obligate Lincoln Life to buy or sell a financial instru- ment at a specified future date for a specified price and may be settled in cash or through delivery of the financial instrument. Cash settlements on the change in market values of financial futures contracts are made daily. Options on financial futures give Lincoln Life the right, but not the obli- gation, to assume a long or short position in the underlying futures at a specified price during a specified time period. Foreign currency derivatives Lincoln Life uses a combination of foreign exchange forward contracts, for- eign currency options and foreign currency swaps, all of which are traded over-the-counter, to hedge some of the foreign exchange risk of investments in fixed maturity securities denominated in foreign currencies. The foreign currency forward contracts obligate Lincoln Life to deliver a specified amount of currency at a future date at a specified exchange rate. Foreign currency options give Lincoln Life the right, but not the obligation, to buy or sell a foreign currency at a specific exchange rate during a speci- fied time period. A foreign currency swap is a contractual agreement to ex- change the currencies of two different countries pursuant to an agreement to reexchange the two currencies at the same rate of exchange at a speci- fied future date. Additional derivative information Expenses for the agreements and contracts described above amounted to $5,600,000 and $5,400,000 in 1995 and 1994, respectively. Deferred losses of $21,800,000 as of December 31, 1995, resulting from (1) terminated and expired spread-lock agreements, (2) financial futures contracts and (3) op- tions on financial futures, are included with the related fixed maturity securities to which the hedge applied and are being amortized over the life of such securities. G-26 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED Short-term and long-term debt Fair values for long-term debt issues are estimated using discounted cash flow analysis based on Lincoln Life's current incremental borrowing rate for similar types of borrowing arrangements. For short-term debt, the car- rying value approximates fair value. Guarantees Lincoln Life's guarantees include guarantees related to real estate part- nerships and mortgage loan pass-through certificates. Based on historical performance where repurchases have been negligible and the current status, which indicates none of the loans are delinquent, the fair value liability for the guarantees related to the mortgage loan pass-through certificates is insignificant. Fair values for all other guarantees are based on fees that would be charged currently to enter into similar agreements, taking into consideration the remaining terms of the agreements and the counterparties' credit standing. Derivatives Lincoln Life's derivatives include interest rate cap agreements, spread- lock agreements, foreign currency exchange contracts, financial futures contracts, options on financial futures, interest rate swaps, foreign cur- rency options and foreign currency swaps. Fair values for these contracts are based on current settlement values. The current settlement values are based on quoted market prices for the foreign currency exchange contracts, financial future contracts and options on financial futures and on broker- age quotes, which utilized pricing models or formulas using current assump- tions, for all other swaps and agreements. Investment commitments Fair values for commitments to make investment in fixed maturity securities (primarily private placements), mortgage loans on real estate and real es- tate are based on the difference between the value of the committed invest- ments as of the date of the accompanying balance sheets and the commitment date, which would take into account changes in interest rates, the counterparties' credit standing and the remaining terms of the commitments. 8.FAIR VALUE OF FINANCIAL INSTRUMENTS CONTINUED Policy loans The estimated fair value of investments in policy loans was calculated on a composite discounted cash flow basis using Treasury interest rates consis- tent with the maturity durations assumed. These durations were based on historical experience. Other investments and cash and invested cash The carrying value for assets classified as other investments and cash and invested cash in the accom- panying balance sheets approximates their fair value. Investment type insurance contracts The balance sheet captions, "Future policy benefits, claims and claims ex- penses" and "Contractholder funds," include investment type insurance con- tracts (i.e., deposit contracts and guaranteed interest contracts). The fair values for the deposit contracts and certain guaranteed interest con- tracts are based on their approximate surrender values. The fair values for the remaining guaranteed interest and similar contracts are estimated using discounted cash flow calculations based on interest rates currently being offered on similar contracts with maturities consistent with those remain- ing for the contracts being valued. The remainder of the balance sheet captions, "Future policy benefits, claims and claims expenses" and "Contractholder funds," that do not fit the definition of "investment type insurance contracts" are considered insur- ance contracts. Fair value disclosures are not required for these insurance contracts and have not been determined by Lincoln Life. It is Lincoln Life's position that the disclosure of the fair value of these insurance contracts is important in that readers of these financial statements could draw inappropriate conclusions about Lincoln Life's shareholder's equity determined on a fair value basis if only the fair value of assets and lia- bilities defined as financial instruments are disclosed. Lincoln Life and other companies in the insurance industry are monitoring the related ac- tions of the various rule-making bodies and attempting to determine an ap- propriate methodology for estimating and disclosing the "fair value" of their insurance contract liabilities. G-27 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 8.FAIR VALUE OF FINANCIAL INSTRUMENTS CONTINUED The carrying values and estimated fair values of Lincoln Life's financial instruments are as follows:
December 31 1995 1994 --------------------------------------------- Carrying Fair Carrying Fair Assets (Liabilities) value value value value --------------------------------------------------------------------------- (in millions) ---------------------------------------------- Fixed maturity securities $ 20,414.8 $ 20,414.8 $ 17,692.2 $ 17,692.2 ------------------------- Equity securities 598.4 598.4 456.3 456.3 ------------------------- Mortgage loans on real estate 3,147.8 3,330.5 2,795.9 2,720.6 ------------------------- Policy loans 565.3 557.4 528.7 508.1 ------------------------- Other investments 241.2 241.2 158.2 158.2 ------------------------- Cash and invested cash 802.7 802.7 990.9 990.9 ------------------------- Investment type insurance contracts: ------------------------- . Deposit contracts and certain guaranteed interest contracts (15,390.8) (15,179.1) (14,294.7) (14,052.5) ------------------------- . Remaining guaranteed interest and similar contracts (2,470.9) (2,396.5) (2,485.5) (2,423.9) ------------------------- Short-term debt (124.8) (124.8) (153.7) (153.7) ------------------------- Long-term debt (40.8) (36.7) (54.8) (57.0) ------------------------- Derivatives 23.7 5.8 19.4 30.5 ------------------------- Investment commitments -- (.8) -- (.5) -------------------------
As of December 31, 1995 and 1994, the carrying values of the deposit contracts and certain guaranteed contracts is net of deferred acquisition costs of $333,797,000 and $399,000,000, respectively, excluding adjustments for deferred acquisition costs applicable to changes in fair value of securities. The carrying values of these contracts are stated net of de- ferred acquisition costs in order that they be comparable with the fair value basis. 9.SEGMENT INFORMATION Lincoln Life has two major business segments: Life Insurance and Annuities and Reinsurance. The Life Insurance and Annui- ties segment offers universal life, pension products and other individual coverages through a network of career agents, independent general agencies and insurance agencies located within a variety of financial institutions. These products are sold throughout the United States by Lincoln Life. Reinsurance sells reinsurance products and services to insurance companies, HMOs, self-funded employers and other primary risk accepting organizations in the U.S. and econom- ically attractive international markets. Effective in the fourth quarter of 1995, operating results of the direct dis- ability income business previously included in the Life In- surance and Annuities segment is now included in the Rein- surance segment. This direct disability income business, which is no longer being sold, is now managed by the Rein- surance segment along with its disability income business. Prior to the sale of 100% of the ownership of its primary underwriter of employee life-health benefit coverages in 1994 (see Note 10), the Employee Life-Health Benefits seg- ment distributed group life and health insurance, managed health care and other related coverages through career agents and independent general agencies. Activity which is not included in the major business segments is shown as "Other Operations." "Other Operations" includes operations not directly related to the business segments and unallocated corporate items (i.e., corporate investment income, interest expense on cor- porate debt and unallocated corporate overhead expenses). G-28 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 9.SEGMENT INFORMATION CONTINUED The revenue, pre-tax income and assets by segment for 1993 through 1995 are as follows:
Year ended December 31 1995 1994 1993 --------------------------- (in millions) ----------------------------- Revenue: . Life Insurance and Annuities $ 2,569.2 $ 2,065.3 $ 2,341.9 --------------------------------------- . Reinsurance 751.2 660.4 610.7 --------------------------------------- . Employee Life-Health Benefits -- 314.9 1,326.8 --------------------------------------- . Other Operations 16.1 74.6 (28.8) --------------------------------------- --------- --------- --------- $ 3,336.5 $ 3,115.2 $ 4,250.6 ========= ========= ========= Income (loss) before income taxes and cumulative effect of accounting change: . Life Insurance and Annuities $ 361.0 $ 75.6 $ 265.3 --------------------------------------- . Reinsurance 83.5 93.9 31.6 --------------------------------------- . Employee Life-Health Benefits -- 22.9 83.0 --------------------------------------- . Other Operations 5.0 67.8 (44.2) --------------------------------------- --------- --------- --------- $ 449.5 $ 260.2 $ 335.7 ========= ========= ========= Assets: . Life Insurance and Annuities $45,280.0 $37,675.9 $36,021.0 --------------------------------------- . Reinsurance 3,383.5 2,311.5 2,328.9 --------------------------------------- . Employee Life-Health Benefits -- -- 588.5 --------------------------------------- . Other Operations 923.6 1,038.1 770.0 --------------------------------------- --------- --------- --------- $49,587.1 $41,025.5 $39,708.4 ========= ========= =========
Provisions for depreciation and capital additions were not material. 10.SALE OF AFFILIATES In December 1993, Lincoln Life recorded a provision for loss of $98,500,000 (also $98,500,000 after-tax) in the "Other Operations" segment for the sale of Security-Connecticut Life Insurance Company (Security-Connecticut). The sale was completed on February 2, 1994 through an initial public of- fering and Lincoln Life received cash and notes, net of re- lated expenses, totaling $237,700,000. The loss on sale and disposal expenses did not differ materially from the esti- mate recorded in the fourth quarter of 1993. For the year ended December 31, 1993, Security-Connecticut, which oper- ated in the Life Insurance and Annuities segment, had reve- nue of $274,500,000 and net income of $24,000,000. In 1994, Lincoln Life completed the sale of 100% of the com- mon stock of EMPHESYS (parent company of Employers Health Insurance Company, which comprised the Employee Life-Health Benefits segment) for $348,200,000 of cash, net of related expenses, and a $50,000,000 promissory note. A gain on sale of $69,000,000 (also $69,000,000 after-tax) was recognized in 1994 in "Other Operations". For the year ended December 31, 1993, EMPHESYS had revenues of $1,304,700,000 and net income of $55,300,000. EMPHESYS had revenue and net income of $314,900,000 and $14,400,000, respectively, during the three months of ownership in 1994. G-29 LINCOLN NATIONAL LIFE INSURANCE CO. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONTINUED Lincoln Life provides services to and receives services from affiliated companies which resulted in a net receipt of $7,500,000, $13,900,000 and $18,900,000 in 1995, 1994 and 1993, respectively. Lincoln Life both cedes and accepts reinsurance from affiliated companies. Premiums in the accompanying statements of income includes reinsurance transactions with affiliated companies as follows:
Year ended December 31 1995 1994 --------- (in millions) --------- Insurance assumed $ 17.6 $ 19.8 ----------------- Insurance ceded 214.4 481.3 -----------------
The balance sheets include reinsurance balances with affiliated companies as follows:
December 31 1995 1994 ----------------------------------------------- (in millions) ----------------------------------------------- Future policy benefits and claims assumed $ 344.8 $341.3 --------------------------------------------------- Future policy benefits and claims ceded 1,344.5 857.7 --------------------------------------------------- Amounts recoverable on paid and unpaid losses 65.9 36.8 --------------------------------------------------- Reinsurance payable on paid losses 5.5 3.5 --------------------------------------------------- Funds held under reinsurance treaties-net liability 712.3 238.4 ---------------------------------------------------
Substantially all reinsurance ceded to affiliated companies is with unau- thorized companies. To take a reserve credit for such reinsurance, Lincoln Life holds assets from the reinsurer, including funds held under reinsur- ance treaties, and is the beneficiary on letters of credit aggregating $340,800,000 and $308,200,000 at December 31, 1995 and 1994, respectively. At December 31, 1995 and 1994, LNC had guaranteed $275,300,000 and $298,200,000, respectively, of these letters of credit. At December 31, 1995, Lincoln Life has a receivable (included in the foregoing amounts) from affiliated insurance companies in the amount of $241,900,000 for stat- utory surplus relief received under financial reinsurance ceded agreements. 11.SUBSEQUENT EVENT In January 1996, LNC announced that it had signed a definitive agreement to acquire the group tax-sheltered annuity business of UNUM Corporation's af- filiates. This purchase is expected to be completed in the form of a rein- surance transaction with an initial ceding commission of approximately $70,000,000. This ceding commission represents the present value of busi- ness in-force and, accordingly, will be classified as other intangible as- sets upon the close of this transaction. This transaction, which is ex- pected to close in the third quarter of 1996, will increase LNC's assets and policy liabilities and accruals by approximately $3,200,000,000. 12.TRANSACTIONS WITH AFFILIATES A wholly owned subsidiary of LNC, Lincoln Financial Group, Inc. ("LFGI"), has a nearly exclusive general agents contract with Lincoln Life under which it sells Lincoln Life's products and provides the service that other- wise would be provided by a home office marketing department and regional offices. For providing these selling and marketing services, Lincoln Life paid LFGI override commissions and operating expense allowances of $81,900,000, $78,500,000 and $74,500,000 in 1995, 1994 and 1993, respec- tively. LFGI incurred expenses of $10,400,000, $10,700,000 and $10,500,000 in 1995, 1994 and 1993, respectively, in excess of the override commission and operating expense allowances received from Lincoln Life, which Lincoln Life is not required to reimburse. Cash and invested cash at December 31, 1995 and 1994 include Lincoln Life's participation in a short-term investment pool with LNC of $333,800,000 and $428,300,000, respectively. Related investment income amounted to $22,500,000, $17,100,000 and $9,100,000 in 1995, 1994 and 1993, respective- ly. Short-term debt at December 31, 1995 and 1994 includes $67,000,000 and $68,600,000, respectively, borrowed from LNC. Lincoln Life paid interest to LNC of $24,000, $8,000 and $137,000 in 1995, 1994 and 1993, respectively. G-30 FINANCIAL SCHEDULES The following consolidated financial statement schedules of Lincoln National Life Insurance Company and subsidiaries are included on pages G-32 through G-36: I. Summary of Investments--Other than Investments in Related Parties -- December 31, 1995 III. Supplementary Insurance Information Years ended Decem- ber 31, 1995, 1994 and 1993 IV. Reinsurance -- Years ended December 31, 1995, 1994 and 1993 V. Valuation and Qualifying Accounts -- Years ended December 31, 1995, 1994 and 1993 All other schedules for which provision is made in the ap- plicable accounting regulation of the Securities and Ex- change Commission are not required under the related in- structions, are inapplicable or the required information is included in the consolidated financial statements, and therefore have been omitted. G-31 LINCOLN NATIONAL LIFE INSURANCE CO. AND SUBSIDIARIES SCHEDULE I SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1995
Column A Column B Column C Column D - ------------------------------------------------------------------------------ Amount at which shown in the balance Type of Investment Cost Value sheet - ------------------------------------------------------------------------------ (000's omitted) ----------------------------------- Fixed maturity securities available- for-sale: Bonds: . United States Government and government agencies and authorities $ 569,552 $ 653,444 $ 653,444 -------------------------------------- . States, municipalities and political subdivisions 12,325 12,375 12,375 -------------------------------------- . Mortgage-backed securities 4,891,521 5,184,751 5,184,751 -------------------------------------- . Foreign governments 927,901 997,567 997,567 -------------------------------------- . Public utilities 2,572,309 2,772,990 2,772,990 -------------------------------------- . Convertibles and bonds with warrants attached 181,431 199,658 199,658 -------------------------------------- . All other corporate bonds 9,658,371 10,551,770 10,551,770 -------------------------------------- Redeemable preferred stocks 39,427 42,230 42,230 -------------------------------------- ----------- ----------- ----------- Total fixed maturity securities 18,852,837 20,414,785 20,414,785 - --------------------------------------- Equity securities available-for-sale: Common stocks: . Public utilities 8,980 10,989 10,989 -------------------------------------- . Banks, trust and insurance companies 74,897 89,197 89,197 -------------------------------------- . Industrial, miscellaneous and all other 345,434 436,556 436,556 -------------------------------------- Nonredeemable preferred stocks 50,950 61,693 61,693 -------------------------------------- ----------- ----------- ----------- Total equity securities 480,261 598,435 598,435 - --------------------------------------- Mortgage loans on real estate 3,176,275 3,147,783(A) Real estate: . Investment properties 635,135 635,135 -------------------------------------- . Acquired in satisfaction of debt 157,441 110,888(A) -------------------------------------- Policy loans 565,325 565,325 - --------------------------------------- Other investments 253,015 241,219(A) - --------------------------------------- ----------- ----------- Total investments $24,120,189 $25,713,570 - --------------------------------------- =========== ===========
(A) Investments which are deemed to have declines in value that are other than temporary are written down or reserved for to reduce their carrying value to their estimated realizable value. G-32 LINCOLN NATIONAL LIFE INSURANCE CO. AND SUBSIDIARIES SCHEDULE III SUPPLEMENTARY INSURANCE INFORMATION
Column A Column B Column C Column D Column E Column F - -------------------------------------------------------------------------------------- Future policy benefits, Other policy Deferred claims and claims and acquisition claim Unearned benefits Premium Segment costs expenses premiums payable revenue (A) - -------------------------------------------------------------------------------------- (000's omitted) ------------------------------------------------------------ Year ended December 31, 1995: Life insurance and annuities $ 713,213 $6,530,475 $ 9,145 $-- $ 685,258 ---------------------- Reinsurance 247,921 1,855,039 45,951 -- 611,416 ---------------------- Other (including consolidating adjustments) (7,300) 49,505 78 -- 622 ---------------------- ---------- ---------- ------- --- ---------- $ 953,834 $8,435,019 $55,174 $-- $1,297,296 ========== ========== ======= === ========== Year ended December 31, 1994: Life insurance and annuities $1,427,692 $5,888,581 $11,201 $-- $ 647,416 ---------------------- Reinsurance 304,913 1,626,033 51,618 -- 542,034 ---------------------- Employee life-health benefits -- -- -- -- 299,338 ---------------------- Other (including consolidating adjustments) 3,921 26,158 (1,347) -- 1,076 ---------------------- ---------- ---------- ------- --- ---------- $1,736,526 $7,540,772 $61,472 $-- $1,489,864 ========== ========== ======= === ========== Year ended December 31, 1993: Life insurance and annuities $ 999,126 $6,782,207 $ 5,188 $-- $ 662,353 ---------------------- Reinsurance 298,787 1,616,088 54,157 -- 491,397 ---------------------- Employee life-health benefits -- 228,892 -- -- 1,243,576 ---------------------- Other (including consolidating adjustments) -- 171,043 315 -- 387 ---------------------- ---------- ---------- ------- --- ---------- $1,297,913 $8,798,230 $59,660 $-- $2,397,713 ========== ========== ======= === ==========
(A) Includes insurance fees on universal life and other interest sensitive products. G-33 LINCOLN NATIONAL LIFE INSURANCE CO. AND SUBSIDIARIES SCHEDULE III SUPPLEMENTARY INSURANCE INFORMATION CONTINUED
Column A Column G Column H Column I Column J Column K - ------------------------------------------------------------------------------------------- Amortization Benefits, claims of deferred Other Net investment and claim acquisition operating Premium Segment income (B) expenses costs expenses (B) written - ------------------------------------------------------------------------------------------- (000's omitted) ------------------------------------------------------------------ Year ended December 31, 1995: Life insurance and annuities $1,741,231 $1,649,119 $298,020 $261,016 $ -- ---------------------- Reinsurance 134,000 472,198 101,729 93,750 -- ---------------------- Other (including consolidating adjustments) 24,399 1,299 -- 9,898 -- ---------------------- ---------- ---------- -------- -------- ----- $1,899,630 $2,122,616 $399,749 $364,664 $ -- ========== ========== ======== ======== ===== Year ended December 31, 1994: Life insurance and annuities $1,542,552 $1,554,479 $ 85,697 $349,529 $ -- ---------------------- Reinsurance 116,957 419,266 29,477 117,238 -- ---------------------- Employee life-health benefits (C) 10,838 218,672 -- 73,355 -- ---------------------- Other (including consolidating adjustments) 3,634 1,630 -- 5,682 -- ---------------------- ---------- ---------- -------- -------- ----- $1,673,981 $2,194,047 $115,174 $545,804 $ -- ========== ========== ======== ======== ===== Year ended December 31, 1993: Life insurance and annuities $1,676,163 $1,615,883 $197,363 $268,066 $ -- ---------------------- Reinsurance 115,582 467,824 38,351 72,840 -- ---------------------- Employee life-health benefits 54,513 943,235 -- 300,648 -- ---------------------- Other (including consolidating adjustments) (22,799) 6,197 5,275 (744) -- ---------------------- ---------- ---------- -------- -------- ----- $1,823,459 $3,033,139 $240,989 $640,810 $ -- ========== ========== ======== ======== =====
(B) The allocation of expenses between investments and other operations are based on a number of assumptions and estimates. Results would change if different methods were applied. (C) Includes data through the March 21, 1994 date of sale of the direct writer of employee life-health coverages. G-34 LINCOLN NATIONAL LIFE INSURANCE CO. AND SUBSIDIARIES SCHEDULE IV REINSURANCE (A)
Column A Column B Column C Column D Column E Column F - -------------------------------------------------------------------------------------- Percentage Ceded Assumed of amount Gross to other from other assumed to Segment amount companies companies Net amount net - -------------------------------------------------------------------------------------- (000's omitted) ------------------------------------------------------------- Year ended December 31, 1995: Life insurance in force $ 51,570,782 $17,612,782 $142,794,000 $176,752,000 80.8% ----------------------- Premiums: ----------------------- Health insurance 302,463 299,222 273,572 276,813 98.8 ---------------------- Life insurance (B) 658,936 142,523 504,070 1,020,483 49.4 ---------------------- ------------ ----------- ------------ ------------ $ 961,399 $ 441,745 $ 777,642 $ 1,297,296 ============ =========== ============ ============ Year ended December 31, 1994: Life insurance in force $ 79,802,000 $45,822,000 $125,640,000 $159,620,000 78.7% ----------------------- Premiums: ----------------------- Health insurance 666,609 496,090 359,659 530,178 67.8 ---------------------- Life insurance (B) 629,185 220,678 551,179 959,686 57.4 ---------------------- ------------ ----------- ------------ ------------ $ 1,295,794 $ 716,768 $ 910,838 $ 1,489,864 ============ =========== ============ ============ Year ended December 31, 1993: Life insurance in force $135,401,000 $61,401,000 $109,257,000 $183,257,000 59.6% ----------------------- Premiums: ----------------------- Health insurance 1,387,414 217,705 262,171 1,431,880 18.3 ---------------------- Life insurance (B) 771,408 350,907 545,332 965,833 56.5 ---------------------- ------------ ----------- ------------ ------------ $ 2,158,822 $ 568,612 $ 807,503 $ 2,397,713 ============ =========== ============ ============
(B) Includes insurance fees on universal life and other interest sensitive products. G-35 LINCOLN NATIONAL LIFE INSURANCE CO. AND SUBSIDIARIES SCHEDULE V VALUATION AND QUALIFYING ACCOUNTS
Column A Column B Column C Column D Column E - --------------------------------------------------------------------------------- Additions ----------------------- (1) (2) Charged to Balance at Charged other Deductions- Balance beginning to costs and accounts- describe at end of Description of period expenses (A) describe (B) period - --------------------------------------------------------------------------------- (000's omitted) -------------------------------------------------------- Year ended December 31, 1995: Deducted from asset accounts: . Reserve for mortgage loans on real estate $ 56,614 $ 2,659 $ -- $ (30,781) $ 28,492 ----------------------- . Reserve for real estate 65,186 (7,227) -- (11,406) 46,553 ----------------------- . Reserve for other long-term investments 13,492 (1,541) -- (155) 11,796 ----------------------- Year ended December 31, 1994: Deducted from asset accounts: . Reserve for mortgage loans on real estate $220,671 $ 19,464 $ -- $(183,521) $ 56,614 ----------------------- . Reserve for real estate 121,427 13,058 -- (69,299) 65,186 ----------------------- . Reserve for other long-term investments 26,730 262 -- (13,500) 13,492 ----------------------- Included in other liabilities: Investment guarantees 1,804 4,280 -- (6,084) -- ----------------------- Year ended December 31, 1993: Deducted from asset accounts: . Reserve for mortgage loans on real estate $129,093 $136,717 $ -- $ (45,139) $220,671 ----------------------- . Reserve for real estate 114,178 21,776 -- (14,527) 121,427 ----------------------- . Reserve for other long-term investments 31,582 3,905 -- (8,757) 26,730 ----------------------- Included in other liabilities: Investment guarantees 12,550 1,674 -- (12,420) 1,804 -----------------------
(A) Exclude charges for the direct write-off of assets. The negative amounts represent improvements in the underlying assets for which valuation ac- counts had previously been established. (B) Deductions reflect sales or foreclosures of the underlying holdings. G-36 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Board of Directors Lincoln National Life Insurance Company We have audited the accompanying consolidated balance sheets of Lincoln National Life Insurance Co., a wholly owned sub- sidiary of Lincoln National Corp., as of December 31, 1995 and 1994, and the related consolidated statements of income, shareholder's equity and cash flows for each of the three years in the period ended December 31, 1995. Our audits also included the financial statement schedules listed on page G- 31. These financial statements and schedules are the respon- sibility of the Company'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 generally ac- cepted auditing standards. 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 fi- nancial statements. An audit also includes assessing the ac- counting 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 Life Insurance Co. at December 31, 1995 and 1994, and the consolidated result of its operations and its cash flows for each of the three years in the period ended December 31, 1995, in conformity with 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 state- ments, in 1993 the Company changed its method of accounting for postretirement benefits other than pensions, accounting for impairment of loans and accounting for certain invest- ments in debt and equity securities. /s/ Ernst & Young LLP Fort Wayne, Indiana February 7, 1996 G-37 LINCOLN NATIONAL LIFE INSURANCE COMPANY BALANCE SHEETS--STATUTORY BASIS
December 31 1996 1995 --------- --------- (in millions) -------------------- ADMITTED ASSETS CASH AND INVESTMENTS: Bonds $19,389.6 $17,729.7 - ------------------------------------------------------------------------------------------------------- Preferred stocks 239.7 89.9 - ------------------------------------------------------------------------------------------------------- Unaffiliated common stocks 358.3 535.5 - ------------------------------------------------------------------------------------------------------- Affiliated common stocks 241.5 193.0 - ------------------------------------------------------------------------------------------------------- Mortgage loans on real estate 2,976.7 2,909.7 - ------------------------------------------------------------------------------------------------------- Real estate 621.3 655.2 - ------------------------------------------------------------------------------------------------------- Policy loans 626.5 515.8 - ------------------------------------------------------------------------------------------------------- Other investments 282.7 248.0 - ------------------------------------------------------------------------------------------------------- Cash and short-term investments 759.2 780.9 - ----------------------------------------------------------------------------------- --------- --------- Total cash and investments 25,495.5 23,657.7 - ------------------------------------------------------------------------------------------------------- Premiums and fees in course of collection 60.9 17.1 - ------------------------------------------------------------------------------------------------------- Accrued investment income 343.6 342.5 - ------------------------------------------------------------------------------------------------------- Funds withheld by ceding companies 25.8 595.3 - ------------------------------------------------------------------------------------------------------- Other admitted assets 355.7 217.7 - ------------------------------------------------------------------------------------------------------- Separate account assets 23,735.1 18,461.6 - ----------------------------------------------------------------------------------- --------- --------- Total admitted assets $50,016.6 $43,291.9 - ----------------------------------------------------------------------------------- ========= ========= LIABILITIES AND CAPITAL AND SURPLUS LIABILITIES: Future policy benefits and claims $ 5,954.0 $ 5,713.3 - ------------------------------------------------------------------------------------------------------- Other policyholder funds 17,262.4 15,598.5 - ------------------------------------------------------------------------------------------------------- Amounts withheld or retained by Company as agent or trustee 250.2 499.3 - ------------------------------------------------------------------------------------------------------- Funds held under reinsurance treaties 564.6 1,053.5 - ------------------------------------------------------------------------------------------------------- Asset valuation reserve 375.5 270.0 - ------------------------------------------------------------------------------------------------------- Interest maintenance reserve 76.7 116.3 - ------------------------------------------------------------------------------------------------------- Other liabilities 490.9 391.3 - ------------------------------------------------------------------------------------------------------- Federal income taxes 4.3 3.2 - ------------------------------------------------------------------------------------------------------- Net transfers due from separate accounts (659.7) (548.0) - ------------------------------------------------------------------------------------------------------- Separate account liabilities 23,735.1 18,461.6 - ----------------------------------------------------------------------------------- --------- --------- Total liabilities 48,054.0 41,559.0 - ------------------------------------------------------------------------------------------------------- CAPITAL AND SURPLUS: Common stock, $2.50 par value: Authorized, issued and outstanding shares--10 million (owned by Lincoln National Corporation) 25.0 25.0 - ------------------------------------------------------------------------------------------------------- Paid-in surplus 883.4 783.4 - ------------------------------------------------------------------------------------------------------- Unassigned surplus 1,054.2 924.5 - ----------------------------------------------------------------------------------- --------- --------- Total capital and surplus 1,962.6 1,732.9 - ----------------------------------------------------------------------------------- --------- --------- Total liabilities and capital and surplus $50,016.6 $43,291.9 - ----------------------------------------------------------------------------------- ========= =========
See accompanying notes. S-1 LINCOLN NATIONAL LIFE INSURANCE COMPANY STATEMENTS OF INCOME--STATUTORY BASIS
Year ended December 31 1996 1995 1994 ----------------------- (in millions) -------------------------- PREMIUMS AND OTHER REVENUES: Premiums and deposits $7,268.5 $4,899.1 $5,648.7 - ------------------------------------------------------------------------------- Net investment income 1,756.3 1,772.2 1,606.8 - ------------------------------------------------------------------------------- Amortization of interest maintenance reserve 27.2 34.0 9.8 - ------------------------------------------------------------------------------- Commissions and expense allowances on reinsurance ceded 90.9 98.3 145.0 - ------------------------------------------------------------------------------- Expense charges on deposit funds 100.7 83.2 70.5 - ------------------------------------------------------------------------------- Other income 16.8 14.5 15.6 - --------------------------------------------------- -------- -------- -------- Total revenues 9,260.4 6,901.3 7,496.4 - ------------------------------------------------------------------------------- BENEFITS AND EXPENSES: Benefits and settlement expenses 5,989.9 4,184.0 5,071.6 - ------------------------------------------------------------------------------- Underwriting, acquisition, insurance and other expenses 2,878.5 2,345.7 2,136.1 - --------------------------------------------------- -------- -------- -------- Total benefits and expenses 8,868.4 6,529.7 7,207.7 - --------------------------------------------------- -------- -------- -------- Gain from operations before dividends to policyholders, income taxes and net realized gain on investments 392.0 371.6 288.7 - ------------------------------------------------------------------------------- Dividends to policyholders 27.3 27.3 18.0 - --------------------------------------------------- -------- -------- -------- Gain from operations before federal income taxes and net realized gain on investments 364.7 344.3 270.7 - ------------------------------------------------------------------------------- Federal income taxes 83.6 103.7 52.8 - --------------------------------------------------- -------- -------- -------- Gain from operations before net realized gain on investments 281.1 240.6 217.9 - ------------------------------------------------------------------------------- Net realized gain on investments, net of income tax expense (benefits) [1996--$28.5; 1995--$48.1; 1994--$(178.1)] and excluding net transfers to (from) the interest maintenance reserve [1996-- $(12.4); 1995--$94.9; 1994--$(147.1)] 53.3 43.9 124.0 - --------------------------------------------------- -------- -------- -------- Net income $ 334.4 $ 284.5 $ 341.9 - --------------------------------------------------- ======== ======== ========
See accompanying notes. S-2 LINCOLN NATIONAL LIFE INSURANCE COMPANY STATEMENTS OF CHANGES IN CAPITAL AND SURPLUS--STATUTORY BASIS
Year ended December 31 1996 1995 1994 -------- -------- -------- (in millions) ---------------------------- Capital and surplus at beginning of year $1,732.9 $1,679.6 $1,302.5 - ---------------------------------------------------------------- CAPITAL AND SURPLUS INCREASE (DECREASE): Net income 334.4 284.5 341.9 - ---------------------------------------------------------------- Differences in cost and admitted investment amounts 38.6 143.2 (123.3) - ---------------------------------------------------------------- Nonadmitted assets (3.0) 2.9 (3.2) - ---------------------------------------------------------------- Regulatory liability for reinsurance 0.6 (2.0) (1.1) - ---------------------------------------------------------------- Life policy reserve valuation basis (0.4) 2.9 (1.3) - ---------------------------------------------------------------- Asset valuation reserve (105.5) (112.5) 83.8 - ---------------------------------------------------------------- Mortgage loan, real estate and other investment reserves -- 2.2 218.6 - ---------------------------------------------------------------- Paid-in surplus 100.0 15.1 -- - ---------------------------------------------------------------- Separate account receivable due to change in valuation -- 27.0 -- - ---------------------------------------------------------------- Accounting for separate account contracts -- -- (13.3) - ---------------------------------------------------------------- Dividends to shareholder (135.0) (310.0) (125.0) - ---------------------------------------------------------------- -------- -------- -------- Capital and surplus at end of year $1,962.6 $1,732.9 $1,679.6 - ---------------------------------------------------------------- ======== ======== ========
SEE ACCOMPANYING NOTES. S-3 LINCOLN NATIONAL LIFE INSURANCE COMPANY STATEMENTS OF CASH FLOWS--STATUTORY BASIS
Year ended December 31 1996 1995 1994 ---------------------------------- (in millions) ---------------------------------- OPERATING ACTIVITIES Premiums, policy proceeds and other considerations received $ 8,059.4 $ 5,430.9 $ 5,654.5 - ------------------------------------------------------------------------------------- Allowances and reserve adjustments received (paid) on reinsurance ceded (767.5) (383.6) 137.1 - ------------------------------------------------------------------------------------- Investment income received 1,700.6 1,713.2 1,588.5 - ------------------------------------------------------------------------------------- Benefits paid (4,050.4) (3,239.6) (3,054.1) - ------------------------------------------------------------------------------------- Insurance expenses paid (2,972.2) (2,513.5) (2,542.5) - ------------------------------------------------------------------------------------- Federal income taxes recovered (paid) (72.3) 38.4 (191.8) - ------------------------------------------------------------------------------------- Dividends to policyholders (27.7) (16.5) (18.4) - ------------------------------------------------------------------------------------- Other income received and expenses paid, net 6.3 14.4 59.2 - ------------------------------------------------------------------------------------- ---------- ---------- ---------- Net cash provided by operating activities 1,876.2 1,043.7 1,632.5 - ------------------------------------------------------------------------------------- INVESTING ACTIVITIES Sale, maturity or repayment of investments 12,542.0 13,183.9 11,877.0 - ------------------------------------------------------------------------------------- Purchase of investments (14,175.4) (14,049.6) (12,871.8) - ------------------------------------------------------------------------------------- Other uses (266.5) (64.0) (123.4) - ------------------------------------------------------------------------------------- ---------- ---------- ---------- Net cash used in investing activities (1,899.9) (929.7) (1,118.2) - ------------------------------------------------------------------------------------- FINANCING ACTIVITIES Surplus paid-in 100.0 15.1 -- - ------------------------------------------------------------------------------------- Proceeds from borrowings 100.0 63.0 63.0 - ------------------------------------------------------------------------------------- Repayment of borrowings (63.0) (63.0) (60.0) - ------------------------------------------------------------------------------------- Dividends paid to shareholder (135.0) (310.0) (125.0) - ------------------------------------------------------------------------------------- ---------- ---------- ---------- Net cash provided by (used in) financing activities 2.0 (294.9) (122.0) - ------------------------------------------------------------------------------------- ---------- ---------- ---------- Net increase (decrease) in cash and short-term investments (21.7) (180.9) 392.3 - ------------------------------------------------------------------------------------- Cash and short-term investments at beginning of year 780.9 961.8 569.5 - ------------------------------------------------------------------------------------- ---------- ---------- ---------- Cash and short-term investments at end of year $ 759.2 $ 780.9 $ 961.8 - ------------------------------------------------------------------------------------- ========== ========== ==========
See accompanying notes. S-4 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS 1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND OPERATIONS The Lincoln National Life Insurance Company ("Company") is a wholly owned subsidiary of Lincoln National Corporation ("LNC") and is domiciled in In- diana. As of December 31, 1996, the Company owns 100% of the outstanding common stock of four insurance company subsidiaries: First Penn-Pacific Life Insurance Company, Lincoln National Health & Casualty Insurance Compa- ny, Lincoln National Reassurance Company and Lincoln Life & Annuity Company of New York. The Company's principal business consist of underwriting annuities, depos- it-type contracts, life and health insurance through multiple distribution channels and the reinsurance of individual and group life and health busi- ness. The Company is licensed and sells its products in 49 states, Canada and several U.S. territories. USE OF ESTIMATES The preparation of financial statements requires management to make esti- mates and assumptions that affect amounts reported in the financial state- ments and accompanying notes. Such estimates and assumptions could change in the future as more information becomes known, which could impact the amounts reported and disclosed herein. BASIS OF PRESENTATION The accompanying financial statements have been prepared in conformity with accounting practices prescribed or permitted by the Indiana Department of Insurance, which practices differ from generally accepted accounting prin- ciples ("GAAP"). The more significant variances from GAAP are as follows: INVESTMENTS Bonds are reported at cost or amortized cost or market value based on their National Association of Insurance Commissioners ("NAIC") rating. For GAAP, the Company's bonds are classified as available-for-sale and, accordingly, are reported at fair value with changes in the fair values reported di- rectly in shareholder's equity after adjustments for related amortization of deferred acquisition costs, additional policyholder commitments and de- ferred income taxes. Investments in real estate are reported net of related obligation rather than on a gross basis. Changes between cost and admitted asset investment amounts are credited or charged directly to unassigned surplus rather than to a separate surplus account. Under a formula prescribed by the NAIC, the Company defers the portion of realized capital gains and losses on sales of fixed income investments, principally bonds and mortgage loans, attributable to changes in the gen- eral level of interest rates and amortizes those deferrals over the remain- ing period to maturity of the individual security sold. The net deferral is reported as the interest maintenance reserve in the accompanying balance sheets. Realized capital gains and losses are reported in income net of federal income tax and transfers to the interest maintenance reserve. The asset valuation reserve is determined by an NAIC prescribed formula and is reported as a liability rather than unassigned surplus. Under GAAP, real- ized capital gains and losses are reported in the income statement on a pre-tax basis in the period that the asset giving rise to the gain or loss is sold and valuation allowances are provided when there has been a decline in value deemed other than temporary, in which case, the provision for such declines are charged to income. SUBSIDIARIES The accounts and operations of the Company's subsidiaries are not consoli- dated with the accounts and operations of the Company as would be required by GAAP. Under statutory accounting principles, the Company's subsidiaries are carried at their statutory-basis net equity. POLICY ACQUISITION COSTS The costs of acquiring and renewing business are expensed when incurred. Under GAAP, acquisition costs related to traditional life insurance, to the extent recoverable from future policy revenues, are deferred and amortized over the premium-paying period of the related policies using assumptions consistent with those used in computing policy benefit reserves. For uni- versal life insurance, annuity and other investment-type products, deferred policy acquisition costs, to the extent recoverable from future gross prof- its, are amortized generally in proportion to the present value of expected gross profits from surrender charges and investment, mortality and expense margins. NONADMITTED ASSETS Certain assets designated as "nonadmitted," principally furniture and equipment and certain receivables, are excluded from the accompanying bal- ance sheets and are charged directly to unassigned surplus. PREMIUMS Premiums and deposits with respect to universal life policies and annuity and other investment-type contracts are reported as premium revenues; whereas, under GAAP, such premiums and deposits are treated as liabilities and policy charges represent revenues. S-5 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED INCOME TAXES Deferred income taxes are not provided for differences between financial statement amounts and tax bases of assets and liabilities. POLICYHOLDER DIVIDENDS Policyholder dividends are recognized when declared rather than over the term of the related policies. Other significant accounting practices are as follows: INVESTMENTS The discount or premium on bonds is amortized using the interest method. For mortgage-backed bonds, the Company recognizes income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect ac- tual payments to date and anticipated future payments. The net investment in the securities is adjusted to the amount that would have existed had the new effective yield been applied since the acquisition of the securities. Short-term investments include investments with maturities of less than one year at the date of acquisition. The carrying amounts for these investments approximate their fair values. Preferred stocks are reported at cost or amortized cost. Common stocks are reported at market value as determined by the Securities Valuation Office of the NAIC and the related unrealized gains (losses) are reported in unassigned surplus without adjustment for federal income taxes. Policy loans are reported at unpaid balances. The Company uses various derivative instruments as part of its overall lia- bility-asset management program for certain investments and life insurance and annuity products. The Company values all derivative instruments on a basis consistent with that of the hedged item. Upon termination, gains and losses on those instruments are included in the carrying values of the un- derlying hedged items and are amortized over the remaining lives of the hedged items as adjustments to investment income or benefits from the hedged items. Any unamortized gains or losses are recognized when the un- derlying hedged items are sold. Mortgage loans on real estate are reported at unpaid balances, less allow- ances for impairments. Real estate is reported at depreciated cost. As of June 30, 1994, the Company changed its method of accounting for reserves on impaired real estate and mortgage loans. The impaired investment is now shown on a pre-tax basis as a nonadmitted asset. Previously, these reserves were presented as a liability, net of related tax benefits, to approximate the impact on surplus if losses were realized. Realized investment gains and losses on investments sold are determined us- ing the specific identification method. Changes in admitted asset carrying amounts of 1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONTINUED BENEFIT RESERVES Certain policy reserves are calculated based on statutorily required inter- est and mortality assumptions rather than on estimated expected experience or actual account balances as would be required under GAAP. Death benefits paid, policy and contract withdrawals, and the change in policy reserves on universal life policies, annuity and other investment- type contracts are reported as benefits and settlement expenses; in the ac- companying statement of income, whereas, under GAAP, withdrawals are treated as a reduction of the policy or contract liabilities and benefits would represent the excess of benefits paid over the policy account value and interest credited to the account values. REINSURANCE Premiums, claims and policy benefits and contract liabilities are reported in the accompanying financial statements net of reinsurance amounts. For GAAP, all assets and liabilities related to reinsurance ceded contracts are reported on a gross basis. A liability for reinsurance balances has been provided for unsecured policy and contract liabilities and unearned premiums ceded to reinsurers not au- thorized by the Indiana Department of Insurance to assume such business. Changes to those amounts are credited or charged directly to unassigned surplus. Under GAAP, an allowance for amounts deemed uncollectible is es- tablished through a charge to income. Commissions on business ceded are reported as income when received rather than deferred and amortized with deferred policy acquisition costs. Certain reinsurance contracts meeting risk transfer requirements under statutory-basis accounting practices have been accounted for using tradi- tional reinsurance accounting whereas such contracts would be accounted for using deposit accounting under GAAP. POSTRETIREMENT BENEFITS For purposes of calculating the Company's postretirement benefit obliga- tion, only vested employees and current retirees are included in the valua- tion. Under GAAP, active employees not currently eligible would also be in- cluded. S-6 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED CLAIMS AND CLAIM ADJUSTMENT EXPENSES Unpaid claims and claim adjustment expenses on accident and health policies represent the estimated ultimate net cost of all reported and unreported claims incurred during the year. The Company does not discount claims and claim adjustment expense reserves. The reserves for unpaid claims and claim adjustment expenses are estimated using individual case-basis valuations and statistical analyses. Those estimates are subject to the effects of trends in claim severity and frequency. Although considerable variability is inherent in such estimates, management believes that the reserves for claims and claim adjustment expenses are adequate. The estimates are con- tinually reviewed and adjusted as necessary as experience develops or new information becomes known; such adjustments are included in current opera- tions. REINSURANCE CEDED AND ASSUMED Reinsurance premiums and claims and claim adjustment expenses are accounted for on bases consistent with those used in accounting for the original pol- icies issued and the terms of the reinsurance contracts. Certain business is transacted on a funds withheld basis and investment income on funds withheld are reported in net investment income. PENSION BENEFITS Costs associated with the Company's defined benefit pension plans is sys- tematically accrued during the expected period of active service of the covered employees. INCOME TAXES The Company and eligible subsidiaries have elected to file consolidated federal and state income tax returns with LNC. Pursuant to an intercompany tax sharing agreement with LNC, the Company provides for income taxes on a separate return filing basis. The tax sharing agreement also provides that the Company will receive benefit for net operating losses, capital losses and tax credits which are not usable on a separate return basis to the ex- tent such items may be utilized in the consolidated income tax returns of LNC. STOCK OPTIONS The Company recognizes compensation expense for its stock option incentive plans using the intrinsic value method of accounting. Under the terms of the intrinsic value method, compensation cost is the excess, if any, of the quoted market price of LNC's common stock at the grant date, or other mea- surement date, over the amount an employee must pay to acquire the stock. ASSETS HELD IN SEPARATE ACCOUNTS AND LIABILITIES RELATED TO SEPARATE ACCOUNTS These assets and liabilities represent segregated funds administered and invested by LNC's insurance subsidiaries for the exclusive benefit of pen- sion and variable life and annuity contractholders. The fees received by the Company for administrative and contractholder maintenance services per- formed for these separate accounts are included in the Company's statements of income. 1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONTINUED bonds, mortgage loans and common and preferred stocks are credited or charged directly in unassigned surplus. DATA PROCESSING EQUIPMENT Data processing equipment is reported at depreciated cost, with deprecia- tion determined on a straight-line basis over five years. GOODWILL Goodwill, which represents the excess of the ceding commission over statu- tory-basis net assets of business purchased under an assumption reinsurance agreement, is amortized on a straight-line basis over ten years. PREMIUMS Life insurance and annuity premiums are recognized as revenue when due. Ac- cident and health premiums are earned prorata over the contract term of the policies. BENEFITS Life, annuity and accident and health benefit reserves are developed by ac- tuarial methods and are determined based on published tables using statuto- rily specified interest rates and valuation methods that will provide, in the aggregate, reserves that are greater than or equal to the minimum or guaranteed policy cash values or the amounts required by the Indiana De- partment of Insurance. The Company waives deduction of deferred fractional premiums on the death of life and annuity policy insureds and returns any premium beyond the date of death, except for policies issued prior to March 1977. Surrender values on policies do not exceed the corresponding benefit reserves. Additional reserves are established when the results of cash flow testing under various interest rate scenarios indicate the need for such reserve. If net premiums exceed the gross premiums on any insurance in- force, additional reserves are established. Benefit reserves for policies underwritten on a substandard basis are determined using the multiple table reserve method. The tabular interest, tabular less actual reserve released and the tabular cost have been determined by formula or from the basic data for such items. Tabular interest funds not involving life contingencies were determined us- ing the actual interest credited to the funds plus the change in accrued interest. Liabilities related to guaranteed investment contracts and policyholder funds left on deposit with the Company generally are equal to fund balances less applicable surrender charges. S-7 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) A reconciliation of the Company's net income and capital and surplus deter- mined on a statutory accounting basis with amounts determined in accordance with GAAP is as follows:
Capital and Surplus Net Income -------------------- ----------------------- Year ended December December 31 31 1996 1995 1996 1995 1994 --------- --------- ------ ------ ------- (in millions) Amounts reported on a statutory basis $ 1,962.6 $ 1,732.9 $334.4 $284.5 $ 341.9 ---------------------------- GAAP adjustments: ---------------------------- Deferred policy acquisition costs and present value of future profits 1,119.1 850.2 66.7 (63.0) 191.1 ---------------------------- Policy and contract reserves (1,405.3) (1,562.2) (57.1) (55.3) (53.6) ---------------------------- Interest maintenance reserve 76.7 116.3 (39.7) 60.9 (157.0) ---------------------------- Deferred income taxes (27.4) (122.5) 1.8 38.3 (138.3) ---------------------------- Policyholders' share of earnings and surplus on participating business (81.9) (91.9) (.3) .2 (3.0) ---------------------------- Asset valuation reserve 375.5 270.0 -- -- -- ---------------------------- Net realized gain (loss) on investments (72.0) (67.4) 78.7 30.0 47.1 ---------------------------- Adjustment to unrealized gain (loss) 825.2 1,494.0 -- -- -- ---------------------------- Nonadmitted assets, including nonadmitted investments (7.1) 57.9 -- -- -- ---------------------------- Net GAAP adjustments of subsidiary companies 156.6 131.2 29.9 34.3 48.2 ---------------------------- Other, net (99.0) (89.7) (82.6) (7.3) (58.6) ---------------------------- --------- --------- ------ ------ ------- Net increase (decrease) 860.4 985.9 (2.6) 38.1 (124.1) ---------------------------- --------- --------- ------ ------ ------- Amounts on a GAAP basis $ 2,823.0 $ 2,718.8 $331.8 $322.6 $ 217.8 ---------------------------- ========= ========= ====== ====== =======
S-8 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 2.PERMITTED STATUTORY ACCOUNTING PRACTICES The Company's statutory-basis financial statements are prepared in accor- dance with accounting practices prescribed or permitted by the Indiana De- partment of Insurance (the "Department"). "Prescribed" statutory accounting practices include state laws, regulations and general administrative rules, as well as a variety of publications of the NAIC. "Permitted" statutory ac- counting practices encompass all accounting practices that are not pre- scribed; such practices may differ from state to state, may differ from company to company within a state and may change in the future. The NAIC currently is in the process of recodifying statutory accounting practices, the result of which is expected to constitute the only source of "pre- scribed" statutory accounting practices. Accordingly, that project, which is expected to be completed in 1998, will likely change, to some extent, prescribed statutory accounting practices, and may result in changes to the accounting practices that the Company uses to prepare its statutory-basis financial statements. In 1994, the Company received approval from the Department to change its accounting for surrender charges applicable to separate account liabilities for variable life and annuity products so that the surrender charges on these products are recorded as a liability in the separate account finan- cial statements payable to the Company's general account. In the accompany- ing financial statements, a corresponding receivable is recorded with the related income impact recorded in the accompanying statement of operations as a change in reserves or change in premium and other deposit funds. The cumulative effect of this change increased 1994 net income by $13,299,000. The Company has approval from the Department to establish valuation allow- ances on mortgage loans on real estate in accordance with GAAP, which are in excess of that prescribed by the NAIC and the Department. Prior to 1995, the Company has considered certain amounts under modified coinsurance reinsurance contracts as adjustments to premiums. As such, pol- icyholder dividends, cash surrender charges and reserve adjustments with interest thereon and commissions on reinsurance assumed are classified as premiums, rather than on expense lines, with no net effect on net income or capital and surplus. On a net-of-ceded basis for the year ended December 31, 1994, this practice resulted in increases to both revenues and expenses of approximately $600,000,000. In addition, reserve adjustments with inter- est thereon and commissions on reinsurance ceded were also classified as premiums, rather than in other revenue classifications. For the year ended December 31, 1994, this intra-revenue grouping reduced premiums by approxi- mately $50,000,000. Beginning in 1995, the Company reports modified coin- surance agreements on a gross basis. This change was made as a result of communications with the Department. This accounting change had no effect on income or surplus and prior period amounts have not been restated. S-9 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 3. INVESTMENTS The major categories of net investment income are as follows:
Year ended December 31 1996 1995 1994 ----------------------------------------- (in millions) -------------------------- Income: Bonds $1,442.2 $1,457.4 $1,266.7 -------------------------------------------------------------------------------- Preferred stocks 9.6 6.4 5.8 -------------------------------------------------------------------------------- Unaffiliated common stocks 6.5 5.2 4.4 -------------------------------------------------------------------------------- Affiliated common stocks 9.5 12.6 62.5 -------------------------------------------------------------------------------- Mortgage loans on real estate 269.3 252.0 255.2 -------------------------------------------------------------------------------- Real estate 114.4 110.0 97.4 -------------------------------------------------------------------------------- Policy loans 35.0 32.1 29.7 -------------------------------------------------------------------------------- Other investments 22.4 62.6 121.3 -------------------------------------------------------------------------------- Cash and short-term investments 48.9 53.2 43.3 --------------------------------------------------------------- -------- -------- -------- Total investment income 1,957.8 1,991.5 1,886.3 ----------------------------------------------------------------------------------- Expenses: Depreciation 25.0 25.9 21.9 -------------------------------------------------------------------------------- Other 176.5 193.4 257.6 --------------------------------------------------------------- -------- -------- -------- Total investment expenses 201.5 219.3 279.5 ---------------------------------------------------------------- -------- -------- -------- Net investment income $1,756.3 $1,772.2 $1,606.8 ---------------------------------------------------------------- ======== ======== ========
Nonadmitted accrued investment income at December 31, 1996 and 1995 amounted to $2,500,000 and $11,500,000, respective- ly, consisting principally of interest on bonds in default and mortgage loans. The cost or amortized cost, gross unrealized gains and losses and the fair value of investments in bonds are summa- rized as follows:
Cost or Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------------------ (in millions) ----------------------------------------- At December 31, 1996: Corporate $12,548.1 $ 586.5 $ 66.6 $13,068.0 -------------------------------------------------------------- U.S. government 1,088.7 43.2 18.0 1,113.9 -------------------------------------------------------------- Foreign government 1,234.0 105.1 1.4 1,337.7 -------------------------------------------------------------- Mortgage-backed 4,478.4 183.3 27.4 4,634.3 -------------------------------------------------------------- State and municipal 40.4 .1 -- 40.5 -------------------- --------- -------- ------ --------- $19,389.6 $ 918.2 $113.4 $20,194.4 ========= ======== ====== ========= At December 31, 1995: Corporate $11,642.0 $1,074.7 $ 41.4 $12,675.3 -------------------------------------------------------------- U.S. government 546.4 82.2 -- 628.6 -------------------------------------------------------------- Foreign government 908.0 68.0 .6 975.4 -------------------------------------------------------------- Mortgage-backed 4,628.3 283.2 11.2 4,900.3 -------------------------------------------------------------- State and municipal 5.0 .1 -- 5.1 -------------------- --------- -------- ------ --------- $17,729.7 $1,508.2 $ 53.2 $19,184.7 ========= ======== ====== =========
S-10 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 3. INVESTMENTS CONTINUED Fair values for bonds are based on quoted market prices, where available. For bonds not actively traded, fair values are estimated using values obtained from independent pricing services or, in the case of private placements, are esti- mated by discounting expected future cash flows using a cur- rent market rate applicable to the coupon rate, credit qual- ity and maturity of the investments. A summary of the cost or amortized cost and fair value of investments in bonds at December 31, 1996, by contractual maturity, is as follows:
Cost or Amortized Fair Cost Value ------------------------------ (in millions) ------------------- Maturity: In 1997 $ 358.0 $ 360.1 ---------------------------------------------------------------------------------------------- In 1998-2001 3,809.0 3,912.3 ---------------------------------------------------------------------------------------------- In 2002-2006 4,760.9 4,917.3 ---------------------------------------------------------------------------------------------- After 2006 5,983.3 6,370.4 ---------------------------------------------------------------------------------------------- Mortgage-backed securities 4,478.4 4,634.3 --------------------------------------------------------------------------- --------- --------- Total $19,389.6 $20,194.4 --------------------------------------------------------------------------- ========= =========
The expected maturities may differ from the contractual ma- turities in the foregoing table because certain borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. At December 31, 1996, the Company did not have a material concentration of financial instruments in a single investee, industry or geographic location. Proceeds from sales of investments in bonds during 1996, 1995 and 1994 were $10,996,900,000, $12,234,100,000 and $9,668,300,000, respectively. Gross gains during 1996, 1995 and 1994 of $169,700,000, $225,600,000 and $62,600,000, re- spectively, and gross losses of $177,000,000, $83,100,000 and $286,800,000, respectively, were realized on those sales. At December 31, 1996 and 1995, investments in bonds, with an admitted asset value of $70,700,000 and $60,700,000, respec- tively, were on deposit with state insurance departments to satisfy regulatory requirements. The cost or amortized cost, gross unrealized gains and losses and the fair value of investments in unaffiliated common stocks and preferred stocks are as follows:
Cost or Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value ------------------------------- (in millions) ------------------------------- At December 31, 1996: Preferred stocks $239.7 $ 10.5 $ 1.7 $248.5 ---------------------------------------------------------- Unaffiliated common stocks 289.9 84.6 16.2 358.3 ---------------------------------------------------------- At December 31, 1995: Preferred stocks 89.9 13.9 .2 103.6 ---------------------------------------------------------- Unaffiliated common stocks 438.0 110.0 12.5 535.5 ----------------------------------------------------------
S-11 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 3. INVESTMENTS CONTINUED The carrying value of affiliated common stocks, representing their statutory-basis net equity, was $241,500,000 and $193,000,000 at December 31, 1996 and 1995, respectively. The cost basis of investments in subsidiaries as of December 31, 1996 and 1995 was $194,000,000 and $123,000,000, respec- tively. During 1996, the maximum and minimum lending rates for mort- gage loans were 10.5% and 6.0%, respectively. At the issu- ance of a loan, the percentage of loan to value on any one loan does not exceed 75%. At December 31, 1996, the Company did not hold any mortgages with interest overdue beyond one year. At December 31, 1996, the Company's investments in mortgage loans were subject to $59,700,000 of prior liens. All properties covered by mortgage loans have fire insurance at least equal to the excess of the loan over the maximum loan that would be allowed on the land without the building. 4.FEDERAL INCOME TAXES The effective federal income tax rate for financial report- ing purposes differs from the prevailing statutory tax rate principally due to tax-exempt investment income, dividends- received tax deductions, differences in policy acquisition costs and policy and contract liabilities for tax return and financial statement purposes. Federal income taxes incurred of $83,600,000, $103,700,000 and $52,800,000 in 1996, 1995 and 1994, respectively, would be subject to recovery in the event that the Company incurs net operating losses within three years of the years for which such taxes were paid. Prior to 1984, a portion of the Company's current income was not subject to current income tax, but was accumulated for income tax purposes in a memorandum account designated as "policyholders' surplus." The Company's balance in the "pol- icyholders' surplus" account at December 31, 1983 of $187,000,000 was "frozen" by the Tax Reform Act of 1984 and, accordingly, there have been no additions to the accounts after that date. That portion of current income on which in- come taxes have been paid will continue to be accumulated in a memorandum account designated as "shareholder's surplus," and is available for dividends to the shareholder without additional payment of tax by the Company. The December 31, 1996 memorandum account balance for "shareholder's surplus" was $1,606,000,000. Should dividends to the shareholder ex- ceed its respective "shareholder's surplus," amounts would need to be transferred from the "policyholders' surplus" and would be subject to federal income tax at that time. Under existing or foreseeable circumstances, the Company neither expects nor intends that distributions will be made that will result in any such tax. 5.SUPPLEMENTAL FINANCIAL DATA The balance sheet caption, "Other Admitted Assets," includes amounts recoverable from other insurers for claims paid by the Company, and the balance sheet caption, "Future Policy Benefits and Claims," has been reduced for insurance ceded as follows:
December 31 -------------------------- 1996 1995 1994 ---------------------------------------- (in millions) ---------------------------------------- Insurance ceded $1,154.5 $1,634.0 $1,721.1 Amounts recoverable from other insurers 16.0 4.4 4.8
S-12 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 5.SUPPLEMENTAL FINANCIAL DATA CONTINUED Reinsurance transactions included in the income statement caption, "Premiums and Deposits," are as follows:
Year ended December 31 1996 1995 1994 -- (in millions) -------------------- Insurance assumed $241.3 $667.7 $607.3 ------------------------------- Insurance ceded 193.3 453.1 583.8 ------------------------------- ------ ------ ------ Net amount included in premiums $ 48.0 $214.6 $ 23.5 ------------------------------- ====== ====== ======
The income statement caption, "Benefits and Settlement Ex- penses," is net of reinsurance recoveries of $787,886,200, $1,407,000,000 and $1,391,100,000 for 1996, 1995 and 1994, respectively. Deferred and uncollected life insurance premiums and annuity considerations included in the balance sheet caption, "Pre- miums and Fees in Course of Collection," are as follows:
December 31, 1996 ----------------------- Net of Gross Loading Loading (in millions) ----------------------- Ordinary new business $ 3.9 $1.9 $ 2.0 --------------------- Ordinary renewal 35.1 3.0 32.1 --------------------- Group life 9.4 (.1) 9.5 --------------------- Group annuity -- -- -- --------------------- ------ ---- ------ $ 48.4 $4.8 $ 43.6 ====== ==== ====== December 31, 1995 ----------------------- Net of Gross Loading Loading (in millions) ----------------------- Ordinary new business $ 2.5 $1.1 $ 1.4 --------------------- Ordinary renewal (19.1) 2.8 (21.9) --------------------- Group life 15.8 -- 15.8 --------------------- Group annuity .2 -- .2 --------------------- ------ ---- ------ $ (.6) $3.9 $ (4.5) ====== ==== ======
The Company has entered into non-exclusive managing general agent agreements with International Benefit Services Corp., HRM Claim Management, Inc. and Pediatrics Insurance Consul- tants, Inc. to write group life and health business. Direct premiums written amounted to $26,200,000 $3,800,000 and $8,600,000 in 1996 and $33,100,000, $10,600,000 and $8,800,000 in 1995, respectively. During 1996, LNC Adminis- trative Services entered into a similar agreement with the Company with direct premiums written amounting to $6,200,000. Authority granted by the managing general agents agreements include underwriting, claims adjustment and claims payment services. S-13 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 6.ANNUITY RESERVES At December 31, 1996, the Company's annuity reserves and de- posit fund liabilities, including separate accounts, that are subject to discretionary withdrawal with adjustment, subject to discretionary withdrawal without adjustment and not subject to discretionary withdrawal provisions are sum- marized as follows:
Amount Percent ---------------- (in millions) ------------------- Subject to discretionary withdrawal with adjustment: With market value adjustment $ 2,971.8 6.0% ------------------------------------------------------ At book value, less surrender charge 5,228.6 12.0 ------------------------------------------------------ At market value 22,703.4 51.0 ------------------------------------------------------ ---------- ------ 30,903.8 69.0 Subject to discretionary withdrawal without adjustment at book value with minimal or no charge or adjustment 10,986.4 25.0 ------------------------------------------------------ Not subject to discretionary withdrawal 2,601.9 6.0 ------------------------------------------------------ ---------- ------ Total annuity reserves and deposit fund 44,492.1 liabilities--before reinsurance 100.0% ------------------------------------------------------ ====== Less reinsurance 1,848.8 ------------------------------------------------------ ---------- Net annuity reserves and deposit fund liabilities, including separate accounts $42,643.3 ------------------------------------------------------ ==========
7.CAPITAL AND SURPLUS Life insurance companies are subject to certain Risk-Based Capital ("RBC") requirements as specified by the NAIC. Under those requirements, the amount of capital and surplus main- tained by a life insurance company is to be determined based on the various risk factors related to it. At December 31, 1996, the Company exceeds the RBC requirements. The payment of dividends by the Company is limited and can- not be made except from earned profits. The maximum amount of dividends that may be paid by life insurance companies without prior approval of the Indiana Insurance Commissioner is subject to restrictions relating to statutory surplus and net gain from operations. In 1997, the Company can pay divi- dends of $281,100,000 without prior approval of the Indiana Insurance Commissioner. 8.EMPLOYEE BENEFIT PLANS Pension plans LNC maintains funded defined benefit pension plans for most of its employees and, prior to January 1, 1995, full-time agents. The benefits for employees are based on total years of service and the highest 60 months of compensation during the last 10 years of employment. The benefits for agents were based on a percentage of each agent's yearly earnings. The plans are funded by contributions to tax-exempt trusts. The Company's funding policy is consistent with the funding requirements of Federal laws and regulations. Contributions are intended to provide not only the benefits attributed to service to date, but also those expected to be earned in the future. Plan assets consist principally of listed equity se- curities, corporate obligations and government bonds. All benefits applicable to the funded defined benefit plan for agents were frozen as of December 31, 1994. The curtail- ment of this plan did not have a significant effect on net pension cost for 1994. Effective January 1, 1995, pension benefits for agents have been provided by a new defined S-14 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 8.EMPLOYEE BENEFIT PLANS CONTINUED contribution plan. Contributions to this plan will be based on 2.3% of an agent's earnings up to the social security wage base and 4.6% of any excess. LNC also administers two types of unfunded, non-qualified, defined benefit plans for certain employees and agents. A supplemental retirement plan provides employees and agents defined benefit pension benefits in excess of limits imposed by Federal tax law. A salary continuation plan provides cer- tain officers of the Company defined pension benefits based on years of service and final monthly salary upon death or retirement. The status of the funded defined benefit pension plans and the amounts recognized in the balance sheets are as follows:
December 31 1996 ------- 1995 (in millions) ---------------- Actuarial present value of benefit obligation: Vested benefits $(156.9) $(146.1) ------------------------------------------------------------------------- Nonvested benefits (6.0) (7.7) ------------------------------------------------------------------------- ------- ------- Accumulated benefit obligation (162.9) (153.8) ------------------------------------------------------------------------- Effect of projected future compensation increases (27.9) (28.5) ------------------------------------------------------------------------- ------- ------- Projected benefit obligation (190.8) (182.3) ------------------------------------------------------------------------- Plan assets at fair value 186.1 173.2 ------------------------------------------------------------------------- ------- ------- Projected benefit obligation in excess of plan assets (4.7) (9.1) ------------------------------------------------------------------------- Unrecognized net loss 4.9 9.3 ------------------------------------------------------------------------- Unrecognized prior service cost 1.4 1.5 ------------------------------------------------------------------------- ------- ------- Prepaid pension costs included in other liabilities $ 1.6 $ 1.7 ------------------------------------------------------------------------- ======= =======
The status of the unfunded defined benefit pension plans and the amounts recognized in the balance sheets are as follows:
December 31 1996 ----- 1995 (in millions) ------------ Actuarial present value of benefit obligation: Vested benefits $(6.6) $(6.4) ------------------------------------------------------------------- Nonvested benefits (.9) (1.1) ------------------------------------------------------------------- ----- ----- Accumulated benefit obligation (7.5) (7.5) ------------------------------------------------------------------- Effect of projected future compensation increases (1.1) (1.7) ------------------------------------------------------------------- ----- ----- Projected benefit obligation (8.6) (9.2) ------------------------------------------------------------------- Unrecognized net loss (gain) (.1) .9 ------------------------------------------------------------------- Unrecognized prior service cost .2 .3 ------------------------------------------------------------------- ----- ----- Accrued pension costs included in other liabilities $(8.5) $(8.0) ------------------------------------------------------------------- ===== =====
S-15 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 8.EMPLOYEE BENEFIT PLANS CONTINUED The determination of the projected benefit obligation for the defined benefit plans was based on the following assump- tions:
December 31 1996 1995 1994 --------------------------- Weighted-average discount rate 7.0% 7.0% 8.0% ---------------------------------------------------------------------- Rate of increase in compensation: ---------------------------------------------------------------------- Salary continuation plan 5.5 6.0 6.5 ---------------------------------------------------------------------- All other plans 4.5 5.0 5.0 ---------------------------------------------------------------------- Expected long-term rate of return on plan assets 9.0 9.0 9.0 ---------------------------------------------------------------------- The components of net pension cost for the defined benefit pension plans are as follows: Year ended December 31 1996 1995 1994 --------------------------- Service cost--benefits earned during the year $ 5.2 $ 4.1 $ 7.9 ------------------------------------------------------------------------ Interest cost on projected benefit obligation 12.9 11.9 11.6 ------------------------------------------------------------------------ Actual return on plan assets (17.5) (32.0) 4.2 ------------------------------------------------------------------------ Net amortization (deferral) 3.1 20.3 (16.7) ------------------------------------------------------------------------ ----- ----- ----- Net pension cost $ 3.7 $ 4.3 $ 7.0 ------------------------------------------------------------------------ ===== ===== =====
401K PLAN LNC and the Company sponsor contributory defined contribu- tion plans for eligible employees and agents. The Company's contributions to the plans are equal to each participant's pre-tax contribution, not to exceed 6% of base pay, multi- plied by a percentage ranging from 25% to 150%, which varies according to certain incentive criteria as determined by LNC's Board of Directors. Expense for these plans amounted to $9,300,000, $6,700,000 and $11,200,000 in 1996, 1995 and 1994, respectively. POSTRETIREMENT MEDICAL AND LIFE INSURANCE BENEFIT PLANS LNC sponsors unfunded defined benefit plans that provide postretirement medical and life insurance benefits to full- time employees and agents who, depending on the plan, have worked for the Company 10 to 15 years and attained age 55 to 60. Medical benefits are also available to spouses and other dependents of employees and agents. For medical benefits, limited contributions are required from individuals retired prior to November 1, 1988; contributions for later retirees, which can be adjusted annually, are based on such items as years of service at retirement and age at retirement. The life insurance benefits are noncontributory, although par- ticipants can elect supplemental contributory benefits. The status of the postretirement medical and life insur- ance benefit plans and the amounts recognized in the bal- ance sheets are as follows:
December 31 1996 1995 -------------------------- (in millions) -------------- Accumulated postretirement benefit obligation: Retirees $(32.4) $(37.9) ------------------------------------------------------------------------ Fully eligible active plan participants (8.2) (8.7) ------------------------------------------------------------------------ ------ ------ Accumulated postretirement benefit obligation (40.6) (46.6) ------------------------------------------------------------------------ Unrecognized net loss (gain) (7.0) .8 ------------------------------------------------------------------------ ------ ------ Accrued plan cost included in other liabilities $(47.6) $(45.8) ------------------------------------------------------------------------ ====== ======
S-16 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 8.EMPLOYEE BENEFIT PLANS CONTINUED The components of periodic postretirement benefit cost are as follows:
Year ended December 31 1996 1995 1994 --------------------------------- (in millions) ---------------- Service cost $1.3 $1.1 $1.4 ------------------------------------------------------------------------ Interest cost 2.7 3.0 3.1 ------------------------------------------------------------------------ Amortized cost (credit) (.5) (.4) .1 ------------------------------------------------------------------------ ---- ---- ---- Net periodic postretirement benefit cost $3.5 $3.7 $4.6 ------------------------------------------------------------------------ ==== ==== ====
The calculation of the accumulated postretirement benefit obligation assumes a weighted-average annual rate of in- crease in the per capita cost of covered benefits (i.e., health care cost trend rate) of 8.5% for 1997. It further assumes the rate will gradually decrease to 5.0% by 2005 and remain at that level. The health care cost trend rate as- sumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point each year would increase the accumulated postretirement benefit obligation as of December 31, 1996 and 1995 by $1,900,000 and $2,100,000, respective- ly. The aggregate of the estimated service and interest cost components of net periodic postretirement benefit cost for the year ended December 31, 1996 would increase by $184,000. The calculation assumes a long-term rate of increase in com- pensation of 4.5% and 5.0% at December 31, 1996 and 1995, respectively. The weighted-average discount rate used in de- termining the accumulated postretirement benefit obligation was 7.0% for both December 31, 1996 and 1995. 9.RESTRICTIONS, COMMITMENTS AND CONTINGENCIES DISABILITY INCOME POLICIES The liability for disability income claims net of the related asset for amounts recoverable from reinsurers at December 31, 1996 and 1995 is a net liability of $572,000,000 and $503,800,000, respectively. This liability is based on the assumption that the recent experience will continue in the fu- ture. If incidence levels or claim termination rates vary significantly from these assumptions, adjustments to reserves may be required in the fu- ture. Accordingly, this liability may prove to be deficient or excessive. However, it is management's opinion that such future development will not materially affect the financial position of the Company. The Company con- tinually reviews and updates the level of these reserves. During the fourth quarter of 1995, the Company completed an in-depth review of the experience of its disability income business. As a result of this study, and based on the assumption that recent experience will continue in the future, net income decreased by $15,200,000 as a result of strengthen- ing the disability income reserve. MARKETING AND COMPLIANCE ISSUES Regulators continue to focus on market conduct and compliance issues. Under certain circumstances companies operating in the insurance and financial services markets have been held responsible for providing incomplete or misleading sales materials and for replacing existing policies with poli- cies that were less advantageous to the policyholder. The Company's manage- ment continues to monitor the Company's sales materials and compliance pro- cedures and is making an extensive effort to minimize any potential liabil- ity. However, due to the uncertainty surrounding such matters, it is not possible to provide a meaningful estimate of the range of potential out- comes at this time. GROUP PENSION ANNUITIES The liabilities for guaranteed interest and group pension annuity con- tracts, which are no longer being sold by the Company, are supported by a single portfolio of assets that attempts to match the duration of these li- abilities. Due to the very long-term nature of group pension annuities and the resulting inability to exactly match cash flows, a risk exists that fu- ture cash flows from investments will not be reinvested at rates as high as currently earned by the portfolio. Accordingly, these liabilities may prove to be deficient or excessive. However, it is management's opinion that such future development will S-17 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED INSURANCE CEDED AND ASSUMED The Company cedes insurance to other companies, including certain affili- ates. The portion of risks exceeding the Company's retention limit is rein- sured with other insurers. Industry regulations prescribe the maximum cov- erage that the Company can retain on an individual insured. As of December 31, 1996, the Company's maximum retention on a single insured was $3,000,000. To cover products other than life insurance, the Company ac- quires other insurance coverages with retentions and limits that management believes are appropriate for the circumstances. The accompanying financial statements reflect premiums and benefits and settlement expenses, net of insurance ceded. The Company remains liable if its reinsurers are unable to meet their contractual obligations under the applicable reinsurance agree- ments. The Company assumes insurance from other companies, including certain af- filiates. At December 31, 1996, the Company has provided $17,200,000 of statutory surplus relief to other insurance companies under reinsurance transactions. Generally, such amounts are offset by corresponding receiv- ables from the ceding company, which are secured by future profits on the reinsured business. However, the Company is subject to the risk that the ceding company may become insolvent and the right of offset would not be permitted. VULNERABILITY FROM CONCENTRATIONS At December 31, 1996, the Company did not have a concentration of: 1) busi- ness transactions with a particular customer, lender or distributor; 2) revenues from a particular product or service; 3) sources of supply of la- bor or services used in the business; or 4) 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 the Company's financial condition. 9.RESTRICTIONS, COMMITMENTS AND CONTINGENCIES CONTINUED not materially affect the financial position of the Company. LEASES The Company leases its home office properties. 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 the Company with the right of first refusal to purchase the properties during the term of the lease, including renewal periods, at a price as defined in the agreements. In addition, the Company has the option to purchase the leased properties at fair value as defined in the agreements on the last day of the initial 25 year lease pe- riod ending in 2009 or on the last day of any of the renewal periods. Total rental expense on operating leases in 1996, 1995 and 1994 was $26,400,000, $22,500,000 and $20,600,000, respectively. Future minimum rental commitments are as follows (in millions): 1997 $ 17.5 1998 17.1 1999 17.4 2000 16.9 2001 17.2 Thereafter 151.6 ------ $237.7 ======
S-18 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 9.RESTRICTIONS, COMMITMENTS AND CONTINGENCIES CONTINUED OTHER CONTINGENCY MATTERS The Company is involved in various pending or threatened legal proceedings 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 proceed- ings ultimately will be resolved without materially affecting the financial position or results of operations of the Company. The number of insurance companies that are under regulatory supervision has resulted, and is expected to continue to result, in assessments by state guaranty funds to cover losses to policyholders of insolvent or rehabili- tated companies. Mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. The Company has accrued for expected assessments net of estimated future premium tax deductions. REINSURANCE The regulatory required liability for unsecured reserves ceded to unautho- rized reinsurers was $4,300,000 and $5,600,000 at December 31, 1996 and 1995, respectively. GUARANTEES The Company has guarantees with off-balance-sheet risks whose contractual amounts represent credit exposure. Outstanding guarantees with off-balance- sheet risks, shown in notional or contract amounts, are as follows:
Notional or Contract Amounts ----------------- December 31 ----------------- 1996 1995 -------------------- (in millions) ----------------- Mortgage loan pass-through certificates $ 50.3 $ 63.6 Real estate partnerships .5 3.3 -------- -------- $ 50.8 $ 66.9 ======== ========
The Company has invested in real estate partnerships that use conventional mortgage loans. In some cases, the terms of these arrangements involve guarantees by each of the partners to indemnify the mortgagor in the event a partner is unable to pay its principal and interest payments. In addi- tion, the Company has sold commercial mortgage loans through grantor trusts which issued pass-through certificates. The Company has agreed to repur- chase any mortgage loans which remain delinquent for 90 days at a repur- chase price substantially equal to the outstanding principal balance plus accrued interest thereon to the date of repurchase. 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 the Company. Accordingly, both the carrying value and fair value of these guarantees is zero at December 31, 1996 and 1995. S-19 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 9.RESTRICTIONS, COMMITMENTS AND CONTINGENCIES CONTINUED DERIVATIVES The Company has derivatives with off-balance-sheet risks whose notional or contract amounts exceed the credit ex- posure. The Company has entered into derivative transac- tions to reduce its exposure to fluctuations in interest rates, the widening of bond yield spreads over comparable maturity U.S. Government obligations and foreign exchange risks. In addition, the Company is subject to the risks associated with changes in the value of its derivatives; however, such changes in the value generally are offset by changes in the value of the items being hedged by such contracts. Outstanding derivatives with off-balance-sheet risks, shown in notional or contract amounts along with their carrying value and estimated fair values, are as follows:
Assets (Liabilities) ------------------------------ Notional or Carrying Fair Carrying Fair contract amounts value value value value --------------------------------------------- December 31 December 31 December 31 1996 1995 1996 1996 1995 1995 --------------------------------------------- (in millions) ------------------------------------------------ Interest rate derivatives: Interest rate cap agreements $5,500.0 $5,110.0 $20.8 $ 8.2 $22.7 $5.3 Spread-lock agreements -- 600.0 -- -- (.9) (.9) Swaptions 672.0 -- 11.0 10.6 -- -- Financial futures contracts 147.7 -- (2.4) (2.4) -- -- Interest rate swaps -- 5.0 -- -- .2 .2 -------- -------- ----- ----- ----- ---- 6,319.7 5,715.0 29.4 16.4 22.0 4.6 Foreign currency derivatives: Foreign exchange forward contracts 251.5 15.7 .2 (.2) (.6) (.6) Foreign currency options 43.9 99.2 .6 .4 1.9 1.4 Foreign currency swaps 15.0 15.0 -- (2.1) .4 .4 -------- -------- ----- ----- ----- ---- 310.4 129.9 .8 (1.9) 1.7 1.2 -------- -------- ----- ----- ----- ---- $6,630.1 $5,844.9 $30.2 $14.5 $23.7 $5.8 ======== ======== ===== ===== ===== ====
S-20 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 9.RESTRICTIONS, COMMITMENTS AND CONTINGENCIES CONTINUED A reconciliation and discussion of the notional or contract amounts for the significant programs using derivative agree- ments and contracts at December 31 is as follows:
Interest Rate Caps Spread Locks Swaptions ---------------------------------------------------------------------- 1996 1995 1996 1995 1996 1995 ---------------------------------------------------------------------- (in millions) ---------------------------------------------------------------- Balance at beginning of year $ 5,110.0 $ 4,400.0 $ 600.0 $ 1,300.0 $ -- $ -- New contracts 390.0 710.0 15.0 800.0 672.0 -- Terminations and -- -- (615.0) (1,500.0) -- -- maturities --------- --------- --------- --------- --------- --------- Balance at end of year $ 5,500.0 $ 5,110.0 $ -- $ 600.0 $ 672.0 $ -- ========= ========= ========= ========= ========= ========= Financial Futures ------------------------------------------ Contracts Options Interest Rate Swaps 1996 1995 1996 1995 1996 1995 ---------------------------------------------------------------------- Balance at beginning of year $ -- $ 382.5 $ -- $ -- $ 5.0 $ -- New contracts 7,918.8 810.5 -- 181.6 -- -- Terminations and (7,771.1) (1,193.0) -- (181.6) (5.0) -- maturities --------- --------- --------- --------- --------- --------- Balance at end of year $ 147.7 $ -- $ -- $ -- $ -- $ -- ========= ========= ========= ========= ========= ========= Foreign Currency Derivatives ---------------------------------------------------------------------- Foreign Exchange Foreign Currency Foreign Forward Contracts Options Currency Swaps 1996 1995 1996 1995 1996 1995 ---------------------------------------------------------------------- (in millions) ---------------------------------------------------------------- Balance at beginning of year $ 15.7 $ 21.2 $ 99.2 $ -- $ 15.0 $ -- New contracts 406.9 131.2 1,168.8 356.6 -- 15.0 Terminations and (171.1) (136.7) (1,224.1) (257.4) -- -- maturities --------- --------- --------- --------- --------- --------- Balance at end of year $ 251.5 $ 15.7 $ 43.9 $ 99.2 $ 15.0 $ 15.0 ========= ========= ========= ========= ========= =========
S-21 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 9.RESTRICTIONS, COMMITMENTS AND CONTINGENCIES CONTINUED INTEREST RATE CAPS The interest rate cap agreements, which expire in 1997 through 2003, enti- tle the Company to receive 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 the Company's interest rate cap agreement program is to protect its annuity line of business from the ef- fect of fluctuating interest rates. The premium paid for the interest rate caps is included in other assets ($20,800,000 as of December 31, 1996) and is being amortized over the terms of the agreements. This amortization is included in net investment income. SWAPTIONS Swaptions, which expire in 2002, entitle the Company to receive settlement payments from the counterparties on specified expiration dates, contingent on future interest rates. For each swaption, the amount of such settlement payments, if any, is determined by the present value of the difference be- tween the fixed rate on a market rate swap and the strike rate multiplied by the notional amount. The purpose of the Company's swaption program is to protect the assets supporting its annuity line of business from the effect of fluctuating interest rates. The premium paid for the swaptions is in- cluded in other assets ($11,000,000 as of December 31, 1996) and is being amortized over the terms of the agreements. This amortization is included in net investment income. SPREAD LOCKS Spread-lock agreements provide for a lump sum payment to or by the Company, depending on whether the spread between the swap rate and a specified U.S. Treasury note is larger or smaller than a contractually specified spread. Cash payments are based on the product of the notional amount, the spread between the swap rate and the yield of an equivalent maturity U.S. Treasury security and the price sensitivity of the swap at that time. It is ex- pressed in dollars-per-basis point. The purpose of the Company's spread- lock program is to protect a portion of its fixed maturity securities against widening of spreads. FINANCIAL FUTURES The Company uses exchange-traded financial futures contracts and options on those financial futures to hedge against interest rate risks and to manage duration of a portion of its fixed maturity securities. Financial futures contracts obligate the Company to buy or sell a financial instrument at a specified future date for a specified price. They may be settled in cash or through delivery of the financial instrument. Cash settlements on the change in market values of financial futures contracts are made daily. Op- tions on financial futures give the Company the right, but not the obliga- tion, to assume a long or short position in the underlying futures at a specified price during a specified time period. FOREIGN CURRENCY DERIVATIVES The Company uses a combination of foreign exchange forward contracts, for- eign currency options and foreign currency swaps, all of which are traded over-the-counter, to hedge some of the foreign exchange risk of investments in fixed maturity securities denominated in foreign currencies. The foreign currency forward contracts obligate the Company to deliver a specified amount of currency at a future date at a specified exchange rate. Foreign currency options give the Company the right, but not the obligation, to buy or sell a foreign currency at a specific exchange rate during a specified time period. A foreign currency swap is a contractual agreement to exchange the currencies of two different countries pursuant to an agreement to re- exchange the two currencies at the same rate of exchange at a specified fu- ture date. ADDITIONAL DERIVATIVE INFORMATION Expenses for the agreements and contracts described above amounted to $6,900,000 and $5,600,000 in 1996 and 1995, respectively. Deferred losses of $37,600,000 as of December 31, 1996, were the result of: 1) terminated and expired spread-lock agreements; and 2) financial futures contracts. These losses are included with the related fixed maturity securities to which the hedge applied and are being amortized over the life of such secu- rities. The Company is exposed to credit loss in the event of nonperformance by counterparties on interest rate cap agreements, swaptions, spread-lock agreements, interest rate swaps, foreign exchange forward contracts, for- eign currency options and foreign currency swaps. However, the Company does not anticipate nonperformance by any of these counterparties. The credit risk associated with such agreements is minimized by purchasing such agree- ments from financial institutions with long-standing, superior performance records. The amount of such exposure is essentially the net replacement cost or market value for such agreements with each counterparty if the net market value is in the Company's favor. At December 31, 1996, the exposure was $17,500,000. 10.FAIR VALUE OF FINANCIAL INSTRUMENTS The following discussion outlines the methodologies and assumptions used to determine the estimated fair values of the Company's financial instruments. Considerable judgment is required to develop these fair values. Ac- S-22 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 10.FAIR VALUE OF FINANCIAL INSTRUMENTS CONTINUED cordingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one-time, current market exchange of all of the Company's financial instruments. BONDS Fair values of bonds are based on quoted market prices, where available. For bonds not actively traded, fair values are estimated using values ob- tained from independent pricing services. In the case of private place- ments, fair values are estimated by discounting expected future cash flows using a current market rate applicable to the coupon rate, credit quality and maturity of the investments. The fair values of affiliated common stocks are based on quoted market prices. MORTGAGE LOANS ON REAL ESTATE The estimated fair value of mortgage loans on real estate was established using a discounted cash flow method based on credit rating, maturity and future income when compared to the expected yield for mortgages having sim- ilar characteristics. The rating for mortgages in good standing are based on property type, location, market conditions, occupancy, debt service cov- erage, loan to value, caliber of tenancy, borrower and payment record. Fair values for impaired mortgage loan are measured based on: 1) the present value of expected future cash flows discounted at the loan's effective in- terest rate; 2) the loan's market price; or 3) the fair value of the col- lateral if the loan is collateral dependent. POLICY LOANS The estimated fair value of investments in policy loans was calculated on a composite discounted cash flow basis using Treasury interest rates consis- tent with the maturity durations assumed. These durations were based on historical experience. OTHER INVESTMENTS AND CASH AND INVESTED CASH The carrying value for assets classified as other investments and cash and invested cash in the accompanying balance sheet approximates their fair value. INVESTMENT-TYPE INSURANCE CONTRACTS The balance sheet captions, "Future Policy Benefits and Claims" and "Other Policyholder Funds," include investment-type insurance contracts (i.e., de- posit contracts and guaranteed interest contracts). The fair values for the deposit contracts and certain guaranteed interest contracts are based on their approximate surrender values. The fair values for the remaining guar- anteed interest and similar contracts are based on their approximate sur- render values. 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 consistent with those remaining for the contracts being valued. The remainder of the balance sheet captions "Future Policy Benefits and Claims" and "Other Policyholder Funds," that do not fit the definition of "investment type insurance contracts" are considered insurance contracts. Fair value disclosures are not required for these insurance contracts and have not been determined by the Company. It is the Company's position that the disclosure of the fair value of these insurance contracts is important because readers of these financial statements could draw inappropriate con- clusions about the Company's capital and surplus determined on a fair value basis. It could be misleading if only the fair value of assets and liabili- ties defined as financial instruments are disclosed. The Company and other companies in the insurance industry are monitoring the related actions of the various rule-making bodies and attempting to determine an appropriate methodology for estimating and disclosing the "fair value" of their insur- ance contract liabilities. SHORT-TERM DEBT Fair values of short-term debt approximates carrying values. GUARANTEES The Company's guarantees include guarantees related to real estate partner- ships and mortgage loan pass-through certificates. Based on historical per- formance where repurchases have been negligible and the current status, which indicates none of the loans are delinquent, the fair value liability for the guarantees related to the mortgage loan pass-through certificates is insignificant. DERIVATIVES The Company's derivatives include interest rate cap agreements, swaptions, spread-lock agreements, foreign currency exchange contracts, financial futures contracts, options on financial futures, interest rate swaps, call options, foreign currency options and foreign currency swaps. Fair values for derivative contracts are based on current settlement val- ues. These values are based on: 1) quoted market prices for the foreign currency exchange contracts, financial future contracts, and options on fi- nancial futures; and 2) brokerage quotes that utilized pricing models or formulas using current assumptions for all other swaps and agreements. S-23 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 10.FAIR VALUE OF FINANCIAL INSTRUMENTS CONTINUED INVESTMENT COMMITMENTS Fair values for commitments to make investment in fixed maturity securities (primarily private placements), mortgage loans on real estate and real es- tate are based on the difference between the value of the committed invest- ments as of the date of the accompanying balance sheets and the commitment date. These estimates would take into account changes in interest rates, the counterparties' credit standing and the remaining terms of the commit- ments. S-24 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 10.FAIR VALUE OF FINANCIAL INSTRUMENTS CONTINUED The carrying values and estimated fair values of the Company's financial instruments are as follows:
December 31 ---------------------------------------------- 1996 1995 ---------------------- ---------------------- Carrying Fair Carrying Fair Assets (Liabilities) value value value value ---------------------------------------- ---------- ---------- ---------- ---------- (in millions) ---------------------------------------------- Bonds $ 19,389.6 $ 20,194.4 $ 17,729.7 $ 19,184.7 ---------------------------------------- Preferred stock 239.7 248.5 89.9 103.6 ---------------------------------------- Unaffiliated common stock 358.3 358.3 535.5 535.5 ---------------------------------------- Mortgage loans on real estate 2,976.7 3,070.9 2,909.7 3,081.9 ---------------------------------------- Policy loans 626.5 612.7 515.8 504.0 ---------------------------------------- Other investments 282.7 282.7 248.0 248.0 ---------------------------------------- Cash and short-term investments 759.2 759.2 780.9 780.9 ---------------------------------------- Investment type insurance contracts: ---------------------------------------- Deposit contracts and certain guaranteed interest contracts (17,871.6) (17,333.0) (15,586.7) (15,046.0) ---------------------------------------- Remaining guaranteed interest and similar contracts (1,799.7) (1,835.4) (2,261.1) (2,340.4) ---------------------------------------- Short-term debt (100.0) (100.0) (63.0) (63.0) ---------------------------------------- Derivatives 26.5 13.8 23.7 5.8 ---------------------------------------- Investment commitments -- (.6) -- (.8) ----------------------------------------
11.ACQUISITIONS AND SALES OF SUBSIDIARIES The Company sold its 100% interest in two subsidiaries--Se- curity Connecticut Life Insurance Company ("SCL") and Em- ployers Health Insurance Company ("EHI"). SCL was sold through a public offering of stock in January 1994. This transaction resulted in a realized gain of $90,000,000 and a direct increase in surplus of $24,000,000. Net of expenses, the Company received cash of $172,000,000 and notes of $65,000,000. EHI was also sold through public offerings in March and April 1994. LNC purchased 29% of the stock of the new pub- licly traded holding company from LNL. Prior to the sale, the Company received a $50,000,000 dividend in the form of a note. The sale transaction resulted in a realized gain of $133,000,000 and a direct reduction in surplus of $21,000,000 due to release of unrealized gain amounts, for a net surplus increase of $112,000,000. Net of expenses, the Company received cash of $348,000,000. In October 1996, the Company and its wholly owned subsidiary purchased a block of group tax qualified annuity business from UNUM Corporation. The transaction was completed in the form of a reinsurance transaction, which resulted in a ced- ing commission of $71,800,000. The ceding commission has been recorded as admissible goodwill of $62,300,000, which is to be amortized on a straight-line basis over 10 years. The Company's subsidiary was required by the New York De- partment of Insurance to expense its portion of the ceding commission in 1996. Policy liabilities and related accruals of the Company and its wholly owned subsidiary increased by $3,200,000,000 as a result of this transaction. In its previously-filed 1996 NAIC Annual Statement, the Com- pany recorded the ceding commission as a nonadmitted asset, which was charged directly to unassigned surplus. According- ly, unassigned surplus was understated at December 31, 1996 by $62,300,000, net of amortization in 1996. In 1997, man- agement will correct its opening balance of unassigned sur- plus in its NAIC Annual Statement. S-25 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED The balance sheets include reinsurance balances with affiliated companies as follows:
December 31 1996 1995 -------- -------- (in millions) ----------------- Future policy benefits and claims assumed $ 312.7 $ 344.8 Future policy benefits and claims ceded 891.8 1,344.5 Amounts recoverable on paid and unpaid losses 31.2 65.9 Reinsurance payable on paid losses 2.7 5.5 Funds held under reinsurance treaties--net liability 1,062.4 712.3
Substantially all reinsurance ceded to affiliated companies is with unau- thorized companies. To take a reserve credit for such reinsurance, the Com- pany holds assets from the reinsurer, including funds held under reinsur- ance treaties, and is the beneficiary on letters of credit aggregating $314,200,000 and $306,800,000 at December 31, 1996 and 1995, respectively. At December 31, 1996 and 1995, LNC had guaranteed $239,200,000 and $241,400,000, respectively, of these letters of credit. At December 31, 1996, the Company has a receivable (included in the foregoing amounts) from affiliated insurance companies in the amount of $135,700,000 for statutory surplus relief received under financial reinsurance ceded agreements. 13. SEPARATE ACCOUNTS Separate account assets and liabilities reported in the accompanying bal- ance sheets represent funds that are separately administered, principally for annuity contracts, and for which the contractholder, rather than the Company, bears the investment risk. Separate account contractholders have no claim against the assets of the general account of the Company. Separate account assets are reported at fair value and consist primarily of long- term bonds, common stocks, short-term investments and mutual funds. The de- tailed operations of the separate accounts are not included in the accompa- nying financial statements. Fees charged on separate account policyholder deposits are included in other income. Separate account premiums, deposits and other considerations amounted to $4,148,700,000, $3,068,200,000 and $2,694,700,000 in 1996, 1995 and 1994, respectively. Reserves for separate accounts with assets at fair value were $23,047,800,000 and $17,891,400,000 at December 31, 1996 and 1995, respec- tively. All reserves are subject to discretionary withdrawal at market val- ue. Substantially all of the Company's separate accounts are nonguaranteed. 12. TRANSACTIONS WITH AFFILIATES A wholly owned subsidiary of LNC, Lincoln Financial Group, Inc. ("LFGI"), has a nearly exclusive general agents contract with the Company under which it sells the Company's products and provides the service that otherwise would be provided by a home office marketing department and regional of- fices. For providing these selling and marketing services, the Company paid LFGI override commissions and operating expense allowances of $56,300,000, $43,300,000 and $41,200,000 in 1996, 1995 and 1994, respectively. LFGI in- curred expenses of $15,700,000, $10,400,000 and $10,700,000 in 1996, 1995 and 1994, respectively, in excess of the override commissions and operating expense allowances received from the Company, which the Company is not re- quired to reimburse. Cash and short-term investments at December 31, 1996 and 1995 include the Company's participation in a short-term investment pool with LNC of $175,100,000 and $324,000,000, respectively. Related investment income amounted to $15,300,000, $21,100,000 and $16,100,000 in 1996, 1995 and 1994, respectively. Other liabilities at December 31, 1996 and 1995 include $100,000,000 of notes payable to LNC. The Company provides services to and receives services from affiliated com- panies which resulted in a net payment of $34,100,000 and $24,900,000 in 1996 and 1995, respectively. The Company both cedes and accepts reinsurance from affiliated companies. Premiums in the accompanying statement of income includes reinsurance transactions with affiliated companies as follows:
Year ended December 31 1996 1995 1994 ------ ------ ------ (in millions) -------------------- Insurance assumed $ 17.9 $ 17.6 $ 19.8 Insurance ceded 302.8 214.4 481.3
S-26 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS CONTINUED 13. SEPARATE ACCOUNTS CONTINUED A reconciliation of transfers to (from) separate accounts are as follows:
Year ended December 31 1996 1995 ---------------------------------------------------- (in millions) --------------------- Transfers as reported in the Summary of Operations of various Separate Accounts: Transfers to separate accounts $ 4,149.6 $ 3,070.2 Transfers from separate accounts (2,058.5) (1,457.8) --------- --------- Net transfer to separate accounts as reported in the Company's NAIC Annual Statement $ 2,091.1 $ 1,612.4 ========= =========
S-27 OTHER FINANCIAL INFORMATION REPORT OF INDEPENDENT AUDITORS Board of Directors The Lincoln National Life Insurance Company We have audited the accompanying statutory-basis balance sheets of The Lincoln National Life Insurance Company (a wholly owned subsidiary of Lincoln National Corporation) as of December 31, 1996 and 1995, and the related statutory-basis statements of income, changes in capital and surplus and cash flows for each of the three years in the period ended December 31, 1996. These financial state- ments are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing stan- dards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of mate- rial misstatement. An audit includes examining, on a test basis, evidence sup- porting 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 pre- sentation. We believe that our audits provide a reasonable basis for our opin- ion. As described in Note 1 to the financial statements, the Company presents its financial statements in conformity with accounting practices prescribed or per- mitted by the Indiana Department of Insurance, which practices differ from gen- erally accepted accounting principles. The variances between such practices and generally accepted accounting principles and the effects on the accompanying financial statements are also described in Note 1. In our opinion, because of the effects of the matter described in the preceding paragraph, the financial statements referred to above do not present fairly, in conformity with generally accepted accounting principles, the financial posi- tion of The Lincoln National Life Insurance Company at December 31, 1996 and 1995, or the results of its operations or its cash flows for each of the three years in the period ended December 31, 1996. However, in our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of The Lincoln Na- tional Life Insurance Company at December 31, 1996 and 1995, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with accounting practices prescribed or permitted by the Indiana Department of Insurance. As described in Note 2, in 1994 the Company changed its method of accounting for separate account contracts. /s/ Ernst & Young LLP February 6, 1997 S-28 LINCOLN NATIONAL LIFE INSURANCE COMPANY SUPPLEMENTAL SCHEDULE OF SELECTED STATUTORY-BASIS FINANCIAL DATA DECEMBER 31, 1996 (IN MILLIONS) Investment income earned: Government bonds $ 74.6 --------------------------------------------------------------------- Other bonds (unaffiliated) 1,367.6 --------------------------------------------------------------------- Preferred stocks (unaffiliated) 9.6 --------------------------------------------------------------------- Common stocks (unaffiliated) 6.5 --------------------------------------------------------------------- Common stocks of affiliates 9.5 --------------------------------------------------------------------- Mortgage loans 269.3 --------------------------------------------------------------------- Real estate 114.4 --------------------------------------------------------------------- Premium notes, policy loans and liens 35.0 --------------------------------------------------------------------- Cash on hand and on deposit 0.9 --------------------------------------------------------------------- Short-term investments 48.0 --------------------------------------------------------------------- Other invested assets 17.6 --------------------------------------------------------------------- Derivative instruments (6.3) --------------------------------------------------------------------- Aggregate write-ins for investment income 11.1 ----------------------------------------------------------- -------- Gross investment income $1,957.8 - ------------------------------------------------------------- ======== Real estate owned (cost, less encumbrances) $ 621.3 - ------------------------------------------------------------- ======== Mortgage loans (unpaid balance): Farm mortgages $ 1.1 --------------------------------------------------------------------- Residential mortgages 3.7 --------------------------------------------------------------------- Commercial mortgages 2,971.9 ----------------------------------------------------------- -------- Total mortgage loans $2,976.7 - ------------------------------------------------------------- ======== Mortgage loans by standing (unpaid balance): Good standing $2,922.1 ----------------------------------------------------------- ======== Good standing with restructured terms $ 39.6 ----------------------------------------------------------- ======== Interest overdue more than three months, not in foreclosure $ -- ----------------------------------------------------------- ======== Foreclosure in process $ 14.9 ----------------------------------------------------------- ======== Other long-term assets (statement value) $ 248.1 - ------------------------------------------------------------- ========
S-29 LINCOLN NATIONAL LIFE INSURANCE COMPANY SUPPLEMENTAL SCHEDULE OF SELECTED STATUTORY-BASIS FINANCIAL DATA CONTINUED DECEMBER 31, 1996 (IN MILLIONS) Bonds and stocks of parent, subsidiaries and affiliates (cost): Common stocks $ 194.0 ------------------------------------------------------------- ========== Bonds and short-term investments by class and maturity: Bonds by maturity (statement value): Due within one year or less $ 1,618.0 ------------------------------------------------------------- Over 1 year through 5 years 5,928.1 ------------------------------------------------------------- Over 5 years through 10 years 6,025.9 ------------------------------------------------------------- Over 10 years through 20 years 3,670.6 ------------------------------------------------------------- Over 20 years 2,860.4 ------------------------------------------------------------- ---------- Total by maturity $ 20,103.0 - --------------------------------------------------------------- ========== Bonds by class (statement value): Class 1 $ 14,013.7 ------------------------------------------------------------- Class 2 4,504.1 ------------------------------------------------------------- Class 3 807.6 ------------------------------------------------------------- Class 4 705.9 ------------------------------------------------------------- Class 5 71.4 ------------------------------------------------------------- Class 6 0.3 ------------------------------------------------------------- ---------- Total by class $ 20,103.0 - --------------------------------------------------------------- ========== Total bonds publicly traded $ 16,520.3 - --------------------------------------------------------------- ========== Total bonds privately placed $ 3,582.7 - --------------------------------------------------------------- ========== Preferred stocks (cost or amortized cost) $ 239.7 - --------------------------------------------------------------- ========== Unaffiliated common stocks (market value) $ 358.3 - --------------------------------------------------------------- ========== Short-term investments (cost or amortized cost) $ 713.4 - --------------------------------------------------------------- ========== Financial options and caps owned (statement value) $ 32.2 - --------------------------------------------------------------- ========== Financial options and caps written (statement value) $ 0.3 - --------------------------------------------------------------- ========== Swap and forward agreements open (statement value) $ 0.2 - --------------------------------------------------------------- ========== Futures contracts open (current value) $ 161.2 - --------------------------------------------------------------- ========== Cash on deposit $ 45.8 - --------------------------------------------------------------- ========== Life insurance in-force: Ordinary $ 97.9 ------------------------------------------------------------- ========== Group life $ 31.4 ------------------------------------------------------------- ==========
S-30 LINCOLN NATIONAL LIFE INSURANCE COMPANY SUPPLEMENTAL SCHEDULE OF SELECTED STATUTORY-BASIS FINANCIAL DATA CONTINUED DECEMBER 31, 1996 (IN MILLIONS) Amount of accidental death insurance in-force under ordinary policies $ 4.9 - ----------------------------------------------------------------------------------------------- ========= Life insurance policies with disability provisions in-force: Ordinary $ 4.9 --------------------------------------------------------------------------------------------- ========= Group life $ 12.9 --------------------------------------------------------------------------------------------- ========= Supplementary contracts in-force: Ordinary--not involving life contingencies: Amount on deposit $ -- --------------------------------------------------------------------------------------------- ========= Income payable $ 3.2 --------------------------------------------------------------------------------------------- ========= Ordinary--involving life contingencies: Income payable $ 0.9 --------------------------------------------------------------------------------------------- ========= Group--not involving life contingencies: Income payable $ -- --------------------------------------------------------------------------------------------- ========= Group--involving life contingencies: Income payable $ 0.9 --------------------------------------------------------------------------------------------- ========= Annuities: Ordinary: Immediate--amount of income payable $ 68.4 --------------------------------------------------------------------------------------------- ========= Deferred--fully paid account balance $ 0.6 --------------------------------------------------------------------------------------------- ========= Deferred--not fully paid account balance $ 326.6 --------------------------------------------------------------------------------------------- ========= Group: Amount of income payable $ -- --------------------------------------------------------------------------------------------- ========= Fully paid account balance $ -- --------------------------------------------------------------------------------------------- ========= Not fully paid account balance $ 78.1 --------------------------------------------------------------------------------------------- ========= Accident and health insurance--premiums in-force: Ordinary $ 180.6 --------------------------------------------------------------------------------------------- ========= Group $ 97.1 --------------------------------------------------------------------------------------------- ========= Deposit funds and dividend accumulations: Deposit funds account balance $17,456.6 --------------------------------------------------------------------------------------------- ========= Dividend accumulations--account balance $ 114.7 --------------------------------------------------------------------------------------------- =========
S-31 LINCOLN NATIONAL LIFE INSURANCE COMPANY SUPPLEMENTAL SCHEDULE OF SELECTED STATUTORY-BASIS FINANCIAL DATA CONTINUED DECEMBER 31, 1996 (IN MILLIONS) Claim payments 1996: Group Accident and Health: 1996 $ 9.4 ===== -------------- 1995 $ 3.1 ===== -------------- 1994 $ 0.1 ===== -------------- 1993 $ -- ===== -------------- 1992 $(0.1) ===== -------------- Prior $ -- ===== --------------
S-32 LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTE TO SUPPLEMENTAL SCHEDULE OF SELECTED STATUTORY-BASIS FINANCIAL DATA NOTE--BASIS OF PRESENTATION The accompanying schedule presents selected statutory-basis financial data as of December 31, 1996 and for the year then ended for purposes of complying with paragraph 9 of the Annual Audited Financial Reports in the General Section of the National Association of Insurance Commissioners' Annual Statement Instruc- tions and agrees to or is included in the amounts reported in The Lincoln Na- tional Life Insurance Company's 1996 Statutory Annual Statement as filed with the Indiana Department of Insurance. S-33 REPORT OF INDEPENDENT AUDITORS ON OTHER FINANCIAL INFORMATION Board of Directors The Lincoln National Life Insurance Company Our audits were conducted for the purpose of forming an opinion on the statutory-basis financial statements taken as a whole. The accompanying supplemental schedule of selected statutory-basis financial data is presented to comply with the National Association of Insurance Commissioners' Annual Statement Instructions and is not a required part of the statutory-basis financial statements. Such information has been subjected to the auditing procedures applied in our au- dit of the statutory-basis financial statements and, in our opinion, is fairly stated in all material respects in rela- tion to the statutory-basis financial statements taken as a whole. /s/ Ernst & Young LLP February 6, 1997 S-34 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E POST-EFFECTIVE AMENDMENT ON FORM N-4 PART C - OTHER INFORMATION Item 24. Financial Statements and Exhibits (a) List of Financial Statements 1. Part A. The Table of Condensed Financial Information is included in Part A of this Registration Statement. 2. Part B. The following Financial Statements of Account E are included in Part B of this Registration Statement: Statement of Assets and Liabilities -- December 31, 1996 Statement of Operations -- Year ended December 31, 1996 Statements of Changes in Net Assets -- Years ended December 31, 1996 and 1995 Notes to Financial Statements -- December 31, 1996 Report of Ernst & Young LLP, Independent Auditors 3. Part B. The following Consolidated Financial Statements and Schedules of The Lincoln National Life Insurance Company are included in Part B of the Registration Statement: Consolidated Balance Sheets -- December 31, 1995 and 1994 Consolidated Statements of Income -- Years ended December 31, 1995, 1994 and 1992 Consolidated Statements of Shareholder's Equity -- Years ended December 31, 1995, 1994 and 1993 Consolidated Statements of Cash Flows -- Years Ended December 31, 1995, 1994 and 1993 Notes to Consolidated Financial Statements -- December 31, 1995 Schedule I-Summary of Investments-Other than Investments in Related Parties -- December 31, 1995 Schedule III-Supplementary Insurance Information -- Years ended December 31, 1995, 1994 and 1993 Schedule IV-Reinsurance -- Years ended December 31, 1995, 1994 and 1993 Schedule V-Valuation and Qualifying Accounts-- Years ended December 31, 1995, 1994 and 1993 Report of Ernst & Young LLP, Independent Auditors The following Statutory Financial Statements and Schedules of Lincoln National Life Insurance Company are included in the SAI: Balance Sheets -- Statutory Basis -- Years ended December 31, 1996 and 1995 Statements of Income -- Statutory Basis -- Years ended December 31, 1996, 1995, and 1994 Statements of Capital and Surplus -- Statutory Basis -- Years ended December 31, 1996, 1995, and 1994 Notes to Financial Statements -- December 31, 1996 Supplemental Schedule of Selected Statutory-Basis Financial Data -- December 31, 1996 Report of Ernst & Young LLP, Independent Auditors (b) List of Exhibits (4) Form of Rider to Variable Annuity Contract/1/ (8) Services Agreement with the Delaware Management Company/1/ (9) Consent and Opinion of Jeremy Sachs, Senior Counsel, Lincoln National Life Insurance Company (10) Consent of Ernst & Young LLP, Independent Auditors. (14) Financial Data Schedules (15) Other Exhibits: (a) Organizational Chart of the Lincoln National Insurance Holding Company System/1/ (b) Books and Records Report. /1/ Incorporated by reference to Post-Effective Amendment No. 11 filed on March 3, 1997. Item 25. DIRECTORS AND OFFICERS OF THE DEPOSITOR Name Positions and Offices with LNL - ---- ------------------------------ Ian M. Rolland** Director Jon A. Boscia* President, Chief Executive Officer and Director Carolyn P. Brody* Vice President Thomas L. Clagg* Vice President and Associate General Counsel Kelly D. Clevenger* Vice President Jeffrey K. Dellinger* Vice President Jack D. Hunter* Executive Vice President and General Counsel Donald E. Keller* Vice President H. Thomas Mc Meekin** Director Reed P. Miller* Vice President Stephen H. Lewis* Senior Vice President Lawrence T. Rowland *** Executive Vice President Keith J. Ryan* Vice President, Asst. Treasurer and Chief Financial Officer Richard C. Vaughan** Director Roy V. Washington* Vice President Janet C. Whitney** Vice President and Treasurer C. Suzanne Womack** Assistant Vice President and Secretary O. Douglas Worthington* Vice President, Controller and Assistant Treasurer *Principal business address is 1300 South Clinton Street, Fort Wayne, Indiana 46802. **Principal business address is 200 East Berry Street, Fort Wayne, Indiana 46802-2706. ***Principal business address is 1700 Magnavox Way, One Reinsurance Place, Fort Wayne, Indiana 46804. Item 26. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH THE DEPOSITOR OR REGISTRANT See Exhibit 15(a): Organizational Chart of the Lincoln National Insurance Holding Company System Item 27. NUMBER OF CONTRACTOWNERS As of March 31, 1997, there were 15,180 Contract Owners (fixed and variable). Item 28. Indemnification Refer to the initial Registration Statement. Item 29. Principal Underwriter (a) American Funds Distributors, Inc., is also the Principal Underwriter of shares of: AMCAP Fund, Inc., American Balanced Fund, Inc., The American Funds Income Series, The American Funds Tax-Exempt Series I, The American Funds Tax-Exempt Series II, American High-Income Municipal Bond Fund, Inc., American High-Income Trust, American Mutual Fund, Inc., The Bond Fund of America, Inc., Capital Income Builder, Inc., Capital World Bond Fund, Inc., Capital World Growth and Income Fund, Inc., The Cash Management Trust of America, EuroPacific Growth Fund, Fundamental Investors, Inc., The Growth Fund of America, Inc., The Income Fund of America, Inc., The Intermediate Bond Fund of America, The Investment Company of America, Limited Term Tax-Exempt Bond Fund of America, The New Economy Fund, New Perspective Fund, Inc., SMALLCAP World Fund, Inc., The Tax-Exempt Bond Fund of America, Inc., The Tax- Exempt Money Fund of America, The U.S. Treasury Money Fund of America and Washington Mutual Investors Fund, Inc. Item 29. Principal Underwriter (continued) (b) (continued) (1) (2) Name and Principal Positions and Offices Business Address with Underwriter - ------------------ --------------------- *David L. Abzug Regional Vice President 5657 Lemona Avenue Van Nuys, CA 91411 John A. Agar Regional Vice President 1501 N. University Drive Little Rock, AR 72207 Robert B. Aprison Vice President 2983 Bryn Wood Drive Madison, WI 53711 %Richard Armstrong Assistant Vice President *William W. Bagnard Vice President Steven L. Barnes Senior Vice President 8000 Town Line Avenue South Suite 204 Minneapolis, MN 55438 Michelle A. Bergeron Vice President 4160 Gateswalk Drive Smyrna, GA 30080 Joseph T. Blair Senior Vice President 27 Drumlin Road West Simsbury, CT 06092 John A. Blanchard Regional Vice President 6421 Aberdeen Road Mission Hills, KS 66208 Ian B. Bodell Senior Vice President 3100 West End Avenue, Suite 870 Nashville, TN 37215 Michael L. Brethower Vice President 108 Hagen Court Georgetown, TX 78628 C. Alan Brown Regional Vice President 4619 McPherson Avenue St. Louis, MO 63108 *Daniel C. Brown Senior Vice President @J. Peter Burns Vice President Brian C. Casey Regional Vice President 9508 Cable Drive Kensington, MO 20895 Victor C. Cassato Vice President 609 W. Littleton Blvd. Suite 310 Littleton, CO 80121 Christopher J. Cassin Senior Vice President 111 West Chicago Avenue Suite G3 Hinsdale, IL 60521 Denise M. Cassin Regional Vice President 1301 Stoney Creek Drive San Ramon, CA 94538 *Larry P. Clemmensen Director *Kevin G. Clifford Director, Senior Vice President Ruth M. Collier Vice President 145 West 67th Street, Suite #12K New York, NY 10023 Item 29. Principal Underwriter (continued) (b) (continued) (1) (2) Name and Principal Positions and Offices Business Address with Underwriter - ------------------ --------------------- Thomas E. Cournoyer Vice President 2333 Granada Boulevard Coral Gables, FL 33134 Douglas A. Critchell Vice President 4116 Woodbine St. Chevy Chase, MD 20815 *Carl D. Cutting Vice President Dan J. Delianedis Regional Vice President 8689 Braxton Drive Eden Prairie, MN 55347 Michael A. Dilella Vice President P.O. Box 661 Ramsey, NJ 07446 G. Michael Dill Senior Vice President 505 East Main Street Jenks, OK 74037 Kirk D. Dodge Vice President 2617 Salisbury Road Ann Arbor, MI 48103 Peter J. Doran Senior Vice President 1205 Franklin Avenue Garden City, NY 11530 *Michael J. Downer Secretary Robert W. Durbin Vice President 74 Sunny Lane Tiffin, OH 44883 &Lloyd G. Edwards Vice President *Paul H. Fieberg Senior Vice President John Fodor Regional Vice President 15 Latisquana Road Southborough, MA 01772 *Mark P. Freeman, Jr. Director and President Clyde E. Gardner Senior Vice President Route 2, Box 3162 Osage Beach, MO 65065 #Evelyn K. Glassford Vice President Jeffrey J. Greiner Regional Vice President 5898 Heather Glen Court Dublin, OH 43017 David E. Harper Senior Vice President R.D.1, Box 210, Rte 519 Frenchtown, NJ 08825 Ronald R. Hulsey Vice President 6744 Avalon Dallas, TX 75214 Robert S. Irish Regional Vice President 1225 Vista Del Mar Dr. Delray Beach, Fl 33483 *Robert L. Johansen Vice President and Controller Michael J. Johnston Chairman of the Board 630 Fifth Ave., 36th Floor New York, NY 10111 Victor J. Kriss Senior Vice President P. O. Box 274 Surfside, CA 90743 Arthur J. Levine Vice President 12558 Highlands Place Fishers, IN 46038 Item 29. Principal Underwriters (continued) (b) (continued) (1) (2) Name and Principal Positions and Offices Business Address with Underwriter - ------------------ ------------------------ #Karl A. Lewis Assistant Vice President T. Blake Liberty Regional Vice President 1940 Blake Street, Ste. 303 Denver, Co 80202 *Lorin E. Liesy Assistant Vice President *Susan G. Lindgren Vice President - Institutional Investment Services Division %Stella Lopez Vice President +Robert W. Lovelace Director Stephen A. Malbasa Regional Vice President 13405 Lake Shore Boulevard Cleveland, OH 44110 Steven M. Markel Vice President 5241 South Race St. Littleton, CO 80121 *John C. Massar Director and Senior Vice President *E. Lee McClennahan Senior Vice President Laurie B. McCurdy Regional Vice President 3500 W. Camino de Urania Tucson, AZ 85255 %John V. McLaughlin Senior Vice President Terry W. McNabb Vice President 2002 Barrett Station Road St. Louis, MO 63131 *R. William Melinat Vice President Institutional Investment Services Division David R. Murray Vice President 25701 S. E. 32nd Place Issaquah, WA 98027 Stephen S. Nelson Vice President 7215 Trevor Road Charlotte, NC 28226 William E. Noe Regional Vice President 304 River Oaks Road Brentwood, TN 37027 Peter A. Nyhus Regional Vice President 3084 Wilds Ridge Court Prior Lake, MN 55372 Eric P. Olson Regional Vice President 62 Park Drive Glenview, IL 60025 Frederic Phillips Vice President 32 Ridge Avenue Newton Centre, MA 02159 #Candance D. Pilgrim Assistant Vice President Item 29. Principal Underwriters (continued) - ------- (b) (continued) (1) (2) Name and Principal Positions and Offices Business Address with Underwriter - ------------------ --------------------- Carl S. Platou Regional Vice President 4021 96th Avenue, SE Mercer Island, WA 98040 *John O. Post, Jr. Vice President Steven J. Reitman Vice President 212 The Lane Hinsdale, IL 60521 Brian A. Roberts Regional Vice President 12025 Delmahoy Drive Charlotte, NC 28277 George S. Ross Vice President 55 Madison Avenue Morristown, NJ 07962 *Julie D. Roth Vice President *James F. Rothenberg Director Douglas F. Rowe Regional Vice President 30309 Oak Tree Drive Georgetown, TX 78628 Christopher Rowey Regional Vice President 9417 Beverlywood Street Los Angeles, CA 90034 Dean B. Rydquist Vice President 1080 Bay Pointe Crossing Alpharetta, GA 30202 Richard R. Samson Vice President 4604 Glencoe Ave., #4 Marina Del Rey, CA 90292 Joe D. Scarpitti Regional Vice President 31465 St. Andrews Westlake, OH 44145 *Daniel B. Seivert Assistant Vice President *R. Michael Shanahan Director David W. Short Director and Senior Vice President 1000 RIDC Plaza, Suite 212 Pittsburgh, PA 15238 William P. Simon, Jr. Vice President 554 Canterbury Lane Berwyn, PA 19312 *John C. Smith Assistant Vice President Institutional Investment Services Division *Mary E. Smith Assistant Vice President Institutional Investment Services Division Rodney G. Smith Regional Vice President 100 N. Central Expressway Richardson, TX 75080 Nicholas D. Spadaccini Regional Vice President 855 Markley Woods Way Cincinnati, OH 45230 Item 29. Principal Underwriters (continued) - -------- (b) (continued) (1) (2) Name and Principal Positions and Offices Business Address with Underwriter - ------------------ --------------------- Daniel S. Spradling Senior Vice President #4 West Fourth Avenue, Suite 406 San Mateo, CA 94402 Thomas A. Stout Regional Vice President 12913 Kendale Lane Bowie, MD 20715 Craig R. Strausser Regional Vice President 17040 Summer Place Lake Oswego, OR 97035 Francis N. Strazzeri Regional Vice President 31641 Saddletree Drive Westlake Village, CA 91361 *Drew Taylor Assistant Vice President %James P. Toomey Assistant Vice President &Christopher E. Trede Assistant Vice President George F. Truesdail Vice President 400 Abbotsford Court Charlotte, NC 28270 Scott W. Ursin-Smith Regional Vice President 606 Glenwood Avenue Mill Valley, CA 94941 *David M. Ward Assistant Vice President Institutional Investment Services Division Thomas E. Warren Regional Vice President 4001 Crockers Lake Blvd. Sarasota, FL 34238 *J. Kelly Webb Senior Vice President and Treasurer Gregory J. Weimer Vice President 125 Surrey Drive Canonsburg, PA 15317 #Timothy W. Weiss Director **N. Dexter Williams Vice President Timothy J. Wilson Regional Vice President 113 Farmview Place Venetia, PA 15367 #Laura L. Wimberly Assistant Vice President *Marshall D. Wingo Director and Senior Vice President *Robert L. Winston Director and Senior Vice President William Yost Regional Vice President 9320 Overlook Trail Eden Prairie, MN 55347 Janet M. Young Regional Vice President 1616 Vermont Houston, TX 77006 Scott D. Zambon Regional Vice President 209 Robinson Drive Tustin Ranch, CA 92782 * Business Address, 333 South Hope Street, Los Angeles, CA 90071 **Business Address, One Market Plaza, Steuart Tower, Suite 1800, San Francisco, CA 94111 + Business Address, 11100 Santa Monica Blvd., Los Angeles, CA 90025 # Business Address, 135 South State College Blvd., Brea, CA 92821 % Business Address, 8000 IH-10, Suite 1400, San Antonio, TX 78230 @ Business Address, 5300 Robin Hood Road, Norfolk, VA 23513 & Business Address, 8332 Woodfield Crossing Boulevard, Indianapolis, IN 46240 Item 30. Location of Accounts and Records Exhibit 15(b) is hereby expressly incorporated herein by this reference. Item 31. Management Services Not Applicable. 50 Item 32. Undertakings - --------------------- (a) Registrant undertakes that it will file a post-effective amendment to this registration statement as frequently as necessary to ensure that the audited financial statements in the registration statement are never more than 16 months old for so long as payments under the variable annuity contracts may be accepted. (b) Registrant undertakes that it will include either (1) as part of any application to purchase a Certificate or an Individual Contract offered by the Prospectus, a space that an applicant can check to request a Statement of Additional Information, or (2) a post card or similar written communication affixed to or included in the Prospectus that the applicant can remove to send for a Statement of Additional Information. (c) Registrant undertakes to deliver any Statement of Additional Information and any financial statements required to be made available under this Form promptly upon written or oral request to Lincoln Life at the address or phone number listed in the Prospectus. (d) Lincoln National Life Insurance Company hereby represents that the fees and charges deducted under the contract, in the aggregate, are reasonable in relation to the services rendered, the expenses expected to be incurred, and the risks assumed by the Lincoln National Life Insurance Company. Item 33. ( Additional Item) - Undertaking Concerning the Texas Optional Retirement Program Refer to the initial Registration Statement. Item 34. (Additional Item) - Undertaking Concerning Withdrawal Restrictions on IRC Section 403(b) Plan Participants Refer to initial Registration Statement. 51 SIGNATURES (a) As required by the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant certifies that it meets the requirements of Securities Act Rule 485(b) for effectiveness of this Amendment and has caused this Amendment to the Registration Statement to be signed on its behalf, in the City of Fort Wayne, and State of Indiana on this 22nd day of April, 1997. LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT E, (Registrant) By: /s/ Stephen H. Lewis ----------------------------- Stephen H. Lewis (Signature-Officer of Depositor) Senior Vice President, LNL (Title) By: THE LINCOLN NATIONAL LIFE INSURANCE COMPANY (LNL) (Depositor) By: /s/ Jon A. Boscia ----------------------------- Jon A. Boscia President (Title) Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated. Signature Title Date - --------- ----- ---- /s/ Jon A. Boscia President, Chief Executive - ----------------- Officer & Director April 22, 1997 Jon A. Boscia (Principal Executive Officer) Director - ------------------ Ian M. Rolland ---------------- */s/ O. Douglas Worthington Vice President and Controller - --------------------------- April 22, 1997 O. Douglas Worthington /s/ Keith J. Ryan Vice President, and Assistant - ------------------- Treasurer and Chief April 22, 1997 Keith J. Ryan Financial Officer (Principal Financial Officer) /s/ Lawrence T. Rowland - ----------------------- Executive Vice President April 22, 1997 Lawrence T. Rowland and Director /s/ Richard C. Vaughan Director - ---------------------- April 22, 1997 Richard C. Vaughan /s/ H. Thomas McMeekin - ---------------------- Director April 22, 1997 H. Thomas McMeekin Executive Vice President, - ---------------------- General Counsel & Director Jack D. Hunter */s/ Jeremy Sachs - ---------------------- , pursuant to a Power of Attorney filed with Jeremy Sachs Post-Effective Amendment No. 5 to this Registration Statement. EX-99.9 2 CONSENT AND OPINION OF JEREMY SACHS LINCOLN NATIONAL LIFE INSURANCE COMPANY Law Division 7C03 1300 South Clinton Fort Wayne, Indiana 46802 Phone: (219)455-3018 Fax: (219)455-5135 Exhibit 9 VIA EDGAR April 22, 1997 Securities and Exchange Commission Division of Investment Management Office of Insurance Products 450 Fifth Street, N.W. Washington, DC 20549 Re: Lincoln National Variable Annuity Account E File Nos. 33-26032; 811-4882 Opinion and Consent of Counsel Ladies and Gentlemen: I have recently made such examination of law and have examined such records and documents as I have deemed necessary to render the opinion expressed below. I am of the opinion that upon acceptance by Lincoln National Variable Annuity Account E (the "Account"), a segregated account of Lincoln National Life Insurance Company (Lincoln Life), of contributions from a person pursuant to an insurance policy issued in accordance with the prospectus contained in this amended Registration Statement on Form N-4, and upon compliance with applicable law, such person will have a legally issued interest in his or her individual account with the Account, and the securities issued will represent binding obligations of Lincoln Life. I consent to the filing of this Opinion as an exhibit to the Account's Post-Effective Amendment No. 12 to the Registration Statement on Form N-4. Very truly yours, /s/ Jeremy Sachs Jeremy Sachs Senior Counsel EX-99.10 3 CONSENT OF ERNST & YOUNG LLP Exhibit 10 Consent of Ernst & Young LLP, Independent Auditors We consent to the reference to our firm under the caption "Independent Auditors" in the Post-Effective Amendment No. 10 to the Registration Statement (Form N-4 No. 33-26032) and related Statement of Additional Information pertaining to the Lincoln National Variable Annuity Account E and to the use therein of our reports (a) dated February 7, 1997 with respect to the consolidated financial statements of The Lincoln National Life Insurance Company and (b) dated March 6, 1997 with respect to the financial statements of Lincoln National Variable Annuity Account E. /s/ Ernst & Young LLP Fort Wayne, Indiana April 26, 1997 EX-27 4 FINANCIAL DATA SCHEDULE
6 This schedule contains summary financial information extracted from Lincoln National Variable Annuity Account E financial statements and is qualified in its entirety by reference to such financial statements. 12-MOS DEC-31-1996 JAN-01-1996 DEC-31-1996 621,409,991 822,553,822 0 0 0 822,553,822 0 0 879,859 879,859 0 275,263,370 349,958,587 375,165,263 252,517,824 0 92,748,938 0 201,143,831 821,673,963 69,501,484 0 0 10,027,910 59,473,574 29,343,024 15,593,387 104,409,985 0 0 0 0 58,569,525 85,447,483 0 35,787,527 193,044,250 63,405,914 0 0 0 0 10,027,910 803,780,199 0 0 0 0 0 0 0 0 0 0
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