-----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, AjvegP6cUB9240eUV4LyIF6YUu3wTxnAiASjbrXvFA/OwUVXe4YGr5xCkf/w7Z+N XxL7eaJ4iHto3K8j3b1HXg== 0001047469-08-005901.txt : 20080505 0001047469-08-005901.hdr.sgml : 20080505 20080505134133 ACCESSION NUMBER: 0001047469-08-005901 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 20080505 DATE AS OF CHANGE: 20080505 EFFECTIVENESS DATE: 20080505 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LINCOLN NATIONAL VARIABLE ANNUITY ACCT L CENTRAL INDEX KEY: 0001015343 IRS NUMBER: 350472300 STATE OF INCORPORATION: IN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 497 SEC ACT: 1933 Act SEC FILE NUMBER: 333-04999 FILM NUMBER: 08801730 BUSINESS ADDRESS: STREET 1: 1300 S CLINTON ST STREET 2: P O BOX 1110 CITY: FORT WAYNE STATE: IN ZIP: 46802 BUSINESS PHONE: 2604552000 MAIL ADDRESS: STREET 1: 1300 S CLINTON ST STREET 2: P O BOX 1110 CITY: FORT WAYNE STATE: IN ZIP: 46802 FORMER COMPANY: FORMER CONFORMED NAME: LINCOLN NATIONAL VARIABLE ANNUITY ACCT L GRP VAR ANNUITY I DATE OF NAME CHANGE: 19960524 0001015343 S000011243 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT L C000030965 Group Variable Annuity 497 1 a2185368z497.txt 497 Lincoln National Variable Annuity Account L Group Variable Annuity Contracts I, II, & III Home Office: The Lincoln National Life Insurance Company 1300 South Clinton Street Fort Wayne, IN 46802 Servicing Office: The Lincoln National Life Insurance Company PO Box 2340 Fort Wayne, IN 46808 1-800-341-0441 www.LFG.com This prospectus describes the group annuity contract and an individual certificate that is issued by The Lincoln National Life Insurance Company (Lincoln Life). They are primarily for use with nonqualified plans and qualified retirement plans. Generally, you do not pay federal income tax on the contract's growth until it is paid out. Qualified retirement plans already provide for tax deferral. Therefore, there should be reasons other than tax deferral for acquiring the contract within a qualified plan. The contract is designed to accumulate account value, and as permitted by the plan, to provide retirement income that you cannot outlive or for an agreed upon time. These benefits may be a variable or fixed amount, if available, or a combination of both. If a participant dies before the annuity commencement date, we pay the beneficiary or the plan a death benefit. If the contractowner gives certain rights to plan participants, we issue active life certificates to them. Participants choose whether account value accumulates on a variable or a fixed (guaranteed) basis or both. If a participant allocates contributions to the fixed account, we guarantee principal and a minimum interest rate. All contributions for benefits on a variable basis will be placed in Lincoln National Variable Annuity Account L (VAA). The VAA is a segregated investment account of Lincoln Life. If a participant puts all or some contributions into one or more of the contract's subaccounts, the participant takes all the investment risk on the account value and the retirement income. If the selected subaccounts make money, account value goes up; if they lose money, it goes down. How much it goes up or down depends on the performance of the selected subaccounts. We do not guarantee how any of the subaccounts or their funds will perform. Also, neither the U.S. Government nor any federal agency insures or guarantees the investment in the contract. The available subaccounts, and the funds in which they invest, are listed below. The contractowner decides which of these subaccounts are available under the contract for participant allocations. For more information about the investment objectives, policies and risk of the funds please refer to the Prospectuses for the funds. AllianceBernstein Variable Products Series Fund (Class B): AllianceBernstein Global Technology Portfolio AllianceBernstein Growth Portfolio* AllianceBernstein Growth and Income Portfolio American Century Variable Portfolios (Class I): Balanced Fund* American Funds Insurance Series (Class 2): American Funds Global Growth Fund American Funds Growth Fund American Funds Growth-Income Fund American Funds International Fund Delaware VIP Trust (Service Class): Delaware VIP REIT Series Delaware VIP Small Cap Value Series Delaware VIP Trend Series Delaware VIP Trust (Standard Class): Delaware VIP Diversified Income Series Delaware VIP High Yield Series Dreyfus Variable Investment Fund (Initial Class): Dreyfus Developing Leaders Portfolio* Dreyfus Stock Index Fund, Inc.* DWS Investments VIT Funds (Class A): DWS Equity 500 Index VIP* DWS Small Cap Index VIP* Fidelity (Reg. TM) Variable Insurance Products (Initial Class): Fidelity (Reg. TM) Asset Manager Portfolio* Fidelity (Reg. TM) Equity-Income Portfolio Fidelity (Reg. TM) Growth Portfolio Fidelity (Reg. TM) Variable Insurance Products (Service Class 2): Fidelity (Reg. TM) Contrafund (Reg. TM) Portfolio Janus Aspen Series (Institutional Shares): Janus Aspen Worldwide Growth Portfolio* Lincoln Variable Insurance Products Trust (Service Class): LVIP Baron Growth Opportunities Fund 1 Lincoln Variable Insurance Products Trust (Standard Class): LVIP Cohen & Steers Global Real Estate Fund LVIP Delaware Bond Fund LVIP Delaware Growth and Income Fund LVIP Delaware Managed LVIP Delaware Social Awareness Fund LVIP Janus Capital Appreciation Fund LVIP Mondrian International Value Fund LVIP T. Rowe Price Structured Mid-Cap Growth Fund LVIP Wilshire 2010 Profile Fund LVIP Wilshire 2020 Profile Fund LVIP Wilshire 2030 Profile Fund LVIP Wilshire 2040 Profile Fund LVIP Wilshire Conservative Profile Fund LVIP Wilshire Moderate Profile Fund LVIP Wilshire Moderately Aggressive Profile Fund LVIP Wilshire Aggressive Profile Fund Neuberger Berman Advisers Management Trust (I Class): Mid-Cap Growth Portfolio Partners Portfolio* T. Rowe Price International Series, Inc. T. Rowe Price International Stock Portfolio* *It is currently anticipated that during the third quarter of 2008, we will close and replace these investment options. See Investments of the VAA - Description of the Funds for further information. This prospectus gives you information about the contracts and certificates that contractowners and participants should know before investing. You should also review the prospectuses for the funds that accompany this prospectus, and keep all prospectuses for future reference. Neither the SEC nor any state securities commission has approved this contract or determined that this prospectus is accurate or complete. Any representation to the contrary is a criminal offense. More information about the contracts is in the current Statement of Additional Information (SAI), dated the same date as this prospectus. The SAI terms are made part of this prospectus, and for a free copy of the SAI, write: The Lincoln National Life Insurance Company, P. O. Box 2340, Fort Wayne, IN 46808 or call 1-800-341-0441. The SAI and other information about Lincoln Life and the VAA are also available on the SEC's website (http://www.sec.gov). There is a table of contents for the SAI on the last page of this prospectus. April 30, 2008 2 Table of Contents
Item Page Special Terms 4 Expense Tables 5 Summary of Common Questions 9 The Lincoln National Life Insurance Company 10 Fixed Side of the Contract 11 Variable Annuity Account (VAA) 11 Investments of the VAA 11 Charges and Other Deductions 15 The Contracts 18 Purchase of the Contracts 18 Transfers On or Before the Annuity Commencement Date 20 Death Benefit Before the Annuity Commencement Date 22 Withdrawals 23 Distribution of the Contracts 25 Annuity Payouts 26 Federal Tax Matters 27 Additional Information 30 Voting Rights 30 Return Privilege 30 Other Information 30 Legal Proceedings 31 Contents of the Statement of Additional Information (SAI) for Lincoln National Variable Annuity Account L 33 Appendix A - Condensed Financial Information A-1
3 Special Terms In this prospectus, the following terms have the indicated meanings: Account or variable annuity account (VAA) - The segregated investment account, Account L, into which we set aside and invest the assets for the variable side of the contract offered in this prospectus. Account value - At a given time before the annuity commencement date, the value of all accumulation units for a contract plus the value of the fixed side of the contract. Accumulation unit - A measure used to calculate contract value for the variable side of the contract before the annuity commencement date. Annuitant - The person upon whose life the annuity benefit payments are based, and upon whose life a death benefit may be paid. Annuity commencement date - The valuation date when funds are withdrawn or converted into annuity units or fixed dollar payout for payment of retirement income benefits under the annuity payout option you select. Annuity payout - An amount paid at regular intervals after the annuity commencement 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 for the variable side of the contract after the annuity commencement date. See Annuity Payouts. Beneficiary - The person or entity designated by the participant to receive any death benefit paid if the participant dies before the annuity commencement date. Contractowner - The party named on the group annuity contract (for example, an employer, a retirement plan trust, an association, or other entity allowed by law). Contributions - Amounts paid into the contract. Death benefit-Before the annuity commencement date, the amount payable to a designated beneficiary if a participant dies. FINRA - Financial Industry Regulatory Authority. Lincoln Life (we, us, our) - The Lincoln National Life Insurance Company. Participant - An employee or other person affiliated with the contractowner on whose behalf we maintain an account under the contract. Participant year - A 12-month period starting with the date we receive the first contribution on behalf of a participant and on each anniversary after that. Plan - The retirement program that an employer offers to its employees for which a contract is used to accumulate funds. SEC - Securities and Exchange Commission. Subaccount - The portion of the VAA that reflects investments in accumulation and annuity units of a class of a particular fund available under the contracts. There is a separate subaccount which corresponds to each class of a fund. 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 p.m. New York time) on each day that the NYSE is open for trading (valuation date) and ending at the close of such trading on the next valuation date. 4 Expense Tables The following tables describe the fees and expenses that you will pay when buying, owning, and surrendering the contract. The first table describes the fees and expenses that contractowners or participants will pay at the time that you buy the contract, surrender the contract, or transfer contract value between investment options and/or the fixed account. State premium taxes may also be deducted. Contractowner/Participant Transaction Expenses for GVA I, II & III: The maximum surrender charge (contingent deferred sales charge) (as a percentage of an account value withdrawn):
GVA I GVA II GVA III - ------- -------- -------- 5%* 6%* None
* The surrender charge percentage is reduced over time. The later the redemption occurs, the lower the surrender charge with respect to that surrender or withdrawal. We may reduce or waive this charge in certain situations. See Charges and Other Deductions - Surrender Charges. The next table describes the fees and expenses that you will pay periodically during the time that you own the contract, not including fund fees and expenses. Annual account fee (per participant): $25 Loan establishment fee (per loan): $50 Systematic withdrawal option fee: $30 The annual fee may be paid by an employer on behalf of participants. It is not charged during the annuity period. We may reduce or waive these charges in certain situations. See Charges and Other Deductions. Separate Account L expenses for GVA I, II, & III subaccounts (as a percentage of average daily net assets in the subaccounts): "standard" mortality and expense risk charge 1.00% "breakpoint" mortality and expense charge* .75%
* Only certain contract or plans are eligible for a breakpoint charge. See - Charges and Other Deductions. For information concerning compensation paid for the sale of the contracts, see "Distribution of the Contracts." The next item shows the minimum and maximum total annual operating expenses charged by the funds that you may pay periodically during the time that you own the contract. The expenses are for the year ended December 31, 2007. More detail concerning each fund's fees and expenses is contained in the prospectus for each fund.
Maximum Minimum --------- -------- Total Annual Fund Operating Expenses (expenses that are deducted from fund assets, including management fees, distribution and/or service (12b-1) fees, and other expenses): 6.06% 0.27% Net Total Annual Fund Operating Expenses (after contractual waivers/reimbursements*): 1.29% 0.27%
* Sixteen of the funds have entered into contractual waiver or reimbursement arrangements that may reduce fund management and other fees and/or expenses during the period of the arrangement. These arrangements vary in length, but no arrangement will terminate before April 30, 2009. The following table shows the expenses charged by each fund for the year ended December 31, 2007: (as a percentage of each fund's average net assets):
Management Other Fees 12b-1 Fees Expenses (before (before (before any any any waivers/ waivers/ waivers/ reimburse- reimburse- reimburse- ments) + ments) + ments) AllianceBernstein VPS Global Technology Portfolio (Class B) 0.75 % 0.25 % 0.17 % AllianceBernstein VPS Growth Portfolio (Class B) 0.75 0.25 0.15 AllianceBernstein VPS Growth and Income Portfolio (Class B) 0.55 0.25 0.04 tal Expen To ns Total Total Contr er Expense ra ctual es waive Contr (before er ra any reimb waive waivers bu er Acquired s/ Fund reimbur e- bu Fees and rs (if ments + Expenses = ments) any) s) AllianceBernstein VPS Global Technology Portfolio (Class B) 0.00 % 1.17 AllianceBernstein VPS Growth Portfolio (Class B) 0.00 1.15 AllianceBernstein VPS Growth and Income Portfolio (Class B) 0.00 0.84
5
Management Other Fees 12b-1 Fees Expenses (before (before (before any any any waivers/ waivers/ waivers/ reimburse- reimburse- reimburse- ments) + ments) + ments) American Century VP Balanced Fund (Class I)(1) 0.90 % 0.00 % 0.00 % American Funds Global Growth Fund (Class 2)* 0.53 0.25 0.02 American Funds Growth Fund (Class 2)* 0.32 0.25 0.01 American Funds Growth-Income Fund (Class 2)* 0.26 0.25 0.01 American Funds International Fund (Class 2)* 0.49 0.25 0.03 Delaware VIP Diversified Income Series (Standard Class)(2) 0.64 0.00 0.09 Delaware VIP High Yield Series (Standard Class)(3) 0.65 0.00 0.10 Delaware VIP REIT Series (Service Class)(4) 0.73 0.30 0.10 Delaware VIP Small Cap Value Series (Service Class)(5) 0.71 0.30 0.10 Delaware VIP Trend Series (Service Class)(6) 0.75 0.30 0.11 Dreyfus Stock Index Fund (Initial Class) 0.25 0.00 0.02 Dreyfus VIF Developing Leaders Portfolio (Initial Class) 0.75 0.00 0.06 DWS Equity 500 Index VIP (Class A)(7)(3) 0.19 0.00 0.12 DWS Small Cap Index VIP (Class A) (8)(9) 0.35 0.00 0.15 Fidelity (Reg. TM) VIP Asset Manager Portfolio (Initial Class)(10) 0.51 0.00 0.12 Fidelity (Reg. TM) VIP Contrafund Portfolio (Service Class 2)(11) 0.56 0.25 0.09 Fidelity (Reg. TM) VIP Equity-Income Portfolio (Initial Class)(12) 0.46 0.00 0.09 Fidelity (Reg. TM) VIP Growth Portfolio (Initial Class)(13) 0.56 0.00 0.09 Janus Aspen Worldwide Growth Portfolio (Institutional Shares)(14,15,16) 0.65 0.00 0.02 LVIP Baron Growth Opportunities (Service Class)(17) 1.00 0.25 0.08 LVIP Cohen & Steers Global Real Estate Fund (Standard Class)(18)(19) 0.95 0.00 0.15 LVIP Delaware Bond Fund (Standard Class) 0.34 0.00 0.06 LVIP Delaware VIP Growth and Income Fund (Standard Class) 0.33 0.00 0.07 LVIP Delaware Managed Fund (Standard Class) 0.40 0.00 0.08 LVIP Delaware Social Awareness Fund (Standard Class) 0.35 0.00 0.06 LVIP Janus Capital Appreciation Fund (Standard Class)(20) 0.74 0.00 0.08 LVIP Mondrian International Value Fund (Standard Class) 0.68 0.00 0.12 LVIP T. Rowe Price Structured Mid-Cap Growth Fund (Standard Class) 0.73 0.00 0.09 LVIP Wilshire 2010 Profile Fund (Standard Class)(21)(22) 0.25 0.00 3.18 LVIP Wilshire 2020 Profile Fund (Standard Class)(21)(22) 0.25 0.00 1.45 LVIP Wilshire 2030 Profile Fund (Standard Class)(21)(22) 0.25 0.00 2.61 LVIP Wilshire 2040 Profile Fund (Standard Class)(21)(22) 0.25 0.00 4.89 LVIP Wilshire Aggressive Profile Fund (Standard Class)(21)(22) 0.25 0.00 0.09 LVIP Wilshire Conservative Profile Fund (Standard Class)(21)(22) 0.25 0.00 0.08 LVIP Wilshire Moderate Profile Fund (Standard Class)(21)(22) 0.25 0.00 0.04 LVIP Wilshire Moderately Aggressive Profile Fund (Standard Class)(21)(22) 0.25 0.00 0.04 Neuberger Berman Mid-Cap Growth Portfolio (I Class)(23) 0.82 0.00 0.07 Neuberger Berman Partners Portfolio (I Class)(23) 0.83 0.00 0.08 T. Rowe Price International Stock Portfolio 0.97 0.00 0.08 otal pense Tes Exafter Total Total Expense ( c- es Contract al (before tu tual any waivers/ waivers reimburs s/ Acquired s/ se - Fund reimbur ments reimbur Fees and rs e- rs + Expenses = ments) (if any) ments) American Century VP Balanced Fund (Class I)(1) 0.00 % 0.90 American Funds Global Growth Fund (Class 2)* 0.00 0.80 American Funds Growth Fund (Class 2)* 0.00 0.58 American Funds Growth-Income Fund (Class 2)* 0.00 0.52 American Funds International Fund (Class 2)* 0.00 0.77 Delaware VIP Diversified Income Series (Standard Class)(2) 0.00 0.73 Delaware VIP High Yield Series (Standard Class)(3) 0.00 0.75 -0.01 0.74 Delaware VIP REIT Series (Service Class)(4) 0.00 1.13 -0.05 1.08 Delaware VIP Small Cap Value Series (Service Class)(5) 0.00 1.11 -0.05 1.06 Delaware VIP Trend Series (Service Class)(6) 0.00 1.16 -0.05 1.11 Dreyfus Stock Index Fund (Initial Class) 0.00 0.27 Dreyfus VIF Developing Leaders Portfolio (Initial Class) 0.00 0.81 DWS Equity 500 Index VIP (Class A)(7)(3) 0.00 0.31 -0.03 0.28 DWS Small Cap Index VIP (Class A) (8)(9) 0.00 0.50 Fidelity (Reg. TM) VIP Asset Manager Portfolio (Initial Class)(10) 0.00 0.63 Fidelity (Reg. TM) VIP Contrafund Portfolio (Service Class 2)(11) 0.00 0.90 Fidelity (Reg. TM) VIP Equity-Income Portfolio (Initial Class)(12) 0.00 0.55 Fidelity (Reg. TM) VIP Growth Portfolio (Initial Class)(13) 0.00 0.65 Janus Aspen Worldwide Growth Portfolio (Institutional Shares)(14,15,16) 0.00 0.67 LVIP Baron Growth Opportunities (Service Class)(17) 0.00 1.33 -0.04 1.29 LVIP Cohen & Steers Global Real Estate Fund (Standard Class)(18)(19) 0.00 1.10 -0.25 0.85 LVIP Delaware Bond Fund (Standard Class) 0.00 0.40 LVIP Delaware VIP Growth and Income Fund (Standard Class) 0.00 0.40 LVIP Delaware Managed Fund (Standard Class) 0.00 0.48 LVIP Delaware Social Awareness Fund (Standard Class) 0.00 0.41 LVIP Janus Capital Appreciation Fund (Standard Class)(20) 0.00 0.82 -0.13 0.69 LVIP Mondrian International Value Fund (Standard Class) 0.00 0.80 LVIP T. Rowe Price Structured Mid-Cap Growth Fund (Standard Class) 0.00 0.82 LVIP Wilshire 2010 Profile Fund (Standard Class)(21)(22) 0.76 4.19 -3.18 1.01 LVIP Wilshire 2020 Profile Fund (Standard Class)(21)(22) 0.79 2.49 -1.45 1.04 LVIP Wilshire 2030 Profile Fund (Standard Class)(21)(22) 0.88 3.74 -2.61 1.13 LVIP Wilshire 2040 Profile Fund (Standard Class)(21)(22) 0.92 6.06 -4.89 1.17 LVIP Wilshire Aggressive Profile Fund (Standard Class)(21)(22) 1.02 1.36 -0.09 1.27 LVIP Wilshire Conservative Profile Fund (Standard Class)(21)(22) 0.77 1.10 -0.08 1.02 LVIP Wilshire Moderate Profile Fund (Standard Class)(21)(22) 0.89 1.18 -0.04 1.14 LVIP Wilshire Moderately Aggressive Profile Fund (Standard Class)(21)(22) 0.92 1.21 -0.04 1.17 Neuberger Berman Mid-Cap Growth Portfolio (I Class)(23) 0.00 0.89 Neuberger Berman Partners Portfolio (I Class)(23) 0.00 0.91 T. Rowe Price International Stock Portfolio 0.00 1.05
6 (*) The investment adviser is voluntarily waiving up to 10% of its management fee. The waiver may be discontinued at any time in consultation with the Series' board, but it is expected to continue at its current level until further review. Total annual fund operating expenses do not reflect this waiver. Information regarding the effect of any waiver on total annual fund operating expenses can be found in the Financial Highlights table in the Series' prospectus and in the audited financial statements in the Series' annual report. (1) The fund pays the advisor a single, unified management fee for arranging all services necessary for the fund to operate. The fee shown is based on assets during the fund's most recent fiscal year. The fund has a stepped fee schedule. As a result, the fund's unified management fee rate generally decreases as assets increase and increases as assets decrease. (2) The investment advisor for the Delaware VIP Diversified Income Series is Delaware Management Company ("DMC"). Under its Management Agreement, the Series pays an annual management fee based on average daily net assets as follows: 0.65% on the first $500 million, 0.60% on the next $500 million, 0.55% on the next $1.5 billion, and 0.50% on assets in excess of $2.5 billion. (3) The investment advisor for the Delaware VIP High Yield Series is Delaware Management Company ("DMC"). For the period May 1, 2007 through April 30, 2009, the advisor has contracted to waive all or a portion of its investment advisory fees and/or reimburse expenses in order to prevent total annual series operating expenses (excluding any 12b-1 plan expenses, taxes, interest, inverse floater program expenses, brokerage fees, certain insurance costs, and non-routine expenses or costs, including, but not limited to, those relating to reorganizations, litigation, certain Trustee retirement plan expenses, conducting shareholder meetings, and liquidations (collectively, "non-routine expenses"))from exceeding, in an aggregate amount, 0.74% of average daily net assets. Under its Management Agreement, the Series pays an annual management fee based on average daily net assets as follows: 0.65% on the first $500 million, 0.60% on the next $500 million, 0.55% on the next $1.5 billion, and 0.50% on assets in excess of $2.5 billion. (4) The investment advisor for the Delaware VIP REIT Series is Delaware Management Company ("DMC"). For the period May 1, 2007 through April 30, 2008, the advisor contracted to waive all or a portion of its investment advisory fees and/or reimburse expenses in order to prevent total annual operating series expenses (excluding any 12b-1 plan expenses, taxes, interest, inverse floater program expenses, brokerage fees, certain insurance costs, and non-routine expenses or costs, including, but not limited to, those relating to reorganizations, litigation, certain Trustee retirement plan expenses, conducting shareholder meetings, and liquidations (collectively, "non-routine expenses")) from exceeding, in an aggregate amount, 1.00% of average daily net assets. Under its Management Agreement, the Series pays an annual management fee based on average daily net assets as follows: 0.75% on the first $500 million, 0.70% on the next $500 million, 0.65% on the next $1.5 billion, and 0.60% on assets in excess of $2.5 billion. The Service Class shares are subject to an annual 12b-1 fee of not more than 0.30%. Effective May 1, 2007 through April 30, 2009, Delaware Distributors, L.P. has contracted to limit the Service Class shares 12b-1 fee to no more than 0.25% of average daily net assets. (5) The investment advisor for the Delaware VIP Small Cap Value Series is Delaware Management Company ("DMC"). Under its Management Agreement, the Series pays an annual management fee based on average daily net assets as follows: 0.75% on the first $500 million, 0.70% on the next $500 million, 0.65% on the next $1.5 billion, and 0.60% on assets in excess of $2.5 billion. The Service Class shares are subject to an annual 12b-1 fee of not more than 0.30%. Effective May 1, 2007 through April 30, 2009, Delaware Distributors, L.P. has contracted to limit the Service Class shares 12b-1 fee to no more than 0.25% of average daily net assets. (6) The investment advisor for the Delaware VIP Trend Series is Delaware Management Company ("DMC"). Under its Management Agreement, the Series pays an annual management fee based on average daily net assets as follows: 0.75% on the first $500 million, 0.70% on the next $500 million, 0.65% on the next $1.5 billion, and 0.60% on assets in excess of $2.5 billion. The Service Class shares are subject to an annual 12b-1 fee of not more than 0.30%. Effective May 1, 2007 through April 30, 2009, Delaware Distributors, L.P. has contracted to limit the Service Class shares 12b-1 fee to no more than 0.25% of average daily net assets. (7) Through April 30, 2009, the Advisor has contractually agreed to waive all or a portion of its management fee and reimburse or pay operating expenses of the fund to the extent necessary to maintain the fund's operating expenses at 0.28% for Class A, excluding certain expenses such as extraordinary expenses, taxes, brokerage and interest. (8) "Other Expenses" are based on estimated amounts for the current fiscal year. Actual expenses may be different. Includes 0.10% administration fee. (9) Through September 30, 2008, the Advisor has contractually agreed to waive all or a portion of its management fee and reimburse or pay operating expenses of the fund to the extent necessary to maintain the fund's operating expenses at 0.47% for Class A, excluding certain expenses such as extraordinary expenses, taxes, brokerage and interest. (10) Asset Manager. A portion of the brokerage commissions that the fund pays may be reimbursed and used to reduce the fund's expenses. In addition, through arrangements with the funds' custodian, credits realized as a result of uninvested cash balances are used to reduce the fund's custodian expenses. Including thee reductions, the total class operating expenses would have been 0.62% for Initial Class. These offsets may be discontinued at any time. (11) Contrafund - A portion of the brokerage commissions that the fund pays may be reimbursed and used to reduce the fund's expenses. In addition, through arrangements with the fund's custodian, credits realized as a result of uninvested cash balances are used to reduce the fund's custodian expenses. Including these reductions, the total class operating expenses would have been 0.89% for Service Class 2. These offsets may be discontinued at any time. (12) Equity-Income. A portion of the brokerage commissions that the fund pays may be reimbursed and used to reduce the fund's expenses. In addition, through arrangements with the fund's custodian, credits realized as a result of uninvested cash balances are used to reduce the fund's custodian expenses. Including these reductions, the total class operating expenses would have been 0.54% for Initial Class. These offsets may be discontinued at any time. (13) Growth. A portion of the brokerage commissions that the fund pays may be reimbursed and used to reduce the fund's expenses. In addition, through arrangements with the fund's custodian, credits realized as a result of uninvested cash balances are used to reduce the fund's custodian expenses. Including these reductions, the total class operating expenses would have been 0.64% for Initial Class. These offsets may be discontinued at any time. (14) All expenses are shown without the effect of expense offset arrangements. Pursuant to such offset arrangements, credits realized as a result of uninvested cash balances are used to reduce custodian and transfer agent expenses. (15) The "Management Fee" is the investment advisory fee rate paid by each Portfolio to Janus Capital as of the end of the fiscal year. For Worldwide Growth Portfolio, this fee may go up or down monthly based on the Portfolio's performance relative to its benchmark index. (16) Worldwide Growth Portfolio pays an investment advisory fee rate that adjusts up or down based upon the Portfolio's performance relative to its benchmark index during the measuring period. This fee rate, prior to any performance adjustment, is 0.60% for Worldwide Growth Portfolio; and may go up or down by a variable of up to 0.15% (assuming constant assets) on a monthly basis. Any such adjustment to the fee rate commenced February 2007 for Worldwide Growth Portfolio may increase or decrease the Management Fee. Refer to the "Management Expenses" section in this Prospectus for additional information with further description in the Statement of Additional Information. (17) The adviser has contractually agreed to reimburse the fund's Service Class to the extent that the fund's Total Annual Fund Operating Expenses exceed 1.29% of average daily net assets. The Agreement will continue at least through April 30, 2009 and renew automatically for one-year terms unless the adviser provides written notice of termination to the fund. Other expenses shown in the table have been restated to reflect the changes in the expense structure of the fund as a result of the reorganization of the fund which was effective June 5, 2007. (18) The adviser has contractually agreed to reimburse the fund's Standard Class to the extent that the fund's Total Annual Fund Operating Expenses 7 exceed 0.85% of average daily net assets. The Agreement will continue at least through April 30, 2009 and renew automatically for one-year terms unless the adviser provides written notice of termination to the fund. (19) The adviser has contractually agreed to waive the following portion of its advisory fee for the fund: 0.22% on the first $250,000,000 of average daily net assets of the fund and 0.32% on the excess over $250,000,000 of average daily net assets of the fund. The fee waiver will continue at least through April 30, 2009, and renew automatically for one-year terms unless the adviser provides written notice of termination to the fund. (20) The adviser has contractually agreed to waive a portion of its advisory fee through April 30, 2009. The waiver amount is: 0.15% on the first $100,000,000 of average daily net assets of the fund; 0.10% of the next $150,000,000 of average daily net assets of the fund; 0.15% on the next $250,000,000 of average daily net assets of the fund; 0.10% on the next $250,000,000 of average daily net assets of the fund; 0.15% on the next $750,000,000 of average daily net assets of the fund; and 0.20% on the excess of $1.5 billion of average daily net assets of the fund; The waiver will renew automatically for one-year terms unless the adviser provides written notice of termination to the fund. (21) The "Acquired Fund Fees and Expenses (AFFE)" in the chart are based on the 2007 fees and expenses of the underlying funds that were owned by each Profile fund during 2007 and are provided to show you an estimate of the underlying fees and expenses attributable to each fund. Each funds' expense ratio will vary based on the actual allocations to the underlying funds that occurred through the year. (22) The adviser has contractually agreed to reimburse each fund's Standard Class to the extent that the fund's Total Annual Fund Operating Expenses (excluding underlying fund fees and expenses) exceed 0.25% of average daily net assets. The agreement will continue at least through April 30, 2009 and renew automatically for one-year terms unless the adviser provides written notice of termination to the fund. (23) Neuberger Berman Management Inc. ("NBMI") has undertaken through December 31, 2011 to waive fees and/or reimburse certain operating expenses, including the compensation of NBMI (except with respect to Balanced, Lehman Brothers Short Duration Bond, Mid-Cap Growth, and Partners Portfolios) and excluding taxes, interest, extraordinary expenses, brokerage commissions and transaction costs, that exceed, in the aggregate, 1% of average daily net asset value of the Balanced, Lehman Brothers Short Duration Bond, Mid-Cap Growth and Partners Portfolios; and 1.50% of the average daily net asset value of the Regency Portfolio. The expense limitation arrangements for the Portfolios are contractual and any excess expenses can be repaid to NBMI within three years of the year incurred, provided such recoupment would not cause a Portfolio to exceed its respective limitation. 8 EXAMPLES This Example is intended to help contractowners or participants compare the cost of investing in the contract with the cost of investing in other variable annuity contracts. These costs include contractowner/participant transaction expenses, contract fees, separate account annual expenses, and fund fees and expenses. The Example assumes that you invest $10,000 in the contract for the time periods indicated. The Example also assumes that your investment has a 5% return each year, the maximum fees and expenses of any of the funds. Although your actual costs may be higher or lower, based on these assumptions, your costs would be: 1) If you surrender your contract at the end of the applicable period:
1 year 3 years 5 years 10 years -------- --------- --------- --------- GVA I Standard* $ 749 $1,266 $1,811 $2,786 GVA II Standard* 850 1,371 1,920 3,037 GVA III Standard* 236 727 1,245 2,666
2) If you do not surrender your contract at the end of the applicable time period:
1 year 3 years 5 years 10 years -------- --------- --------- --------- GVA I Standard* $ 235 $ 724 $1,240 $2,656 GVA II Standard* 234 721 1,235 2,646 GVA III Standard* 236 727 1,245 2,666
* Examples shown may be less for plans qualifying for "breakpoint" mortality and expense risk charge. The Expense Tables reflect expenses of the VAA as well as the maximum fees and expenses of any of the funds. We provide these examples, which are unaudited, to show the direct and indirect costs and expenses of the contract. For more information, see - Charges and Other Deductions in the prospectus, and in the prospectuses for the funds. Premium taxes may also apply, although they do not appear in the examples. These examples should not be considered a representation of past or future expense. Actual expenses may be more or less than those shown. Summary of Common Questions What kind of contract is this? It is a group variable annuity contract between the contractowner and Lincoln Life. It may provide for a fixed annuity and/or a variable annuity. This prospectus describes the variable side of the contract. See The Contracts. This prospectus provides a general description of the contract. The contract and certain riders, benefits, service features and enhancements may not be available in all states, and the charges may vary in certain states. You should refer to your contract for any state specific provisions. Please check with your investment representative regarding their availability. What is the variable annuity account (VAA)? It is a separate account we established under Indiana insurance law, and registered with the SEC as a unit investment trust. VAA assets are allocated to one or more subaccounts, according to your investment choices. VAA assets are not chargeable with liabilities arising out of any other business which we may conduct. See Variable Annuity Account. What are my investment choices? Based upon your instruction for purchase payments, the VAA applies your purchase payments to buy shares in one or more of the investment options. In turn, each fund holds a portfolio of securities consistent with its investment policy. See Investments of the Variable Annuity Account - Description of the Funds. Who invests my money? Several different investment advisers manage the investment options. See Investments of the Variable Annuity Account - Description of the Funds. How do the contracts work? If we approve the application, we will send the contractowner a contract. When participants make contributions, they buy accumulation units. If the participant decides to receive retirement income payments, we convert accumulation units to annuity units. Retirement income payments will be based on the number of annuity units received and the value of each annuity unit on payout days. See - The Contracts and Annuity Payments. What charges do I pay under the contract? If participants in GVA I or GVA II withdraw account value, a surrender charge of 0-5% or 0-6%, respectively, of the gross withdrawal amount applies depending upon how many participation years the participant has been in the contract. We may reduce or waive surrender charges in certain situations. See Charges and Other Deductions - Surrender Charge for GVA I and GVA II. There is no surrender charge for GVA III. 9 We charge an account fee charge of $25 per participant account. We will deduct any applicable premium tax from contributions or account value at the time the tax is incurred or at another time we choose. We apply a charge to the daily net asset value of the VAA and those charges are: "standard" mortality and expense risk charge 1.00% "breakpoint" mortality and expense charge* .75%
See - Charges and Other Deductions. The funds' investment management fees, 12b-1 fees, expenses and expense limitations, if applicable, are more fully described in the prospectuses for the funds. What contributions are necessary, and how often? Contributions made on behalf of participants may be in any amount unless the contractowner or the plan has a minimum amount. See - The Contracts-Contributions. How will my annuity payouts be calculated? If a participant decides to annuitize, you may select an annuity option and start receiving annuity payouts from your contract as a fixed option or variable option or a combination of both. See Annuity Payouts - Annuity Options. Remember that participants in the VAA benefit from any gain, and take a risk of any loss, in the value of the securities in the funds' portfolios. What happens if a participant dies before annuitizing? Depending upon the plan, the beneficiary may receive a death benefit and have options as to how the death benefit is paid. See The Contracts - Death Benefit. May participants transfer account value between subaccounts, and between the VAA and the fixed account? Before the annuity commencement date, yes, subject to the terms of the plan. See - The Contracts - Transfers On or Before the Annuity Commencement Date and Transfers After the Annuity Commencement Date. May a participant withdraw account value? Yes, during the accumulation period, subject to contract requirements, to the restrictions of any plan, and to certain restrictions under GVA III. See - Charges and Other Deductions. Under GVA III the following restrictions apply: o a participant may not transfer more than 20% of their fixed account holdings to the VAA each year, unless the participant intends to liquidate their fixed account value; o liquidation of the entire fixed account value must be over 5 annual installments. See Fixed Account Withdrawal/Transfer Limits for GVA III. The contractowner must also approve participant withdrawals under Section 401(a) plans and plan subject to Title I of ERISA. Certain charges may apply. See - Charges and other deductions. A portion of withdrawal proceeds may be taxable. In addition, a 10% Internal Revenue Service (IRS) tax penalty may apply to distributions before age 59 1/2. A withdrawal also may be subject to 20% withholding. See - Federal Tax Matters. Do participant's get a free look at their certificates? A participant under a Section 403(b) or 408 plan and certain non-qualified plans can cancel the active life certificate within ten days (in some states longer) of the date the participant receives the certificate. The participant needs to give notice to our servicing office. See - Return Privilege. Where may I find more information about accumulation unit values? The Appendix to this prospectus provides more information about accumulation unit values. Investment Results The VAA advertises the annual performance of the subaccounts for the funds on both a standardized and non-standardized basis. The standardized calculation measures average annual total return. This is based on a hypothetical $1,000 payment made at the beginning of a one-year, a five-year and a 10-year period. This calculation reflects all fees and charges that are or could be imposed on all contractowner accounts. The nonstandardized calculation compares changes in accumulation unit values from the beginning of the most recently completed calendar year to the end of that year. It may also compare changes in accumulation unit values over shorter or longer time periods. This calculation reflects mortality and expense risk charges. It also reflects management fees and other expenses of the fund. It does not include the surrender charge or the account charge; if included, they would decrease the performance. The Lincoln National Life Insurance Company The Lincoln National Life Insurance Company (Lincoln Life), organized in 1905, is an Indiana-domiciled insurance company, engaged primarily in the direct issuance of life insurance contracts and annuities. Lincoln Life is wholly owned by Lincoln National Corporation (LNC), a publicly held insurance and financial services holding company incorporated in Indiana. Lincoln Life is obligated to pay all 10 amounts promised to policy owners under the policies. Guarantees provided within death benefit options and living benefit riders are backed by the claims-paying ability of Lincoln Life. Lincoln Financial Group is the marketing name for Lincoln National Corporation (NYSE:LNC) and its affiliates. Lincoln Financial Group sells a wide variety of financial products and solutions through financial advisors: mutual funds, managed accounts, retirement solutions, life insurance, 401(k) and 403(b) plans, savings plans, institutional investments and comprehensive financial planning and advisory services. Fixed Side of the Contract The portion of the account value allocated to the fixed side of the contract becomes part of our general account, and does not participate in the investment experience of the VAA. The general account is subject to regulation and supervision by the Indiana Insurance Department as well as the insurance laws and regulations of the jurisdictions in which the contracts are distributed. In reliance on certain exemptions, exclusions and rules, we have not registered interests in the general account as a security under the Securities Act of 1933 (1933 Act) and have not registered the general account as an investment company under the Investment Company Act of 1940 (1940 Act). Accordingly, neither the general account nor any interests in it are regulated under the 1933 Act or the 1940 Act. We have been advised that the staff of the SEC has not made a review of the disclosures which are included in this prospectus which relate to our general account and to the fixed account under the contract. These disclosures, however, may be subject to certain provisions of the federal securities laws relating to the accuracy and completeness of statements made in prospectuses. This prospectus is generally intended to serve as a disclosure document only for aspects of the contract involving the VAA, and therefore contains only selected information regarding the fixed side of the contract. Complete details regarding the fixed side of the contract are in the contract. Contributions allocated to the fixed side of the contract are guaranteed to be credited with a minimum interest rate, specified in the contract, of at least 3%. A contribution allocated to the fixed side of the contract is credited with interest beginning on the next calendar day following the date of receipt if all participant data is complete. Lincoln Life may vary the way in which it credits interest to the fixed side of the contract from time to time. ANY INTEREST IN EXCESS OF 3% WILL BE DECLARED IN ADVANCE AT LINCOLN LIFE'S SOLE DISCRETION. CONTRACTOWNERS AND PARTICIPANTS BEAR THE RISK THAT NO INTEREST IN EXCESS OF 3% WILL BE DECLARED. Under GVA III, special limits apply to transfers and withdrawals from the fixed account. See - Charges and Other Deductions-Fixed Account Withdrawal/Transfer Limits for GVA III. Variable Annuity Account (VAA) On April 29, 1996, the VAA was established as an insurance company separate account under Indiana law. It is registered with the SEC as a unit investment trust under the provisions of the Investment Company Act of 1940 (1940 Act). 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. We are the issuer of the contracts and the obligations set forth in the contract, other than those of the contractowner, are ours. The VAA satisfies the definition of a separate account under the federal securities laws. We do not guarantee 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. Financial Statements The financial statements of the VAA and the consolidated financial statements of Lincoln Life are located in the SAI. If you would like a free copy of the SAI, complete and mail the request on the last page of this prospectus, or call 1-800-341-0441. Investments of the VAA The contractowner decides which of the subaccount(s) available under the contract will be available for participant allocations. There is a separate subaccount which corresponds to each fund. Participant allocations may change 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 funds are required to redeem fund shares at net asset value upon our request. 11 Investment Advisers As compensation for its services to the fund, the investment adviser receives a fee from the fund which is accrued daily and paid monthly. This fee is based on the net assets of each fund, as defined in the prospectus for the fund. Certain Payments We Receive with Regard to the Funds With respect to a fund, including affiliated funds, the adviser and/or distributor, or an affiliate thereof, may make payments to us (or an affiliate). It is anticipated that such payments will be based on a percentage of assets of the particular fund attributable to the Contracts along with certain other variable contracts issued or administered by us (or an affiliate). These percentages are negotiated and vary with each fund. Some funds may pay us significantly more than other funds and the amount we receive may be substantial. These percentages currently range up to 0.46%, and as of the date of this prospectus, we were receiving payments from each fund family. We (or our affiliates) may profit from these payments or use these payments for a variety of purposes, including payment of expenses that we (and our affiliates) incur in promoting, marketing, and administering the Contracts and, in our role as intermediary, the funds. These payments may be derived, in whole or in part, from the investment advisory fee deducted from fund assets. Contractowners, through their indirect investment in the funds, bear the costs of these investment advisory fees (see the funds' prospectuses for more information). Additionally, a fund's adviser and/or distributor or its affiliates may provide us with certain services that assist us in the distribution of the contracts and may pay us and/or certain affiliates amounts for marketing programs and sales support, as well as amounts to participate in training and sales meetings. The AllianceBernstein, American Funds, Delaware and Fidelity Funds offered as part of this contract make payments to us under their distribution plans (12b-1 plans). The payment rates range up to 0.25% based on the amount of assets invested in those Funds. Payments made out of the assets of the fund will reduce the amount of assets that otherwise would be available for investment, and will reduce the fund's investment return. The dollar amount of future asset-based fees is not predictable because these fees are a percentage of the fund's average net assets, which can fluctuate over time. If, however, the value of the fund goes up, then so would the payment to us (or our affiliates). Conversely, if the value of the funds goes down, payments to us or our affiliates would decrease. Description of the Funds Each of the subaccounts of the VAA is invested solely in shares of one of the funds available under the contract. Each fund may be subject to certain investment policies and restrictions which may not be changed without a majority vote of shareholders of that fund. We select the funds offered through the contract based on several factors, including, without limitation, asset class coverage, the strength of the manager's reputation and tenure, brand recognition, performance, and the capability and qualification of each sponsoring investment firm. Another factor we consider during the initial selection process is whether the fund or an affiliate of the fund will make payments to us or our affiliates. We review each fund periodically after it is selected. Upon review, we may remove a fund or restrict allocation of additional purchase payments to a fund if we determine the fund no longer meets one or more of the factors and/or if the fund has not attracted significant contractowner assets. Finally, when we develop a variable annuity product in cooperation with a fund family or distributor (e.g., a "private label" product), we generally will include funds based on recommendations made by the fund family or distributor, whose selection criteria may differ from our selection criteria. We currently anticipate closing and replacing the following funds during the third quarter of 2008: AllianceBernstein VP Growth Portfolio (Class B) with AllianceBernstein VP Growth and Income Portfolio (Class B); American Century VP Balanced Fund (Class 1) with LVIP Delaware Managed Fund (Standard Class); Dreyfus VIF Developing Leaders Portfolio (Initial Class) with LVIP Small Cap Index (Standard Class); Dreyfus Stock Index Fund, Inc. with LVIP S&P 500 Index Fund (Standard Class); DWS Equity 500 Index Portfolio -Class A with LVIP S&P 500 Index Fund (Standard Class); DWS Small-Cap Index Portfolio (Class A) with LVIP Small-Cap Index Fund (Standard Class); Fidelity VIP Asset Manager Portfolio (Initial Class) with LVIP Delaware Managed Fund (Standard Class); Janus Aspen Worldwide Growth Portfolio (Institutional Class) with LVIP S&P 500 Index Fund (Standard Class); Neuberger Berman AMT Partners Portfolio with AllianceBernstein VP Growth and Income Portfolio (Class B); T. Rowe Price International Stock Portfolio with LVIP Mondrian International Fund (Standard Class). Certain funds offered as part of this contract have similar investment objectives and policies to other portfolios managed by the adviser. The investment results of the funds, however, may be higher or lower than the other portfolios that are managed by the adviser or sub-adviser. There can be no assurance, and no representation is made, that the investment results of any of the funds will be comparable to the investment results of any other portfolio managed by the adviser or sub-adviser, if applicable. Following are brief summaries of the fund descriptions. More detailed information may be obtained from the current prospectus for the fund. You should read each fund prospectus carefully before investing. Please be advised that there is no assurance that any of the funds will achieve their stated objectives. AllianceBernstein Variable Products Series Fund, advised by AllianceBernstein L.P. o AllianceBernstein Global Technology Portfolio (Class B): Maximum capital appreciation. o AllianceBernstein Growth Portfolio (Class B): Capital appreciation. It is currently anticipated that during the third quarter of 2008, we will close and replace this investment option. 12 o AllianceBernstein Growth and Income Portfolio (Class B): Growth and income. American Century Variable Products, advised by American Century Investment o Balanced Fund (Class I): Long-term capital growth & current income. It is currently anticipated that during the third quarter of 2008, we will close and replace this investment option. American Funds Insurance SeriesSM, advised by Capital Research and Management Company o Global Growth Fund (Class 2): Long-term growth. o Growth Fund (Class 2): Long-term growth. o Growth-Income Fund (Class 2): Growth and income. o International Fund (Class 2): Long-term growth. Delaware VIP Trust, advised by Delaware Management Company o Diversified Income Series (Standard Class): Total return. o High Yield Series (Standard Class): Total return. o REIT Series (Service Class): Total return. o Small Cap Value Series (Service Class): Capital appreciation. o Trend Series (Service Class): Capital appreciation. Dreyfus Variable Investment Fund, advised by The Dreyfus Corporation o Developing Leaders Portfolio (Initial Class): Capital growth. (Sub-advised by Franklin Portfolio Associates, LLC) It is currently anticipated that during the third quarter of 2008, we will close and replace this investment option. o Stock Index Fund, Inc. (Initial Class): Match the total return of the Standard & Poor's 500 Composite Stock Price Index. (Sub-advised by Mellon Capital Management Corporation) It is currently anticipated that during the third quarter of 2008, we will close and replace this investment option. DWS Investments VIT Funds, advised by Deutsche Asset Management, Inc. o DWS Equity 500 Index VIP (Class A): Capital appreciation. (Sub-advised by Northern Trust Investments, Inc.) It is currently anticipated that during the third quarter of 2008, we will close and replace this investment option. o DWS Small Cap Index VIP (Class A): Capital appreciation. (Sub-advised by Northern Trust Investments, Inc.) It is currently anticipated that during the third quarter of 2008, we will close and replace this investment option. Fidelity (Reg. TM) Variable Insurance Products, advised by Fidelity Management and Research Company o Asset Manager Portfolio (Initial Class): High total return. It is currently anticipated that during the third quarter of 2008, we will close and replace this investment option. o Contrafund (Reg. TM) Portfolio (Service Class 2): Long-term capital appreciation. o Equity-Income Portfolio (Initial Class): Reasonable income. o Growth Portfolio (Initial Class): Capital appreciation. Janus Aspen Series, advised by Janus Capital Management LLC o Worldwide Growth Portfolio (Institutional Shares): Long-term growth. It is currently anticipated that during the third quarter of 2008, we will close and replace this investment option. Lincoln Variable Insurance Products Trust, advised by Lincoln Investment Advisors o LVIP Baron Growth Opportunities Fund (Service Class): Long-term growth. (Sub-advised by BAMCO, Inc.) o LVIP Cohen & Steers Global Real Estate Fund (Standard Class): Total return. (Sub-advised by Cohen & Steers Capital Management) o LVIP Delaware Bond Fund (Standard Class): Current income. (Sub-advised by Delaware Management Company) 13 o LVIP Delaware Growth and Income Fund (Standard Class): Capital appreciation. (Sub-advised by Delaware Management Company) o LVIP Delaware Managed Fund (Standard Class): Total return. (Sub-advised by Delaware Management Company) o LVIP Delaware Social Awareness Fund (Standard Class): Capital appreciation. (Sub-advised by Delaware Management Company) o LVIP Janus Capital Appreciation Fund (Standard Class): Long-term growth. (Sub-advised by Janus Capital Management LLC) o LVIP Mondrian International Value Fund (Standard Class): Long-term capital appreciation. (Sub-advised by Mondrian Investment Partners Limited) o LVIP T. Rowe Price Structured Mid-Cap Growth Fund (Standard Class): Maximum capital appreciation. (Sub-advised by T. Rowe Price Associates, Inc.) o LVIP Wilshire 2010 Profile Fund (Standard Class): Total return; a fund of funds.* (Sub-advised by Wilshire Associates Incorporated) o LVIP Wilshire 2020 Profile Fund (Standard Class): Total return; a fund of funds.* (Sub-advised by Wilshire Associates Incorporated) o LVIP Wilshire 2030 Profile Fund (Standard Class): Total return; a fund of funds.* (Sub-advised by Wilshire Associates Incorporated) o LVIP Wilshire 2040 Profile Fund (Standard Class): Total return; a fund of funds.* (Sub-advised by Wilshire Associates Incorporated) o LVIP Wilshire Conservative Profile Fund (Standard Class): Current income; a fund of funds.* (Sub-advised by Wilshire Associates Incorporated) o LVIP Wilshire Moderate Profile Fund (Standard Class): Total return; a fund of funds.* (Sub-advised by Wilshire Associates Incorporated) o LVIP Wilshire Moderately Aggressive Profile Fund (Standard Class): Growth and income; a fund of funds.* (Sub-advised by Wilshire Associates Incorporated) o LVIP Wilshire Aggressive Profile Fund (Standard Class): Capital appreciation; a fund of funds.* (Sub-advised by Wilshire Associates Incorporated) *Funds offered in a fund of funds structure may have higher expenses than funds that invest directly in debt or equity securities. Neuberger Berman Advisers Management Trust, advised by Neuberger Berman Management Inc. o Mid-Cap Growth Portfolio (I Class): Capital appreciation. (Sub-advised by Neuberger Berman, LLC) o Partners Portfolio (I Class): Capital appreciation. (Sub-advised by Neuberger Berman, LLC) It is currently anticipated that during the third quarter of 2008, we will close and replace this investment option. T. Rowe Price International Series, Inc., advised by T. Rowe Price International, Inc. o T. Rowe Price International Stock Portfolio: Long-term growth. It is currently anticipated that during the third quarter of 2008, we will close and replace this investment option. Fund Shares 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 appropriate funds to pay annuity payouts, death benefits, surrender/withdrawal proceeds or for other purposes described in the contract. If you want to transfer 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. Redeemed 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 us, 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 a fund sells any of its shares both to variable annuity and to variable life insurance separate accounts, it is said to engage in mixed funding. When a fund sells any of its shares to separate accounts of unaffiliated life insurance companies, it is said to engage in shared funding. 14 The funds currently engage in mixed and shared funding. Therefore, due to differences in redemption rates or tax treatment, or other considerations, the interest of various contractowners participating in a fund could conflict. Each of the fund's Board of Directors will monitor for the existence of any material conflicts, and determine what action, if any, should be taken. The funds do not foresee any disadvantage to contractowners arising out of mixed or shared funding. If such a conflict were to occur, one of the separate accounts might withdraw its investment in a fund. This might force a fund to sell portfolio securities at disadvantageous prices. See the prospectuses for the funds. Reinvestment of Dividends and Capital Gain Distributions All dividends and capital gain distributions of the funds are automatically reinvested in shares of the distributing funds at their net asset value on the date of distribution. Dividends are not paid out to contractowners or participants as additional units, but are reflected as changes in unit values. Addition, Deletion or Substitution of Investments We reserve the right, within the law, to make certain changes to the structure and operation of the VAA at our discretion and without your consent. We may add, delete, or substitute funds for all contractowners or only for certain classes of contractowners. New or substitute funds may have different fees and expenses, and may only be offered to certain classes of contractowners. Substitutions may be made with respect to existing investments or the investment of future purchase payments, or both. We may close subaccounts to allocations of purchase payments or contract value, or both, at any time in our sole discretion. The funds, which sell their shares to the subaccounts pursuant to participation agreements, also may terminate these agreements and discontinue offering their shares to the subaccounts. Substitutions might also 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 management, for the purposes of the contract, or for any other reason in our sole discretion. We also may: o remove, combine, or add subaccounts and make the new subaccounts available to you at our discretion; o transfer assets supporting the contracts from one subaccount to another or from the VAA to another separate account; o combine the VAA with other separate accounts and/or create new separate accounts; o deregister the VAA under the 1940 Act; and o operate the VAA as a management investment company under the 1940 Act or as any other form permitted by law. We may modify the provisions of the contracts to reflect changes to the subaccounts and the VAA and to comply with applicable law. We will not make any changes without any necessary approval by the SEC. We will also provide you written notice. Charges and Other Deductions We will deduct the charges described below to cover our costs and expenses, services provided and risks assumed under the contracts. 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: o processing applications for and issuing the contracts; o processing purchases and redemptions of fund shares as required (including dollar cost averaging, systematic transfer, account sweep and portfolio rebalancing services); o maintaining records; o administering annuity payouts; o furnishing accounting and valuation services (including the calculation and monitoring of daily subaccount values); o reconciling and depositing cash receipts; o providing contract confirmations; o providing toll-free inquiry services and o furnishing telephone and electronic fund transfer services. The risks we assume include: o the risk that annuitants receiving annuity payouts under contracts live longer than we assumed when we calculated our guaranteed rates (these rates are incorporated in the contract and cannot be changed); o the risk that death benefits paid will exceed the actual contract value; o the risk that more owners than expected will qualify for waivers of the surrender charge; o the risk that our costs in providing the services will exceed our revenues from contract charges (which we cannot change). 15 The amount of a charge may not necessarily correspond to the costs associated with providing the services or benefits indicated by the description of the charge. For example, the contingent deferred sales charge collected may not fully cover all of the sales and distribution expenses actually incurred by us. Any remaining expenses will be paid from our general account which may consist, among other things, of proceeds derived from mortality and expense risk charges deducted from the account. We may profit from one or more of the fees and charges deducted under the contract. We may use these profits for any corporate purpose, including financing the distribution of the contracts. Annual Contract Fee During the accumulation period, we currently deduct $25 (or the balance of the participant's account, if less) per year from each participant's account value on the last business day of the month in which a participant anniversary occurs, to compensate us for administrative services provided. We also deduct the charge from a participant's account if the participant's account is totally withdrawn. The charge may be increased or decreased. Surrender Charge for GVA I and GVA II* Under GVA I and GVA II, a surrender charge applies (except as described below) to total or partial withdrawals of a participant's account balance during the accumulation period as follows:
During Participation Year GVA I GVA II - --------------------------- ------- ------- 1-5 ..................... 5% 6% 6 ....................... 5% 3% 7 ....................... 4% 3% 8 ....................... 3% 3% 9 ....................... 2% 3% 10 ...................... 1% 3% 11-15 ................... 0% 1% 16 and later ............ 0% 0%
* There is no surrender charge taken on withdrawals from GVA III. The surrender charge is imposed on the gross withdrawal amount, and is deducted from the subaccounts and the fixed account in proportion to the amount withdrawn from each. We do not impose a surrender charge on death benefits, or on account balances converted to an annuity payout option. For any participant, the surrender charge will never exceed 8.5% of the cumulative contributions to the participant's account. Fixed Account Withdrawal/Transfer Limits for GVA III GVA III has no surrender charges, but under GVA III, special limits apply to withdrawals and transfers from the fixed account. During any one calendar year a participant may make one withdrawal from the fixed account, or one transfer to the VAA from the fixed account, of up to 20% of their fixed account balance. Participants who want to liquidate their entire fixed account balance or transfer it to the VAA, however, may make one withdrawal or transfer request from their fixed account in each of five consecutive calendar years according to the following percentages:
Percentage of Fixed Account Available Year Request Received by Lincoln Life Under GVA III - --------------------------------------- -------------------- 1 ................................... 20% 2 ................................... 25% 3 ................................... 33.33% 4 ................................... 50% 5 ................................... 100%
Each consecutive withdrawal or transfer may not be made more frequently than twelve months apart. This liquidation schedule is also subject to the same conditions as other withdrawals and transfers. We reserve the right to prohibit any additional contributions by a participant that notifies us of their intention to liquidate their fixed account balance and stop contributions to the contract. In addition, at contract termination certain 403(b) GVA III contracts offer lump sum payouts from the fixed account which may have a market value adjustment. Lump sum payouts will never be less than net contributions accumulated at an annual effective rate of 3%. Waiver of Surrender Charges and Fixed Account Withdrawal/Transfer Limits Under certain conditions, a participant may withdraw part or all of his or her fixed account balance without incurring a surrender charge under GVA I or GVA II, or without being subject to the fixed account withdrawal/transfer limits under GVA III. We must receive 16 reasonable proof of the condition with the withdrawal request. The chart below shows the standard conditions provided by GVA I, GVA II, and GVA III, as well as optional conditions the contractowner may or may not make available under the contracts:
Standard conditions ------------------------------------------------------------------- GVA I o the participant has attained age 591/2 o the participant has died o the participant has incurred a disability (as defined under the contract) o the participant has separated from service with their employer ------------------------------------------------------------------- GVA II o the participant has attained age 591/2 o the participant has died o the participant has incurred a disability (as defined under the contract) o the participant has separated from service with their employer and is at least 55 years of age ------------------------------------------------------------------- GVA III o the participant has attained age 591/2 o the participant has died o the participant has incurred a disability (as defined under the contract) o the participant has separated from service with their employer o the participant is experiencing financial hardship* Optional conditions ----------------------------------------------------------------- GVA I o the participant has separated from service with their employer and is at least 55 years of age o the participant is experiencing financial hardship ----------------------------------------------------------------- GVA II o the participant has separated from service with their employer o the participant is experiencing financial hardship ----------------------------------------------------------------- GVA III o the participant has separated from service with their employer and is at least 55 years of age
* A GVA III contractowner has the option not to include the financial hardship condition. Under GVA I and GVA II, a contractowner may also elect an optional contract provision that permits participants to make a withdrawal once each contract year of up to 20% of the participant's account balance without a surrender charge. A contractowner choosing one or more of the optional provisions may receive a different declared interest rate on the fixed account than will holders of contract without these provisions. Deductions from the VAA for GVA I, II & III We apply to the average daily net asset value of the subaccounts, a charge which is equal to an annual rate of: "standard" mortality and expense risk charge 1.00% "breakpoint" mortality and expense charge* .75%
* Only certain contract or plans are eligible for a breakpoint charge. See - Charges and Other Deductions. This maximum level of mortality and expense risk charge is guaranteed not to increase. It is assessed during the accumulation period and during the annuity period, even though during the annuity period, we bear no mortality risk on annuity options that do not have life contingencies. If the mortality and expense risk charge proves insufficient to cover underwriting and administrative costs in excess of the charges made for the administrative expenses, we will absorb the loss. However, if the amount deducted proves more than sufficient, we will keep the profit. Contracts eligible for the lower, or "breakpoint", mortality and expense risk charge are those contracts which, either individually or in combination with other contracts under the same employer group or association, either at issue or after issue and at the end of a calendar quarter, satisfy eligibility criteria anticipated to result in lower issue and administrative costs for us over time. Such criteria include, for example, expected size of account value and contributions, administrative simplicity, and/or limited competition. For cases not eligible for the lower mortality and risk expense charge at issue, the lower charge will be implemented no later than the calendar quarter-end valuation date following the end of the calendar quarter in which the contract becomes eligible for the lower charge. We periodically modify the criteria for eligibility. Modifications will not be unfairly discriminatory against any person. Contact your agent for our current eligibility criteria. Special Arrangements The surrender and account charges, described previously may be reduced or eliminated for any particular contract. In addition, the amount credited to and/or the interest rate declared on the fixed account may be enhanced for certain contracts. Such reductions, eliminations or enhancements may be available where Lincoln Life's administrative and/or distribution costs or expenses are anticipated to be lower due to, for example, the terms of the contract, the duration or stability of the plan or contract; economies due to the size of the plan, the number of certain characteristics of participants, or the amount or frequency of contributions anticipated; or other 17 support provided by the contractowner or the plan. In addition, the group contractowner or the plan may pay the annual administration charge on behalf of the participants under a contract or by election impose this charge only on particpants with account balances in the VAA . Lincoln Life will enhance the fixed interest crediting rate and reduce or eliminate fees, charges, or rates in accordance with Lincoln Life's eligibility criteria in effect at the time a contract is issued, or in certain cases, after a contract has been held for a period of time. Lincoln Life may, from time to time, modify both the amounts of reductions or enhancements and the criteria for qualification. Reductions, enhancements, or waivers will not be unfairly discriminatory against any person, including participants under other contracts issued through the VAA. Fees, charges and rates under the contracts, including charges for premium taxes; loan rates of interest; and the availability of certain free withdrawals, may be subject to variation based on state insurance regulation. The contractowner and participant should read the contract carefully to determine whether any variations apply in the state in which the contract is issued. The exact amount for all fees, charges, and rates applicable to a particular contract will be stated in that contract. 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 account 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 generally depend upon the law of your state of residence. The tax ranges from zero to 3.5%. Other Charges and Deductions There are additional deductions from and expenses paid out of the assets of the underlying funds that are more fully described in the prospectuses for the funds. Among these deductions and expenses are 12b-1 fees which reimburse us or an affiliate for certain expenses incurred in connection with certain administrative and distribution support services provided to the funds. The Contracts Purchase of the Contracts A prospective contractowner wishing to purchase a contract must apply for it through one of our authorized sales representatives. The completed application is sent to us and we decide whether we can accept it based on our underwriting guidelines. Once the application is accepted, a contract is prepared and executed by our legally authorized officers. The contract is then sent to the contractowner through its sales representative. For plans that have allocated rights to the participant, we will issue to each participant a separate active life certificate that describes the basic provisions of the contract. Initial Contributions When we receive a complete enrollment form and all other information necessary for processing a contribution, we will price the initial contribution for a participant to his or her account no later than two business days after we receive the contribution. If we receive contribution amounts with incomplete or no allocation instructions, we will notify the contractowner and direct contribution amounts to the pending allocation account. The pending allocation account invests in Fidelity (Reg. TM) VIP Money Market Portfolio, which is not available as an investment option under the contract. We do not impose the mortality and expense risk charge or the annual administration charge on the pending allocation account. The participant's participation date will be the date we deposited the participant's contribution into the pending allocation account. We will transfer the account value from the pending allocation account in accordance with allocation percentages elected on properly completed allocation instructions within two valuation dates of receipt of such instructions, and allocate all future contributions in accordance with these percentages until we are notified of a change. If we do not receive properly completed instructions after we have sent three monthly notices, we will refund account value in the pending allocation account within 105 days of the initial contribution. Participants may not allocate contributions to, make transfer to or from, take loans from, or make withdrawals from the pending allocation account, except as set forth in the contract. Contributions Contractowners generally forward contributions to us for investment. Depending on the plan, the contributions may consist of salary reduction contributions, employer contributions or post-tax contributions. 18 Contributions may accumulate on either a guaranteed or variable basis selected from those subaccounts made available by the contractowner. Contributions made on behalf of participants may be in any amount unless there is a minimum amount set by the contractowner or plan. A contract may require the contractowner to contribute a minimum annual amount on behalf of all participants. Annual contributions under qualified plans may be subject to maximum limits imposed by the tax code. Annual contributions under non-qualified plans may be limited by the terms of the contract. Subject to any restrictions imposed by the plan or the tax code, we will accept transfers from other contracts and qualified rollover contributions. Section 830.205 of the Texas Education Code provides that employer or state contributions (other than salary reduction contributions) on behalf of participants in the Texas Optional Retirement Program (ORP) vest after one year of participation in the program. We will return employer contributions to the contractowner for those employees who terminate employment in all Texas institutions of higher education before becoming vested. During this first participation year in the ORP, ORP participants may only direct employer and state contributions to the fixed account. Contributions must be in U.S. funds, and all withdrawals and distributions under the contract will be in U.S. funds. If a bank or other financial institution does not honor the check or other payment method used for a contribution, we will treat the contribution as invalid. All allocation and subsequent transfers resulting from the invalid contributions will be reversed and the party responsible for the invalid contribution must reimburse us for any losses or expenses resulting from the invalid contribution. Replacement of Existing Insurance Careful consideration should be given prior to surrendering or withdrawing money from an existing insurance contract to purchase the contract described in this prospectus. Participant Surrender charges may be imposed on your existing contract. An investment representative or tax adviser should be consulted prior to making an exchange. Cash surrenders from an existing contract may be subject to tax and tax penalties. Valuation Date Accumulation and annuity units will be valued once daily at the close of trading (normally, 4:00 p.m., New York time) on each day the New York Stock Exchange is open (valuation date). On any date other than a valuation date, the accumulation unit value and the annuity unit value will not change. Allocation of Contributions The contractowner forwards contributions to us, specifying the amount being contributed on behalf of each participant and allocation information in accordance with our procedures. Contributions are placed into the VAA's subaccounts, each of which invests in shares of a fund, and/or the fixed account, according to written participant instructions and subject to the plan. The contribution allocation percentage to the subaccount's or the fixed account must be in any whole percent. If we receive your purchase payment from you or your broker-dealer in good order at our servicing office prior to 4:00 p.m., New York time, we will use the accumulation unit value computed on that valuation date when processing your purchase payment. If we receive your purchase payment at or after 4:00 p.m., New York time, we will use the accumulation unit value computed on the next valuation date. If you submit your purchase payment to your representative, we will generally not begin processing the purchase payment until we receive it from your representative's broker-dealer. If your broker-dealer submits your purchase payment to us through the Depository Trust and Clearing Corporation (DTCC) or, pursuant to terms agreeable to us, uses a proprietary order placement system to submit your purchase payment to us, and your purchase payment was placed with your broker-dealer prior to 4:00 p.m., New York time, then we will use the accumulation unit value computed on that valuation date when processing your purchase payment. If your purchase payment was placed with your broker-dealer at or after 4:00 p.m. New York time, then we will use the accumulation unit value computed on the next valuation date. The number of accumulation units determined in this way is not impacted 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 underlying fund's investments perform, but also upon the expenses of the VAA and the underlying funds. Subject to the terms of the plan, a participant may change the allocation of contributions by notifying us in writing or by telephone in accordance with our published procedures. The change is effective for all contributions received concurrently with the allocation change form and for all future contributions, unless the participant specifies a later date. Changes in the allocation of future contributions have no effect on amounts a participant may have already contributed. Such amounts, however, may be transferred between subaccount and the fixed account pursuant to the requirements described in Transfers on or before the annuity commencement date. Allocation of employer contributions may be restricted by the applicable plan. 19 Valuation of Accumulation Units Purchase payments allocated to the VAA are converted into accumulation units. This is done by dividing the amount allocated by the value of an accumulation unit for the valuation period during which the purchase payments are allocated to the VAA. The accumulation unit value for each subaccount was or will be established at the inception of the subaccount. It may increase or decrease from valuation period to valuation period. Accumulation unit values are affected by investment performance of the funds, fund expenses, and the contract charges. The accumulation unit value for a subaccount for a later valuation period is determined as follows: 1. The total value of the fund shares held in the subaccount is calculated by multiplying the number of fund shares owned by the subaccount at the beginning of the valuation period by the net asset value per share of the fund at the end of the valuation period, and adding any dividend or other distribution of the fund if an ex-dividend date occurs during the valuation period; minus 2. The liabilities of the subaccount at the end of the valuation period. These liabilities include daily charges imposed on the subaccount, and may include a charge or credit with respect to any taxes paid or reserved for by us that we determine result from the operations of the VAA; and 3. The result is divided by the number of subaccount units outstanding at the beginning of the valuation period. The daily charges imposed on a subaccount for any valuation period are equal to the daily mortality and expense risk charge and the daily administrative charge multiplied by the number of calendar days in the valuation period. In certain circumstances, and when permitted by law, it may be prudent for us to use a different standard industry method for this calculation, called the Net Investment Factor method. We will achieve substantially the same result using either method. Transfers On or Before the Annuity Commencement Date Subject to the terms of a plan, a participant may transfer all or a portion of the participant's account balance from one subaccount to another, and between the VAA and the fixed account. Under GVA III transfers from the fixed account are subject to special limits. See - Fixed account withdrawals/transfer limits for GVA III. 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 determined at the end of the valuation date on which the transfer request is received. There is no charge for a transfer. We do not limit the number of transfers except as described under - Charges and other deductions-Fixed account withdrawal/transfer limits for GVA III. A transfer request may be made to us using written, telephone, fax, or electronic instructions, if the appropriate authorization is on file with us. Our address, telephone number, and internet address are on the first page of this prospectus. In order to prevent unauthorized or fraudulent transfers, we may require certain identifying information before we will act upon instructions. We may also assign the participant a Personal Identification Number (PIN) to serve as identification. We will not be liable for following instructions we reasonably believe are genuine. Telephone requests will be recorded and written confirmation of all transfer requests will be mailed to the participant on the next valuation date. Please note that the telephone and/or electronic devices may not always be available. Any telephone or electronic device, whether it is yours, your service provider's, or your agent's, can experience outages or slowdowns for a variety of reasons. These outages or slowdowns may delay or prevent our processing of your request. Although we have taken precautions to limit these problems, we cannot promise complete reliability under all circumstances. If you are experiencing problems, you should make your transfer request by writing to our servicing office. Requests for transfers will be processed on the valuation date that they are placed in our customer service center before the end of the valuation date (normally 4:00 p.m. New York time). If we receive a transfer request placed at or after 4:00 p.m., New York time, we will process the request using the accumulation unit value computed on the next valuation date. When thinking about a transfer of contract value, you should consider the inherent risk involved. Frequent transfers based on short-term expectations may increase the risk that a transfer will be made at an inopportune time. Market Timing Frequent, large, or short-term transfers among subaccounts and the fixed account, such as those associated with "market timing" transactions, can affect the funds and their investment returns. Such transfers may dilute the value of the fund shares, interfere with the efficient management of the fund's portfolio, and increase brokerage and administrative costs of the funds. As an effort to protect our participants and the funds from potentially harmful trading activity, we utilize certain market timing policies and procedures (the "Market Timing Procedures"). Our Market Timing Procedures are designed to detect and prevent such transfer activity among the subaccounts and the fixed account that may affect other participants or fund shareholders. In addition, the funds may have adopted their own policies and procedures with respect to frequent purchases and redemptions of their respective shares. The prospectuses for the funds describe any such policies and procedures, which may be more or less restrictive than the frequent trading policies and procedures of other funds and the Market Timing Procedures we have adopted to 20 discourage frequent transfers among subaccounts. While we reserve the right to enforce these policies and procedures, participants and other persons with interests under the contracts should be aware that we may not have the contractual authority or the operational capacity to apply the frequent trading policies and procedures of the funds. However, under SEC rules, we are required to: (1) enter into a written agreement with each fund or its principal underwriter that obligates us to provide to the fund promptly upon request certain information about the trading activity of individual participants, and (2) execute instructions from the fund to restrict or prohibit further purchases or transfers by specific participants who violate the excessive trading policies established by the fund. You should be aware that the purchase and redemption orders received by the funds generally are "omnibus" orders from intermediaries such as retirement plans or separate accounts funding variable insurance contracts. The omnibus orders reflect the aggregation and netting of multiple orders from individual retirement plan participants and/or individual owners of variable insurance contracts. The omnibus nature of these orders may limit the funds' ability to apply their respective disruptive trading policies and procedures. We cannot guarantee that the funds (and thus our participants) will not be harmed by transfer activity relating to the retirement plans and/or other insurance companies that may invest in the funds. In addition, if a fund believes that an omnibus order we submit may reflect one or more transfer requests from participants engaged in disruptive trading activity, the fund may reject the entire omnibus order. Our Market Timing Procedures detect potential "market timers" by examining the number of transfers made by participants within given periods of time. In addition, managers of the funds might contact us if they believe or suspect that there is market timing. If requested by a fund company, we may vary our Market Timing Procedures from subaccount to subaccount to comply with specific fund policies and procedures. We may increase our monitoring of participants who we have previously identified as market timers. When applying the parameters used to detect market timers, we will consider multiple contracts owned by the same participant if that participant has been identified as a market timer. For each participant, we will investigate the transfer patterns that meet the parameters being used to detect potential market timers. We will also investigate any patterns of trading behavior identified by the funds that may not have been captured by our Market Timing Procedures. Once a participant has been identified as a "market timer" under our Market Timing Procedures, we will notify the participant in writing that future transfers (among the subaccounts and/or the fixed account) will be temporarily permitted to be made only by original signature sent to us by U.S. mail, standard delivery for the remainder of the calendar year. Overnight delivery or electronic instructions (which may include telephone, facsimile, or Internet instructions) submitted during this period will not be accepted. If overnight delivery or electronic instructions are inadvertently accepted from a participant that has been identified as a market timer, upon discovery, we will reverse the transaction within 1 or 2 business days. We will impose this "original signature" restriction on that participant even if we cannot identify, in the particular circumstances, any harmful effect from that participant's particular transfers. Participants seeking to engage in frequent, large, or short-term transfer activity may deploy a variety of strategies to avoid detection. Our ability to detect such transfer activity may be limited by operational systems and technological limitations. The identification of participants determined to be engaged in such transfer activity that may adversely affect other participants or fund shareholders involves judgments that are inherently subjective. We cannot guarantee that our Market Timing Procedures will detect every potential market timer. If we are unable to detect market timers, you may experience dilution in the value of your fund shares and increased brokerage and administrative costs in the funds. This may result in lower long-term returns for your investments. Our Market Timing Procedures are applied consistently to all participants. An exception for any participant will be made only in the event we are required to do so by a court of law. In addition, certain funds available as investment options in your contract may also be available as investment options for owners of other, older life insurance policies issued by us. Some of these older life insurance policies do not provide a contractual basis for us to restrict or refuse transfers which are suspected to be market timing activity. In addition, because other insurance companies and/or retirement plans may invest in the funds, we cannot guarantee that the funds will not suffer harm from frequent, large, or short-term transfer activity among subaccounts and the fixed accounts of variable contracts issued by other insurance companies or among investment options available to retirement plan participants. In our sole discretion, we may revise our Market Timing Procedures at any time without prior notice as necessary to better detect and deter frequent, large, or short-term transfer activity to comply with state or federal regulatory requirements, and/or to impose additional or alternate restrictions on market timers (such as dollar or percentage limits on transfers). If we modify our Market Timing Procedures, they will be applied uniformly to all participants or as applicable to all participants investing in underlying funds. We also reserve the right to implement and administer redemption fees imposed by one or more of the funds in the future. Some of the funds have reserved the right to temporarily or permanently refuse payments or transfer requests from us if, in the judgment of the fund's investment adviser, the fund would be unable to invest effectively in accordance with its investment objective or policies, or would otherwise potentially be adversely affected. To the extent permitted by applicable law, we reserve the right to defer or reject a transfer request at any time that we are unable to purchase or redeem shares of any of the funds available through the VAA, including any refusal or restriction on purchases or redemptions of the fund shares as a result of the funds' own policies and procedures on market timing activities. If a fund refuses to accept a transfer request we have already processed, we will reverse the transaction within 1 or 2 business days. We will notify you in writing if we have reversed, restricted or refused any of your transfer 21 requests. Some funds also may impose redemption fees on short-term trading (i.e., redemptions of mutual fund shares within a certain number of business days after purchase). We reserve the right to administer and collect any such redemption fees on behalf of the funds. You should read the prospectuses of the funds for more details on their redemption fees and their ability to refuse or restrict purchases or redemptions of their shares. Transfers After the Annuity Commencement Date We do not permit transfers of a participant's account balance after the annuity commencement date. Additional Services There are four additional services available to you: dollar-cost averaging, systematic transfer (GVA III only), account sweep and portfolio rebalancing. In order to take advantage of one of these services, you will need to complete the applicable election form. Dollar-cost averaging allows you to transfer a designated amount from the fixed account into one or more subaccounts on a monthly basis for 1, 2 or 3 years. The systematic transfer service allows you to fully liquidate your fixed account balance over four years and transfer the amounts into one or more of the subaccounts. This service is only available for GVA III participants. The account sweep service allows you to keep a designated amount in one subaccount or the fixed account, and automatically transfer the excess to other subaccounts of your choice. Portofolio rebalancing is an option that restores to a pre-determined level the percentage of account value allocated to each subaccount or the fixed account. The rebalancing may take place quarterly, semi-annually or annually. Death Benefit Before the Annuity Commencement Date The payment of death benefits is governed by the applicable plan and the tax code. In addition, no payment of death benefits provided upon the death of the participant will be allowed that does not satisfy the requirements of code section 72(s) or section 401(a)(9) of the tax code. The participant may designate a beneficiary during the participant's lifetime and change the beneficiary by filing a written request with us. Each change of beneficiary revokes any previous designation. If the participant dies before the annuity commencement date, the death benefit paid to the participant's designated beneficiary will be the greater of: (1) the net contributions; or (2) the participant's account balance less any outstanding loan (including principal due and accrued interest), provided that, if we are not notified of the participant's death within six months of such death, we pay the beneficiary the amount in (2). We determine the value of the death benefit as of the date on which the death claim is approved for payment. This payment will occur when we receive (1) proof, satisfactory to us, of the death of the participant; (2) written authorization for payment; and (3) all required claim forms, fully completed. If a death benefit is payable, the beneficiary may elect to receive payment of the death benefit either in the form of a lump sum settlement or an annuity payout, or as a combination of these two. If a lump sum settlement is requested, the proceeds will be mailed within seven days of receipt of satisfactory claim documentation as discussed previously, subject to the laws and regulations governing payment of death benefits. If no election is made within 60 days after we receive satisfactory notice of the participant's death, we will pay a lump sum settlement to the beneficiary at that time. This payment may be postponed as permitted by the 1940 Act. Payment will be made in accordance with applicable laws and regulations governing payment of death benefits. Under qualified contracts, if the beneficiary is someone other than the spouse of the deceased participant, the tax code provides that the beneficiary may not elect an annuity which would commence later than December 31st of the calendar year following the calendar year of the participant's death. If a non-spousal beneficiary elects to receive payment in a single lump sum, the tax code provides that such payment must be received no later than December 31st of the fourth calendar year following the calendar year of the participant's death. If the beneficiary is the surviving spouse of the deceased participant, distributions generally are not required under the tax code to begin earlier than December 31st of the calendar year in which the participant would have attained age 70. If the surviving spouse dies before the date distributions commence, then, for purposes of determining the date distributions to the beneficiary must commence, the date of death of the surviving spouse is substituted for the date of death of the participant. Other rules apply to non-qualified annuities. See "Federal Tax Matters." If there is no living named beneficiary on file with us at the time of a participant's death and unless the plan directs otherwise, we will pay the death benefit to the participant's estate in the form of a lump sum payment, upon receipt of satisfactory proof of the participant's death, but only if we receive proof of death no later than the end of the fourth calendar year following the year of the participant's death. In such case, the value of the death benefit will be determined as of the end of the valuation period during which we receive due proof of death, and the lump sum death benefit generally will be paid within seven days of that date. 22 Withdrawals Before the annuity commencement date and subject to the terms of the plan, withdrawals may be made from the subaccounts or the fixed account of all or part of the participant's account balance remaining after deductions for any applicable (1) surrender charge; (2) annual administration charge (imposed on total withdrawals), (3) premium taxes, and (4) outstanding loan. Converting all or part of the account balance or death benefit to an annuity payout is not considered a withdrawal. Under GVA III, special limits apply to withdrawals from the fixed account. See "Charges and Other Deductions- Fixed Account Withdrawal/Transfer Limits for GVA III." The account balance available for withdrawal is determined at the end of the valuation period during which we receive the withdrawal request on an approved Lincoln distribution request form (available from the Home Office). If we receive a surrender or withdrawal request placed at or after 4:00 p.m., New York time, we will process the request using the accumulation unit value computed on the next valuation date. Unless a request for withdrawal specifies otherwise, withdrawals will be made from all subaccounts within the VAA and from the fixed account in the same proportion that the amount of withdrawal bears to the total participant account balance. Unless prohibited, withdrawal payments will be mailed within seven days after we receive a valid written request. The payment may be postponed as permitted by the 1940 Act. There are charges associated with withdrawals of account value. See "Charges and Other Deductions." The tax consequences of a withdrawal are discussed later in this booklet. See "Federal Tax Matters." Total Withdrawals. Only participants with no outstanding loans can make a total withdrawal. A total withdrawal of a participant's account will occur when (a) the participant or contractowner requests the liquidation of the participant's entire account balance, or (b) the amount requested plus any surrender charge results in a remaining participant account balance of an amount less than or equal to the annual administration charge, in which case we treat the request as a request for liquidation of the participant's entire account balance. Any active life certificate must be surrendered to us when a total withdrawal occurs. If the contractowner resumes contributions on behalf of a participant after a total withdrawal, the participant will receive a new participation date and active life certificate. Partial Withdrawals. A partial withdrawal of a participant's account balance will occur when less than a total withdrawal is made from a participant's account. Systematic Withdrawal Option. Participants who are at least age 591/2, are separated from service from their employer, or are disabled, and certain spousal beneficiaries and alternate payees who are former spouses, may be eligible for a Systematic Withdrawal Option ("SWO") under the contract. Payments are made only from the fixed account. Under the SWO a participant may elect to withdraw either a monthly amount which is an approximation of the interest earned between each payment period based upon the interest rate in effect at the beginning of each respective payment period, or a flat dollar amount withdrawn on a periodic basis. A participant must have a vested pre-tax account balance of at least $10,000 in the fixed account in order to select the SWO. A participant may transfer amounts from the VAA to the fixed account in order to support SWO payments. These transfers, however, are subject to the transfer restrictions imposed by any applicable plan. A one-time fee of up to $30 will be charged to set up the SWO. This charge is waived for total vested pre-tax account balances of $25,000 or more. More information about SWO, including applicable fees and charges, is available in the contracts and active life certificates and from us. Required Minimum Distribution Program Under certain contracts participants who are at least age 701/2 may ask us to calculate and pay to them the minimum annual distribution required by Sections 401(a)(9), 403(b)(10) or 408 of the tax code. The participant must complete the forms we require to elect this option. We will base our calculation solely on the participant's account value with us. Participants who select this option are responsible for determining the minimum distributions amount applicable to their non-Lincoln Life contracts. Withdrawal Restrictions. Withdrawals under Section 403(b) contracts are subject to the limitations under Section 403(b)(11) of the tax code and regulations thereof and in any applicable plan document. That section provides that withdrawals of salary reduction contributions deposited and earnings credited on any salary reduction contributions after December 31, 1988, can only be made if the participant has (1) died; (2) become disabled; (3) attained age 591/2; (4) separated from service; or (5) incurred a hardship. If amounts accumulated in a Section 403(b)(7) custodial account are deposited in a contract, these amounts will be subject to the same withdrawal restrictions as are applicable to post-1988 salary reduction contributions under the contracts. For more information on these provisions see "Federal Tax Matters." Withdrawal requests for a participant under Section 401(a) plans and plans subject to Title I of ERISA must be authorized by the contractowner on behalf of a participant. All withdrawal requests will require the contractowner's written authorization and written documentation specifying the portion of the participant's account balance which is available for distribution to the participant. As required by Section 830.105 of the Texas Education Code, withdrawal requests by participants in the Texas Optional Retirement Program ("ORP") are only permitted in the event of (1) death; (2) retirement; (3) termination of employment in all Texas institutions of 23 higher education; or (4) attainment of age 701/2. A participant in an ORP contract is required to obtain a certificate of termination from the participant's employer before a withdrawal request can be granted. For withdrawal requests (other than transfers to other investment vehicles) by participants under plans not subject to Title I of ERISA and non-401(a) plans, the participant must certify to us that one of the permitted distribution events listed in the tax code has occurred (and provide supporting information, if requested) and that we may rely on this representation in granting the withdrawal request. See "Federal Tax Matters." A participant should consult his or her tax adviser as well as review the provisions of their plan before requesting a withdrawal. A plan and applicable law may contain additional withdrawal or transfer restrictions. Withdrawals may have Federal tax consequences. In addition, early withdrawals, as defined under Section 72(q) and 72(t) of the tax code, may be subject to a 10% excise tax. The SecureLine (Reg. TM) account is a special service that we offer in which your surrender proceeds are placed into an interest -bearing account in your name. The checking account is established at a bank of our choosing. Instead of mailing you a check, we will send a checkbook so that you will have access to the account simply by writing a check for all or any part of the proceeds. You are the owner of the account, and are the only one authorized to transfer proceeds from the account. You may choose to leave the proceeds in this account, or you may begin writing checks immediately. The funds that support the SecureLine (Reg. TM) account are part of our general account and are subject to the claims of our creditors and are not FDIC insured. We receive a financial benefit from all amounts left in the SecureLine (Reg. TM) account. If you request a lump sum surrender payable to yourself for either an in-service or termination distribution, and your surrender value is $10,000 or more, your money will be placed into the account in your name unless you instruct us otherwise. You are the owner of the account, and are the only one authorized to transfer proceeds from the account. You may choose to leave the proceeds in this account, or you may begin writing checks immediately. In the case of a death of one of the parties to the annuity contract, if the recipient of the death benefit has elected a lump sum settlement and the contract value is $10,000 or more, the proceeds will be placed into the interest-bearing account in the recipient's name as the owner of the account. The SecureLine (Reg. TM) account allows the recipient additional time to decide how to manage death benefit proceeds with the balance earning interest from the day the account is opened. Loans If the plan permits loans, then during the participant's accumulation period, the participant may apply for a loan by completing a loan application that we provide. The participant's account balance in the fixed account secures the loan. Loans are subject to restrictions imposed by the IRC, Title I of the Employee Retirement Income Security Act of 1974 (ERISA), and the participant's plan. For plans subject to the IRC and Title I of ERISA, the initial amount of a participant loan cannot exceed the lesser of 50% of the participant's vested account balance in the fixed account or $50,000 and, pursuant to the terms of the contract, must be at least $1,000. For plans subject to the IRC, but not subject to Title I of ERISA, a participant is subject to the same $50,000 maximum, but may borrow up to $10,000 of his or her vested account balance even if that would be greater than 50% of his or her vested account balance. A participant may have only one loan outstanding at a time and may not take more than one loan in any six-month period. Amounts serving as collateral for the loan are not subject to the minimum interest rate under the contract and will accrue interest at a rate below the loan interest rate provided in the contract. More information about loan and loan interest rates is provided in the contract, the active life certificates, and the annuity loan agreement, and is also available from us. Delay of Payments Contract proceeds from the VAA will be paid within seven days, except: o when the NYSE is closed (other than weekends and holidays); o times when market trading is restricted or the SEC declares an emergency, and we cannot value units or the funds cannot redeem shares; or o when the SEC so orders to protect contractowners. We may delay payment from the fixed account for up to six months. During this period, we will continue to credit the current declared interest rate to a participant's account in the fixed account. Due to federal laws designed to counter terrorism and prevent money laundering by criminals, we may be required to reject a purchase payment and/or deny payment of a request for transfers, withdrawals, surrenders, or death benefits, until instructions are received from the appropriate regulator. We also may be required to provide additional information about a contractowner's account to government regulators. 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. Any changes are subject to prior approval of your state's insurance department (if required). 24 Ownership Contractowners 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; and 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 permitted by applicable law and upon written notification to us. Qualified contracts and active life certificates may not be assigned or transferred except as permitted by ERISA and on written notification to us. In addition, a participant, beneficiary, or annuitant may not, unless permitted by law, assign or encumber any payment due under the contract. Distribution of the Contracts Lincoln Financial Distributors ("LFD") serves as Principal Underwriter of this contract. LFD is affiliated with Lincoln Life and is registered as a broker-dealer with the SEC under the Securities Exchange Act of 1934 and is a member of FINRA. The Principal Underwriter has entered into selling agreements with Lincoln Financial Advisors Corporation ("LFA"), also an affiliate of ours. The Principal Underwriter has also entered into selling agreements with broker-dealers that are unaffiliated with us. While the Principal Underwriter has the legal authority to make payments to broker-dealers which have entered into selling agreements, we will make such payments on behalf of the Principal Underwriter in compliance with appropriate regulations. We also pay on behalf of LFD certain of its operating expenses related to the distribution of this and other of our contracts. The following paragraphs describe how payments are made by us and The Principal Underwriter to various parties. Compensation Paid to LFA. The maximum commission the Principal Underwriter pays to LFA is 3.50% of purchase payments. LFA may elect to receive a lower commission when a purchase payment is made along with an earlier quarterly payment based on contract value for so long as the contract remains in effect. Upon annuitization, the maximum commission the Principal Underwriter pays to LFA is 1.18% of annuitized value and/or ongoing annual compensation of up to 0.00% of annuity value or statutory reserves. Lincoln Life also pays for the operating and other expenses of LFA, including the following sales expenses: sales representative training allowances; compensation and bonuses for LFA's management team; advertising expenses; and all other expenses of distributing the contracts. LFA pays its sales representatives a portion of the commissions received for their sales of contracts. LFA sales representatives and their managers are also eligible for various cash benefits, such as bonuses, insurance benefits and financing arrangements, and non-cash compensation items that we may provide jointly with LFA. Non-cash compensation items may include conferences, seminars, trips, entertainment, merchandise and other similar items. In addition, LFA sales representatives who meet certain productivity, persistency and length of service standards and/or their managers may be eligible for additional compensation. Sales of the contracts may help LFA sales representatives and/or their managers qualify for such benefits. LFA sales representatives and their managers may receive other payments from us for services that do not directly involve the sale of the contracts, including payments made for the recruitment and training of personnel, production of promotional literature and similar services. Compensation Paid to Unaffiliated Selling Firms. The Principal Underwriter pays commissions to all Selling Firms. The maximum commission the Principal Underwriter pays to Selling Firms, other than LFA, is 3.50% of purchase payments. Some Selling Firms may elect to receive a lower commission when a purchase payment is made along with an earlier quarterly payment based on contract value for so long as the contract remains in effect. Upon annuitization, the maximum commission the Principal Underwriter pays to Selling Firms is 1.18% of annuitized value and/or ongoing annual compensation of up to 0.00% of annuity value or statutory reserves. LFD also acts as wholesaler of the contracts and performs certain marketing and other functions in support of the distribution and servicing of the contracts. LFD may pay certain Selling Firms or their affiliates additional amounts for, among other things: (1) "preferred product" treatment of the contracts in their marketing programs, which may include marketing services and increased access to sales representatives; (2) sales promotions relating to the contracts; (3) costs associated with sales conferences and educational seminars for their sales representatives; (4) other sales expenses incurred by them; and (5) inclusion in the financial products the Selling Firm offers. Lincoln Life may provide loans to broker-dealers or their affiliates to help finance marketing and distribution of the contracts, and those loans may be forgiven if aggregate sales goals are met. In addition, we may provide staffing or other administrative support and services to broker-dealers who distribute the contracts. LFD, as wholesaler, may make bonus payments to certain Selling Firms based on aggregate sales of our variable insurance contracts (including the contracts) or persistency standards. These additional payments are not offered to all Selling Firms, and the terms of any particular agreement governing the payments may vary among Selling Firms. These additional types of compensation are not offered to all Selling Firms. The terms of any particular agreement governing compensation may vary among Selling Firms and the amounts may be significant. The prospect of receiving, or the receipt of, additional compensation may provide Selling Firms and/or their registered representatives with an incentive to favor sales of the contracts over other variable annuity contracts (or other investments) with respect to which a Selling Firm does not receive additional compensation, or lower levels of additional compensation. You may wish to take such payment arrangements into account when considering and evaluating any recommendation relating to the contracts. Additional information relating to compensation paid in 2007 is contained in the SAI. 25 Compensation Paid to Other Parties. Depending on the particular selling arrangements, there may be others whom LFD compensates for the distribution activities. For example, LFD may compensate certain "wholesalers", who control access to certain selling offices, for access to those offices or for referrals, and that compensation may be separate from the compensation paid for sales of the contracts. LFD may compensate marketing organizations, associations, brokers or consultants which provide marketing assistance and other services to broker-dealers who distribute the contracts, and which may be affiliated with those broker-dealers. A marketing expense allowance is paid to American Funds Distributors (AFD) in consideration of the marketing assistance AFD provides to LFD. This allowance, which ranges from 0.10% to 0.16% is based on the amount of purchase payments initially allocated to the American Funds Insurance Series underlying the variable annuity. Commissions and other incentives or payments described above are not charged directly to contract owners or the Separate Account. All compensation is paid from our resources, which include fees and charges imposed on your contract. Contractowner Questions The obligations to purchasers under the contracts are those of Lincoln Life. This prospectus provides a general description of the contract. Questions about your contract should be directed to us at 1-800-341-0441. Annuity Payouts As permitted by the plan, the participant, or the beneficiary of a deceased participant, may elect to convert all or part of the participant's account balance or the death benefit to any annuity payout. The contract provides optional forms of payouts of annuities (annuity options), each of which is payable on a variable basis, a fixed basis or a combination of both as you specify. The contract provides that all or part of the contract value may be used to purchase an annuity payout option. You may elect annuity payouts in monthly, quarterly, semiannual or annual installments. If the participant's account balance or the beneficiary's death benefit is less than $2,000 or if the amount of the first payout is less than $20, we have the right to cancel the annuity and pay the participant or beneficiary the entire amount in a lump sum. We may maintain variable annuity payouts in the VAA, or in another separate account of Lincoln Life (variable payout division). We do not impose a charge when the annuity conversion amount is applied to a variable payout division to provide an annuity payout option. The contract benefits and charges for an annuity payout option, whether maintained in the VAA or in a variable payout division, are as described in this prospectus. The selection of funds available through a variable payout division may be different from the funds available through the VAA. If we will maintain a participant's variable annuity payout in a variable payout division, we will provide a prospectus for the variable payout division before the annuity commencement date. 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 beneficiaries. However, there is the risk under this option that the recipient would receive no payouts if he or 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 Annuity with Guaranteed Period. This option guarantees 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 (or participant in an allocated contract). Joint Life Annuity. This option offers a periodic payout during the joint lifetime of the annuitant and a designated joint annuitant. The payouts continue during the lifetime of the survivor. However, under a joint life annuity, if both annuitants die before the date set for the first payout, no payouts will be made. Only one payment would be made if both deaths occur before the second scheduled payout, and so on. Non-Life Annuities. Annuity payouts are guaranteed monthly for the selected number of years. While there is no right to make any total or partial withdrawals during the annuity period, an annuitant or beneficiary who has selected this annuity option as a variable annuity may request at any time during the payout period that the present value of any remaining installments be paid in one lump sum. This lump sum payout will be treated as a total withdrawal during the accumulation period and may be subject to a surrender charge. See - Charges and Other Deductions and Federal Tax Matters. General Information Under the options listed above, you may not make withdrawals. Other options may be made available by us. Annuity payout options are only available if consistent with the contract, the plan, the tax code, and ERISA. The mortality and expense risk charge will be assessed on all variable annuity payments, including options that do not have a life contingency and therefore no mortality risk. Under any option providing for guaranteed payouts, the number of payouts which remain unpaid at the date of the annuitant's death (or surviving annuitant's death in the case of a joint life annuity) will be paid to the beneficiary as payouts become due. 26 Annuity Payout Calculation Fixed annuity payouts are determined by dividing the participant's annuity conversion amount in the fixed account as of the initial annuity payout calculation date by the applicable annuity conversion factor (in the contract) for the annuity payout option selected. Variable Annuity Payouts Variable annuity payouts will be determined using: o The participant's annuity conversion amount in the VAA as of the innitial annuity payout calculation date; o The annuity conversion factor contained in the contract; o The annuity option selected; and o 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 retired life certificate with a specific 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 a specified percentage per year, as applied to the applicable mortality table. The amount of each annuity payout after the initial pay-out will depend upon how the underlying fund(s) perform, relative to the assumed rate. If the actual net investment rate (annualized) exceeds the assumed rate, the payment will increase at a rate proportional to the amount of such excess. Conversely, if the actual rate is less than the assumed rate, annuity payouts will decrease. There is a more complete explanation of this calculation in the SAI. Federal Tax Matters Introduction The Federal income tax treatment of the contract is complex and sometimes uncertain. The Federal income tax rules may vary with your particular circumstances. This discussion does not include all the Federal income tax rules that may affect you and your contract. This discussion also does not address other Federal tax consequences (including consequences of sales to foreign individuals or entities), or state or local tax consequences, associated with the contract. As a result, you should always consult a tax adviser about the application of tax rules to your individual situation. Qualified Retirement Plans We designed the contracts for use in connection with certain types of retirement plans that receive favorable treatment under the tax code. Contracts issued to or in connection with a qualified retirement plan are called "qualified contracts." We issue contracts for use with various types of qualified plans. The Federal income tax rules applicable to those plans are complex and varied. As a result, this prospectus does not attempt to provide more than general information about the use of the contract with the various types of qualified plans. Persons planning to use the contract in connection with a qualified plan should obtain advice from a competent tax adviser. Types of Qualified Contracts and Terms of Contracts Qualified plans include the following: o Individual Retirement Accounts and Annuities ("Traditional IRAs") o Roth IRAs o Traditional IRA that is part of a Simplified Employee Pension Plan ("SEP") o SIMPLE 401(k) plans (Savings Incentive Matched Plan for Employees) o 401(a) plans (qualified corporate employee pension and profit-sharing plans) o 403(a) plans (qualified annuity plans) o 403(b) plans (public school system and tax-exempt organization annuity plans) o H.R. 10 or Keogh Plans (self-employed individual plans) o 457(b) plans (deferred compensation plans for state and local governments and tax-exempt organizations) o Roth 403(b) plans We may issue a contract for use with other types of qualified plans in the future. We do not offer certain types of qualified plans for all of our annuity products. Check with your representative concerning qualified plan availability for this product. 27 We will amend contracts to be used with a qualified plan as generally necessary to conform to the tax law requirements for the type of plan. However, the rights of a person to any qualified plan benefits may be subject to the plan's terms and conditions. In addition, we are not bound by the terms and conditions of qualified plans to the extent such terms and conditions contradict the contract, unless we consent. Tax Deferral on Earnings The Federal income tax law generally does not tax any increase in your contract value until you receive a contract distribution. However, for this general rule to apply, certain requirements must be satisfied: o An individual must own the contract (or the tax law must treat the contract as owned by an individual). o The investments of the VAA must be "adequately diversified" in accordance with IRS regulations. o Your right to choose particular investments for a contract must be limited. o The annuity commencement date must not occur near the end of the annuitant's life expectancy. Investments in the VAA Must Be Diversified For a contract to be treated as an annuity for Federal income tax purposes, the investments of the VAA must be "adequately diversified." IRS regulations define standards for determining whether the investments of the VAA are adequately diversified. If the VAA fails to comply with these diversification standards, you could be required to pay tax currently on the excess of the contract value over the contract purchase payments. Although we do not control the investments of the underlying investment options, we expect that the underlying investment options will comply with the IRS regulations so that the VAA will be considered "adequately diversified." Restrictions Federal income tax law limits your right to choose particular investments for the contract. Because the IRS has not issued guidance specifying those limits, the limits are uncertain and your right to allocate contract values among the subaccounts may exceed those limits. If so, you would be treated as the owner of the assets of the VAA and thus subject to current taxation on the income, bonus credits, persistency credits and gains, if applicable, from those assets. We do not know what limits may be set by the IRS in any guidance that it may issue and whether any such limits will apply to existing contracts. We reserve the right to modify the contract without your consent to try to prevent the tax law from considering you as the owner of the assets of the VAA. Tax Treatment of Qualified Contracts The Federal income tax rules applicable to qualified plans and qualified contracts vary with the type of plan and contract. For example, o Federal tax rules limit the amount of purchase payments that can be made, and the tax deduction or exclusion that may be allowed for the purchase payments. These limits vary depending on the type of qualified plan and the plan participant's specific circumstances, e.g., the participant's compensation. o Under most qualified plans, such as a traditional IRA, the owner must begin receiving payments from the contract in certain minimum amounts by a certain age, typically age 701/2. Other qualified plans may allow the participant to take required distributions upon the later of reaching age 701/2 or retirement. Tax Treatment of Payments The Federal income tax rules generally include distributions from a qualified contract in the participant's income as ordinary income. These taxable distributions will include purchase payments that were deductible or excludible from income. Thus, under many qualified contracts, the total amount received is included in income since a deduction or exclusion from income was taken for purchase payments. There are exceptions. For example, you do not include amounts received from a Roth IRA in income if certain conditions are satisfied. Required Minimum Distributions Under most qualified plans, you must begin receiving payments from the contract in certain minimum amounts by the later of age 701/2 or retirement. You are required to take distributions from your traditional IRAs beginning in the year you reach age 701/2. If you own a Roth IRA, you are not required to receive minimum distributions from your Roth IRA during your life. Failure to comply with the minimum distribution rules applicable to certain qualified plans, such as Traditional IRAs, will result in the imposition of an excise tax. This excise tax equals 50% of the amount by which a minimum required distribution exceeds the actual distribution from the qualified plan. The IRS has issued new regulations concerning required minimum distributions. The regulations may impact the distribution method you have chosen and the amount of your distributions. Under new regulations, the presence of an enhanced death benefit, Lincoln SmartSecurity (Reg. TM) Advantage, or other benefit, if any, may require you to take additional distributions. An enhanced death benefit is any death benefit that has the potential to pay more than the contract value or a return of purchase payments. Please contact your tax adviser regarding any tax ramifications. 28 Federal Penalty Taxes Payable on Distributions The tax code may impose a 10% penalty tax on a distribution from a qualified contract that must be included in income. The tax code does not impose the penalty tax if one of several exceptions applies. The exceptions vary depending on the type of qualified contract you purchase. For example, in the case of an IRA, exceptions provide that the penalty tax does not apply to a withdrawal, surrender, or annuity payout: o received on or after the annuitant reaches 591/2, o received on or after the annuitant's death or because of the annuitant's disability (as defined in the tax law), o received as a series of substantially equal periodic payments based on the annuitant's life (or life expectancy), or o received as reimbursement for certain amounts paid for medical care. These exceptions, as well as certain others not described here, generally apply to taxable distributions from other qualified plans. However, the specific requirements of the exception may vary. Taxation of Death Benefits We may distribute amounts from your contract because of your death. Federal tax rules may limit the payment options available to your beneficiaries. If your spouse is your beneficiary, your surviving spouse will generally receive special treatment and will have more available payment options. Non-spouse beneficiaries do not receive the same special treatment. Payment options may be further limited depending upon whether you reached the date upon which you were required to begin minimum distributions. The Pension Protection Act of 2006 ("PPA") permits non-spouse beneficiary rollovers to an "inherited IRA" (effective January 1, 2007). Transfers and Direct Rollovers As a result of the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), you may be able to move funds between different types of qualified plans, such as 403(b) and 457(b) governmental plans, by means of a rollover or transfer. You may be able to rollover or transfer amounts between qualified plans and traditional IRAs. These rules do not apply to Roth IRAs and 457(b) non-governmental tax-exempt plans. There are special rules that apply to rollovers, direct rollovers and transfers (including rollovers or transfers or after-tax amounts). If the applicable rules are not followed, you may incur adverse Federal income tax consequences, including paying taxes which you might not otherwise have had to pay. Before we send a rollover distribution, we will provide a notice explaining tax withholding requirements (see Federal Income Tax Withholding). We are not required to send you such notice for your IRA. You should always consult your tax adviser before you move or attempt to move any funds. The PPA permits direct conversions from certain qualified, 403(b) or 457(b) plans to Roth IRAs (effective for distribution after 2007). Federal Income Tax Withholding We will withhold and remit to the IRS a part of the taxable portion of each distribution made under a contract unless you notify us prior to the distribution that tax is not to be withheld. In certain circumstances, Federal income tax rules may require us to withhold tax. At the time a withdrawal, surrender, or annuity payout is requested, we will give you an explanation of the withholding requirements. Certain payments from your contract may be considered eligible rollover distributions (even if such payments are not being rolled over). Such distributions may be subject to special tax withholding requirements. The Federal income tax withholding rules require that we withhold 20% of the eligible rollover distribution from the payment amount, unless you elect to have the amount directly transferred to certain qualified plans or contracts. The IRS requires that tax be withheld, even if you have requested otherwise. Such tax withholding requirements are generally applicable to 401(a), 403(a) or (b), HR 10, and 457(b) governmental plans and contracts used in connection with these types of plans. Nonqualified Annuity Contracts A nonqualified annuity is a contract not issued in connection with a qualified retirement plan receiving special tax treatment under the tax code, such as an IRA or 403(b) plan. These contracts are not intended for use with nonqualified annuity contracts. Different federal tax rules apply to nonqualified annuity contracts. Persons planning to use the contract in connection with a nonqualified annuity should obtain advice from a tax advisor. Our Tax Status Under existing Federal income tax laws, we do not pay tax on investment income and realized capital gains of the VAA. We do not expect that we will incur any Federal income tax liability on the income and gains earned by the VAA. However, the Company does expect, to the extent permitted under Federal tax law, to claim the benefit of the foreign tax credit as the owner of the assets of the VAA. Therefore, we do not impose a charge for Federal income taxes. If Federal income tax law changes and we must pay tax on some or all of the income and gains earned by the VAA, we may impose a charge against the VAA to pay the taxes. 29 Changes in the Law The above discussion is based on the tax code, IRS regulations, and interpretations existing on the date of this prospectus. However, Congress, the IRS, and the courts may modify these authorities, sometimes retroactively. Additional Information Voting Rights As required by law, we will vote the fund shares held in the VAA at meetings of the shareholders of the funds. The voting will be done according to the instructions of contractowners who have interests in any subaccounts which invest in classes of the funds. 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 fund 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 applying 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. Each underlying fund is subject to the laws of the state in which it is organized concerning, among other things, the matters which are subject to a shareholder vote, the number of shares which must be present in person or by proxy at a meeting of shareholders (a "quorum"), and the percentage of such shares present in person or by proxy which must vote in favor of matters presented. Because shares of the underlying fund held in the Separate Account are owned by us, and because under the 1940 Act we will vote all such shares in the same proportion as the voting instruction which we receive, it is important that each contractowner provide their voting instructions to us. Even though contractowners may choose not to provide voting instruction, the shares of a fund to which such contractowners would have been entitled to provide voting instruction will, subject to fair representation requirements, be voted by us in the same proportion as the voting instruction which we actually receive. As a result, the instruction of a small number of contractowners could determine the outcome of matters subject to shareholder vote. All shares voted by us will be counted when the underlying fund determines whether any requirement for a minimum number of shares be present at such a meeting to satisfy a quorum requirement has been met. 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 shareholders meeting is called, we will provide or make available to each person having a voting interest in a subaccount proxy voting material, reports and other materials relating to the funds. Since the funds engage in shared funding, other persons or entities besides Lincoln Life may vote fund shares. See Investments of the Variable Annuity Account - Fund Shares. Return Privilege Participants under Sections 403(b), 408 and certain non-qualified plans will receive an active life certificate. Within the free-look period (ten days) after the participant receives the active life certificate, the participant may cancel it for any reason by giving us written notice. The postmark date of the notice is the date of notice for these purposes. An active life certificate canceled under this provision will be void. With respect to the fixed side of the contract, we will return the participant's contributions less withdrawals made on behalf of the participant. With respect to the VAA, we will return the greater of the participant's contributions less withdrawals made on behalf of the participant, or the participant's account balance in the VAA on the date we receive the written notice. No surrender charge applies. State Regulation As a life insurance company organized and operated under Indiana law, we are subject to provisions governing life insurers and to regulation by the Indiana Commissioner of Insurance. Our books and accounts are subject to review and examination by the Indiana Department of Insurance at all times. A full examination of our operations is conducted by that Department at least every five years. Records and Reports As presently required by the 1940 Act and applicable regulations, we are responsible for maintaining all records and accounts relating to the VAA. We have entered into an agreement with Mellon Bank, N.A., One Mellon Bank Center, 500 Grant Street, Pittsburgh, Pennsylvania, 15258, to provide accounting services to the VAA. We will mail to you, at your last known address of record at the servicing office, at least semi-annually after the first contract year, reports containing information required by that Act or any other applicable law or regulation. Other Information Contract Deactivation. Under certain contracts, we may deactivate a contract by prohibiting new contributions and/or new participants after the date of deactivation. We will give the contractowner and participants at least ninety (90) days notice of the deactivation date. 30 Legal Proceedings In the ordinary course of its business, Lincoln Life, the VAA, and the principal underwriter may become or are involved in various pending or threatened legal proceedings, including purported class actions, arising from the conduct of business. In some instances, these proceedings include claims for unspecified or substantial punitive damages and similar types of relief in addition to amounts for alleged contractual liability or requests for equitable relief. After consultation with legal counsel and a review of available facts, it is management's opinion that these proceedings, after consideration of any reserves and rights to indemnification, ultimately will be resolved without materially affecting the consolidated financial position of Lincoln Life, the VAA, or the principal underwriter. However, given the large and indeterminate amounts sought in certain of these proceedings and the inherent difficulty in predicting the outcome of such legal proceedings, it is possible that an adverse outcome in certain matters could be material to our operating results for any particular reporting period. 31 (This page intentionally left blank) 32 Contents of the Statement of Additional Information (SAI) for Lincoln National Variable Annuity Account L
Item Special Terms Services Principal Underwriter Purchase of Securities Being Offered Annuity Payouts Determination of Accumulation and Annuity Unit Value Advertising Additional Services Other Information Financial Statements
For a free copy of the SAI complete the form below. Statement of Additional Information Request Card Group Variable Annuity Account Contracts I, II, & III Please send me a free copy of the current Statement of Additional Information for Lincoln National Variable Annuity Account L (Group Variable Annuity Contracts I, II & III). (Please Print) Name: ------------------------------------------------------------------------- Address: ---------------------------------------------------------------------- City --------------------------------------------------- State --------- Zip --------- Mail to: The Lincoln National Life Insurance Co., P.O. Box 2340, Fort Wayne, IN 46808 33 (This page intentionally left blank) 34 (This page intentionally left blank) 35 Appendix A - Condensed Financial Information Accumulation Unit Values The following information relates to accumulation unit values and accumulation units for funds available in the periods ended December 31. It should be read along with the VAA's financial statement and notes which are included in the SAI.
Standard Breakpoint ---------------------------------------- ---------------------------------------- Accumulation unit value Accumulation unit value ----------------------- Number of ----------------------- Number of Beginning End of accumulation Beginning End of accumulation of period period units of period period units ----------- -------- ------------- ----------- -------- ------------- (Accumulation unit value in dollars and Number of accumulation units in thousands) AllianceBernstein VPS Global Technology 2000......... 10.000 7.094 58 10.000 7.098 1 2001......... 7.094 5.235 222 7.098 5.252 6 2002......... 5.235 3.016 345 5.252 3.033 11 2003......... 3.016 4.294 622 3.033 4.329 13 2004......... 4.294 4.467 624 4.329 4.515 21 2005......... 4.467 4.584 528 4.515 4.645 16 2006......... 4.584 4.919 502 4.645 4.997 16 2007......... 4.919 5.839 572 4.997 5.946 41 - ------------- ------ ----- --- ------ ----- -- AllianceBernstein VPS Growth 2000......... 10.000 8.743 8 10.000 8.748 1 2001......... 8.743 6.609 28 8.748 6.629 2 2002......... 6.609 4.693 70 6.629 4.720 7 2003......... 4.693 6.259 163 4.720 6.310 4 2004......... 6.259 7.097 196 6.310 7.173 5 2005......... 7.097 7.844 176 7.173 7.948 5 2006......... 7.844 7.670 178 7.948 7.791 6 2007......... 7.670 8.555 175 7.791 8.711 12 - ------------- ------ ----- --- ------ ----- -- AllianceBernstein VPS Growth and Income 2004......... 10.249 11.133 15 10.467 11.149 1 2005......... 11.133 11.529 47 11.149 11.575 2 2006......... 11.529 13.353 72 11.575 13.439 2 2007......... 13.353 13.862 97 13.439 13.996 8 - ------------- ------ ------ --- ------ ------ -- American Century VP Balanced Fund* 1996......... 15.698 16.213 2 1997......... 16.213 18.550 1,267 1998......... 18.550 21.263 1,269 1999......... 21.263 23.168 1,099 21.702 23.198 94 2000......... 23.168 22.330 1,000 23.198 22.414 98 2001......... 22.330 21.327 1,015 22.414 21.460 92 2002......... 21.327 19.096 1,006 21.460 19.263 80 2003......... 19.096 22.586 1,033 19.263 22.840 67 2004......... 22.586 24.547 1,034 22.840 24.886 70 2005......... 24.547 25.502 976 24.886 25.919 68 2006......... 25.502 27.677 914 25.919 28.200 65 2007......... 27.677 28.754 794 28.200 29.371 77 - ------------- ------ ------ ----- ------ ------ -- American Funds Global Growth Fund**** 2004......... 10.188 11.310 16 11.347 11.327 1 (a) 2005......... 11.310 12.774 85 11.327 12.826 1 2006......... 12.774 15.230 217 12.826 15.331 3 2007......... 15.230 17.317 357 15.331 17.475 19 - ------------- ------ ------ ----- ------ ------ -- American Funds Growth Fund*** 2000......... 10.000 8.991 88 10.000 8.997 1 2001......... 8.991 7.285 510 8.997 7.309 11 2002......... 7.285 5.449 900 7.309 5.480 21 2003......... 5.449 7.380 1474 5.480 7.441 16 2004......... 7.380 8.220 1,976 7.441 8.309 52 2005......... 8.220 9.456 2,520 8.309 9.582 78 2006......... 9.456 10.319 2,836 9.582 10.482 104 2007......... 10.319 11.477 2,652 10.482 11.688 314 - ------------- ------ ------ ----- ------ ------ ---
A-1
Standard Breakpoint ---------------------------------------- ---------------------------------------- Accumulation unit value Accumulation unit value ----------------------- Number of ----------------------- Number of Beginning End of accumulation Beginning End of accumulation of period period units of period period units ----------- -------- ------------- ----------- -------- ------------- (Accumulation unit value in dollars and Number of accumulation units in thousands) American Funds Growth-Income Fund**** 2004......... 10.240 10.978 159 10.180 10.994 3 2005......... 10.978 11.502 443 10.994 11.549 9 2006......... 11.502 13.119 655 11.549 13.205 15 2007......... 13.119 13.644 757 13.205 13.767 44 - ------------- ------ ------ --- ------ ------ -- American Funds International Fund*** 2000......... 10.000 8.582 17 10.000 8.587 1 2001......... 8.582 6.807 53 8.587 6.828 3 2002......... 6.807 5.739 163 6.828 5.771 8 2003......... 5.739 7.662 383 5.771 7.724 9 2004......... 7.662 9.051 687 7.724 9.148 12 2005......... 9.051 10.888 1,078 9.148 11.032 15 2006......... 10.888 12.825 1,393 11.032 13.027 26 2007......... 12.825 15.240 1,522 13.027 15.519 82 - ------------- ------ ------ ----- ------ ------ -- Delaware VIP Diversified Income Series**** 2004......... 10.044 10.935 36 10.563 10.951 1 (a) 2005......... 10.935 10.778 118 10.951 10.820 1 (a) 2006......... 10.778 11.516 153 10.820 11.590 5 2007......... 11.516 12.271 314 11.590 12.381 18 - ------------- ------ ------ ----- ------ ------ -- Delaware VIP High Yield Series 2005......... 10.182 10.273 34 10.234 10.289 1 2006......... 10.273 11.437 115 10.289 11.483 2 2007......... 11.437 11.640 149 11.483 11.716 15 - ------------- ------ ------ ----- ------ ------ -- Delaware VIP REIT Series*** 2000......... 10.000 10.569 56 10.000 10.575 1 2001......... 10.569 11.371 179 10.575 11.406 1 2002......... 11.371 11.751 495 11.406 11.817 17 2003......... 11.751 15.558 600 11.817 15.684 15 2004......... 15.558 20.192 827 15.684 20.406 28 2005......... 20.192 21.362 787 20.406 21.643 29 2006......... 21.362 27.986 879 21.643 28.425 31 2007......... 27.986 23.779 612 28.425 24.212 32 - ------------- ------ ------ ----- ------ ------ -- Delaware VIP Small Cap Value Series**** 2004......... 10.307 12.116 128 10.270 12.135 3 2005......... 12.116 13.093 400 12.135 13.146 8 2006......... 13.093 15.022 625 13.146 15.121 12 2007......... 15.022 13.856 544 15.121 13.982 39 - ------------- ------ ------ ----- ------ ------ -- Delaware VIP Trend Series*** 2000......... 10.000 7.781 45 10.000 7.786 1 2001......... 7.781 6.513 67 7.786 6.533 5 2002......... 6.513 5.155 123 6.533 5.183 7 2003......... 5.155 6.879 220 5.183 6.934 3 2004......... 6.879 7.649 326 6.934 7.730 5 2005......... 7.649 7.998 339 7.730 8.103 10 2006......... 7.998 8.500 345 8.103 8.633 11 2007......... 8.500 9.295 280 8.633 9.464 49 - ------------- ------ ------ ----- ------ ------ -- Dreyfus Stock Index Fund* 1996......... 21.013 22.705 3 1997......... 22.705 29.827 3,317 1998......... 29.827 37.861 3,913 1999......... 37.861 45.208 3,815 41.583 45.265 352 2000......... 45.208 40.604 3,325 45.265 40.757 282 2001......... 40.604 35.304 3,209 40.757 35.525 205 2002......... 35.304 27.136 2,922 35.525 27.375 161 2003......... 27.136 34.486 2,883 27.375 34.877 131 2004......... 34.486 37.776 2,766 34.877 38.299 144 2005......... 37.776 39.155 2,412 38.299 39.796 130 2006......... 39.155 44.773 2,198 39.796 45.621 119 2007......... 44.773 46.657 1,912 45.621 47.659 151 - ------------- ------ ------ ----- ------ ------ ---
A-2
Standard Breakpoint ---------------------------------------- ---------------------------------------- Accumulation unit value Accumulation unit value ----------------------- Number of ----------------------- Number of Beginning End of accumulation Beginning End of accumulation of period period units of period period units ----------- -------- ------------- ----------- -------- ------------- (Accumulation unit value in dollars and Number of accumulation units in thousands) Dreyfus VIP Developing Leaders Portfolio* 1996......... 14.854 15.286 12 1997......... 15.286 17.632 3,524 1998......... 17.632 16.856 3,954 1999......... 16.856 20.552 3,430 18.723 20.578 192 2000......... 20.552 23.056 3,368 20.578 23.142 159 2001......... 23.056 21.430 3,319 23.142 21.564 119 2002......... 21.430 17.159 3,153 21.564 17.310 91 2003......... 17.159 22.372 3,135 17.310 22.625 74 2004......... 22.372 24.662 2,969 22.625 25.003 106 2005......... 24.662 25.833 2,596 25.003 26.256 99 2006......... 25.833 26.540 2,241 26.256 27.042 93 2007......... 26.540 23.370 1,752 27.042 23.871 142 - ------------- ------ ------ ----- ------ ------ --- DWS VIP Equity 500 Index**** 2004......... 10.278 11.100 69 10.068 11.116 1 (a) 2005......... 11.100 11.503 133 11.116 11.548 2 2006......... 11.503 13.156 166 11.548 13.241 5 2007......... 13.156 13.715 189 13.241 13.838 8 - ------------- ------ ------ ----- ------ ------ --- DWS VIP Small Cap Index**** 2004......... 10.286 11.788 36 10.188 11.806 1 2005......... 11.788 12.168 87 11.806 12.217 2 2006......... 12.168 14.155 164 12.217 14.247 6 2007......... 14.155 13.748 170 14.247 13.872 16 - ------------- ------ ------ ----- ------ ------ --- Fidelity VIP Money Market Portfolio* (Pending Allocation Account) 1996......... 11.123 11.277 1 1997......... 11.277 11.894 30 1998......... 11.894 12.544 17 1999......... 12.544 13.192 12 12.843 13.195 1 2000......... 13.192 14.024 7 13.195 14.054 1 2001......... 14.024 14.610 7 14.054 14.633 1 2002......... 14.610 14.859 5 14.633 14.871 1 2003......... 14.859 15.007 3 14.871 15.020 0 2004......... 15.007 15.189 3 15.021 15.214 1 (a) 2005......... 15.189 15.649 3 15.214 15.673 1 (a) 2006......... 15.649 16.412 3 15.673 16.438 1* 2007......... 16.412 17.267 20 16.438 17.295 1 - ------------- ------ ------ ----- ------ ------ --- Fidelity (Reg. TM) VIP Asset Manager Portfolio* 1996......... 16.309 17.267 25 1997......... 17.267 20.583 4,471 1998......... 20.583 23.445 4,638 1999......... 23.445 25.787 4,152 24.279 25.819 251 2000......... 25.787 24.527 3,547 25.819 24.619 200 2001......... 24.527 23.290 3,360 24.619 23.436 102 2002......... 23.290 21.046 3,052 23.436 21.231 80 2003......... 21.046 24.582 2,804 21.231 24.860 71 2004......... 24.582 25.668 2,579 24.860 26.023 91 2005......... 25.668 26.441 2,308 26.023 26.874 83 2006......... 26.441 28.093 2,070 26.874 28.624 74 2007......... 28.093 32.126 1,790 28.624 32.815 88 - ------------- ------ ------ ----- ------ ------ --- Fidelity (Reg. TM) VIP Contrafund (Reg. TM) Portfolio*** 2000......... 10.000 9.412 2 10.000 9.419 1 2001......... 9.412 8.157 62 9.419 8.183 2 2002......... 8.157 7.300 167 8.183 7.342 7 2003......... 7.300 9.265 259 7.342 9.342 3 2004......... 9.265 10.563 475 9.342 10.677 20 2005......... 10.563 12.199 975 10.677 12.362 34 2006......... 12.199 13.459 1,382 12.362 13.672 42 2007......... 13.459 15.630 1,405 13.672 15.918 101 - ------------- ------ ------ ----- ------ ------ ---
A-3
Standard Breakpoint ---------------------------------------- ---------------------------------------- Accumulation unit value Accumulation unit value ----------------------- Number of ----------------------- Number of Beginning End of accumulation Beginning End of accumulation of period period units of period period units ----------- -------- ------------- ----------- -------- ------------- (Accumulation unit value in dollars and Number of accumulation units in thousands) Fidelity (Reg. TM) VIP Equity-Income Portfolio* 1996......... 14.763 15.790 10 1997......... 15.790 19.985 3,608 1998......... 19.985 22.087 4,155 1999......... 22.087 23.252 3,856 24.433 23.281 182 2000......... 23.252 24.959 3,030 23.281 25.052 155 2001......... 24.959 23.486 3,059 25.052 23.633 132 2002......... 23.486 19.312 2,830 23.633 19.481 70 2003......... 19.312 24.918 2,772 19.481 25.200 59 2004......... 24.918 27.515 2,736 25.200 27.896 88 2005......... 27.515 28.839 2,551 27.896 29.311 85 2006......... 28.839 34.318 2,482 29.311 34.967 88 2007......... 34.318 34.496 2,121 34.967 35.237 191 - ------------- ------ ------ ----- ------ ------ --- Fidelity (Reg. TM) VIP Growth Portfolio* 1996......... 22.793 23.220 8 1997......... 23.220 28.328 4,982 1998......... 28.328 39.122 5,291 1999......... 39.122 53.234 5,554 44.085 53.301 151 2000......... 53.234 46.917 5,136 53.301 47.094 184 2001......... 46.917 38.252 4,883 47.094 38.492 144 2002......... 38.252 26.469 4,445 38.492 26.703 99 2003......... 26.469 34.815 4,189 26.703 35.209 82 2004......... 34.815 35.633 3,748 35.209 36.127 132 2005......... 35.633 37.324 3,151 36.127 37.936 119 2006......... 37.324 39.484 2,795 37.936 40.232 105 2007......... 39.484 49.632 2,448 40.232 50.698 155 - ------------- ------ ------ ----- ------ ------ --- Janus Aspen Worldwide Growth Portfolio** 1998......... 10.000 12.520 75 1999......... 12.520 20.385 1,054 13.979 20.410 74 2000......... 20.385 17.019 2,225 20.410 17.083 150 2001......... 17.019 13.069 2,218 17.083 13.152 139 2002......... 13.069 9.639 2,090 13.152 9.724 112 2003......... 9.639 11.833 1,917 9.724 11.967 81 2004......... 11.833 12.275 1,683 11.967 12.446 100 2005......... 12.275 12.866 1,363 12.446 13.077 89 2006......... 12.866 15.057 1,168 13.077 15.342 83 2007......... 15.057 16.342 1,054 15.342 16.694 101 - ------------- ------ ------ ----- ------ ------ --- Lincoln VIPT Baron Growth Opportunities** (b) 1998......... 10.000 13.218 27 1999......... 13.218 17.775 460 15.583 17.800 23 2000......... 17.775 17.132 635 17.800 17.198 32 2001......... 17.132 19.054 740 17.198 19.176 30 2002......... 19.054 16.186 911 19.176 16.330 28 2003......... 16.186 20.835 931 16.330 21.073 20 2004......... 20.835 25.916 1,017 21.073 26.278 35 2005......... 25.916 26.522 902 26.278 26.959 43 2006......... 26.522 30.334 760 26.959 30.911 49 2007......... 30.334 31.059 666 30.911 31.730 82 - ------------- ------ ------ ----- ------ ------ --- Lincoln VIPT Cohen & Steers Global Real Estate 2007......... 10.091 8.265 5 8.946 8.278 1* - ------------- ------ ------ ----- ------ ------ --- Lincoln VIPT Delaware Bond**** 2004......... 10.052 10.551 60 10.542 10.567 3 2005......... 10.551 10.722 221 10.567 10.765 6 2006......... 10.722 11.115 321 10.765 11.188 8 2007......... 11.115 11.604 376 11.188 11.709 24 - ------------- ------ ------ ----- ------ ------ ---
A-4
Standard Breakpoint ---------------------------------------- ---------------------------------------- Accumulation unit value Accumulation unit value ----------------------- Number of ----------------------- Number of Beginning End of accumulation Beginning End of accumulation of period period units of period period units ----------- -------- ------------- ----------- -------- ------------- (Accumulation unit value in dollars and Number of accumulation units in thousands) Lincoln VIPT Delaware Growth and Income*** 2000......... 10.000 9.051 9 10.000 9.057 1 2001......... 9.051 7.954 81 9.057 7.980 4 2002......... 7.954 6.139 193 7.980 6.174 26 2003......... 6.139 7.884 376 6.174 7.948 10 2004......... 7.884 8.741 554 7.948 8.835 28 2005......... 8.741 9.134 632 8.835 9.255 32 2006......... 9.134 10.161 630 9.255 10.321 33 2007......... 10.161 10.675 596 10.321 10.871 49 - ------------- ------ ------ --- ------ ------ -- Lincoln VIPT Delaware Managed**** 2004......... 10.231 11.013 29 11.035 11.029 1 (a) 2005......... 11.013 11.397 68 11.029 11.444 1 (a) 2006......... 11.397 12.476 79 11.444 12.559 1* 2007......... 12.476 12.918 76 12.559 13.038 25 - ------------- ------ ------ --- ------ ------ -- Lincoln VIPT Delaware Social Awareness** 1998......... 10.000 12.791 33 1999......... 12.791 14.619 1,107 13.358 14.637 88 2000......... 14.619 13.268 1,127 14.637 13.318 116 2001......... 13.268 11.885 1,173 13.318 11.959 115 2002......... 11.885 9.164 1,213 11.959 9.244 96 2003......... 9.164 11.963 1,279 9.244 12.099 77 2004......... 11.963 13.349 1,292 12.099 13.534 83 2005......... 13.349 14.805 1,255 13.534 15.048 81 2006......... 14.805 16.462 1,228 15.048 16.774 81 2007......... 16.462 16.782 1,119 16.774 17.143 98 - ------------- ------ ------ ----- ------ ------ --- Lincoln VIPT Janus Capital Appreciation*** 2000......... 10.000 8.243 25 10.000 8.249 3 2001......... 8.243 6.048 110 8.249 6.068 7 2002......... 6.048 4.374 165 6.068 4.399 13 2003......... 4.374 5.736 245 4.399 5.783 11 2004......... 5.736 5.979 276 5.783 6.043 19 2005......... 5.979 6.168 256 6.043 6.250 21 2006......... 6.168 6.697 274 6.250 6.803 20 2007......... 6.697 7.984 269 6.803 8.131 25 - ------------- ------ ------ ----- ------ ------ --- Lincoln VIPT Mondrian International Value**** 2004......... 10.000 12.255 21 10.343 12.274 1 (a) 2005......... 12.255 13.655 113 12.274 13.710 5 2006......... 13.655 17.576 419 13.710 17.691 11 2007......... 17.576 19.400 571 17.691 19.576 62 - ------------- ------ ------ ----- ------ ------ --- Lincoln VIPT T. Rowe Price Structured Mid-Cap Growth** 1998......... 10.000 12.454 19 1999......... 12.454 17.563 1,486 12.865 17.585 202 2000......... 17.563 16.920 2,416 17.585 16.984 156 2001......... 16.920 11.175 2,306 16.984 11.246 137 2002......... 11.175 7.720 2,202 11.246 7.788 118 2003......... 7.720 10.137 2,246 7.788 10.252 91 2004......... 10.137 11.407 2,107 10.252 11.565 114 2005......... 11.407 12.402 1,884 11.565 12.605 112 2006......... 12.402 13.417 1,652 12.605 13.672 103 2007......... 13.417 15.089 1,451 13.672 15.413 127 - ------------- ------ ------ ----- ------ ------ --- Lincoln VIPT Wilshire 2010 Profile 2007......... 9.998 10.493 5 10.460 10.509 1* - ------------- ------ ------ ----- ------ ------ --- Lincoln VIPT Wilshire 2020 Profile 2007......... 10.001 10.337 10 9.924 10.353 1* - ------------- ------ ------ ----- ------ ------ --- Lincoln VIPT Wilshire 2030 Profile 2007......... 10.045 10.444 8 10.342 10.461 1* - ------------- ------ ------ ----- ------ ------ --- Lincoln VIPT Wilshire 2040 Profile 2007......... 10.072 10.269 3 9.914 10.285 2 - ------------- ------ ------ ----- ------ ------ ---
A-5
Standard Breakpoint ---------------------------------------- ---------------------------------------- Accumulation unit value Accumulation unit value ----------------------- Number of ----------------------- Number of Beginning End of accumulation Beginning End of accumulation of period period units of period period units ----------- -------- ------------- ----------- -------- ------------- (Accumulation unit value in dollars and Number of accumulation units in thousands) Lincoln VIPT Wilshire Aggressive Profile 2005......... 10.006 10.939 18 10.134 10.955 1 (a) 2006......... 10.939 12.622 84 10.955 12.672 1 2007......... 12.622 13.873 151 12.672 13.962 5 - ------------- ------ ------ --- ------ ------ - Lincoln VIPT Wilshire Conservative Profile 2005......... 10.000 10.304 12 10.148 10.319 1 (a) 2006......... 10.304 11.155 178 10.319 11.198 2 2007......... 11.155 11.902 250 11.198 11.979 5 - ------------- ------ ------ --- ------ ------ - Lincoln VIPT Wilshire Moderate Profile 2005......... 10.006 10.524 32 10.415 10.540 1 (a) 2006......... 10.524 11.674 206 10.540 11.721 10 2007......... 11.674 12.629 319 11.721 12.711 29 - ------------- ------ ------ --- ------ ------ -- Lincoln VIPT Wilshire Moderately Aggressive Profile 2005......... 10.049 10.701 39 10.306 10.715 1 (a) 2006......... 10.701 12.093 126 10.715 12.139 4 2007......... 12.093 13.147 292 12.139 13.230 13 - ------------- ------ ------ --- ------ ------ -- Neuberger Berman AMT Mid-Cap Growth Portfolio*** 2000......... 10.000 7.673 59 10.000 7.678 1 2001......... 7.673 5.725 115 7.678 5.743 2 2002......... 5.725 4.005 154 5.743 4.027 6 2003......... 4.005 5.078 234 4.027 5.119 3 2004......... 5.078 5.847 312 5.119 5.910 9 2005......... 5.847 6.585 508 5.910 6.672 12 2006......... 6.585 7.477 600 6.672 7.595 19 2007......... 7.477 9.070 1,084 7.595 9.236 60 - ------------- ------ ------ ----- ------ ------ -- Neuberger Berman AMT Partners Portfolio** 1998......... 10.000 11.861 27 1999......... 11.861 12.609 150 13.254 12.625 21 2000......... 12.609 12.571 212 12.625 12.619 32 2001......... 12.571 12.094 323 12.619 12.170 39 2002......... 12.094 9.083 405 12.170 9.163 46 2003......... 9.083 12.148 507 9.163 12.286 38 2004......... 12.148 14.309 583 12.286 14.508 42 2005......... 14.309 16.723 683 14.508 16.998 46 2006......... 16.723 18.584 602 16.998 18.936 37 2007......... 18.584 20.116 475 18.936 20.549 51 - ------------- ------ ------ ----- ------ ------ -- T. Rowe Price International Stock Portfolio* 1996......... 11.687 12.276 5 1997......... 12.276 12.503 1,837 1998......... 12.503 14.342 2,049 1999......... 14.342 18.931 1,818 14.861 18.955 122 2000......... 18.931 15.400 1,634 18.955 15.457 80 2001......... 15.400 11.859 1,544 15.457 11.934 62 2002......... 11.859 9.593 1,438 11.934 9.678 53 2003......... 9.593 12.397 1,435 9.678 12.538 40 2004......... 12.397 13.965 1,377 12.538 14.158 51 2005......... 13.965 16.043 1,284 14.158 16.305 51 2006......... 16.043 18.915 1,190 16.305 19.273 48 2007......... 18.915 21.167 1,038 19.273 21.622 70 - ------------- ------ ------ ----- ------ ------ ---
* The Subaccount indicated commenced operations on September 26, 1996. ** The Subaccount indicated commenced operation on October 1, 1998. *** The Subaccount indicated commenced operation on September 27, 2000. **** The Subaccount indicated commenced operation on May 24, 2004. (a) All numbers less than 500 were rounded up to one. (b) Effective June 5, 2007, the Baron Capital Asset Fund, a series of Baron Capital Funds Trust, was reorganized into the LVIP Baron Growth Opportunities Fund, a series of Lincoln Variable Insurance Products Trust. The values in the table for periods prior to the date of the reorganization reflect investments in the Baron Capital Asset Fund. A-6 Group Variable Annuity Contracts I, II, & III Funded Through the SubAccounts of Lincoln National Variable Annuity Account L of The Lincoln National Life Insurance Company Statement of Additional Information (SAI) This SAI should be read in conjunction with the prospectus of the Group Variable Annuity Contracts (the ""Contracts""), dated April 30, 2008. You may obtain a copy of the prospectus to which this SAI relates without charge by writing to The Lincoln National Life Insurance Company, PO Box 2340, Fort Wayne, IN 46808, by calling Lincoln Life at 1-800-341-0441, or by visiting www.LFG.com. Table of Contents
Item Page Special Terms B-2 Services B-2 Principal Underwriter B-2 Purchase of Securities Being Offered B-2 Annuity Payouts B-2 Determination of Accumulation and Annuity Unit Value B-3
Item Page Advertising B-3 Additional Services B-5 Other Information B-5 Financial Statements B-5
This SAI is not a prospectus. The date of this SAI is April 30, 2008. Special Terms The special terms used in this SAI are the ones defined in the Prospectus. Services Independent Registered Public Accounting Firm The financial statements of the VAA and the consolidated financial statements of Lincoln Life appearing in this SAI and Registration Statement have been audited by Ernst & Young LLP, independent registered public accounting firm, 2300 National City Center, 110 West Berry Street, Fort Wayne, Indiana 46802, as set forth in their reports, also appearing in this SAI and in the Registration Statement. The financial statements audited by Ernst & Young LLP have been included herein in reliance on their reports given on their authority as experts in accounting and auditing. Keeper of Records All accounts, books, records and other documents which are required to be maintained for the VAA are maintained by us or by third parties responsible to Lincoln Life. We have entered into an agreement with Mellon Bank, N.A., One Mellon Bank Center, 500 Grant Street, Pittsburgh, Pennsylvania, 15258, to provide accounting services to the VAA. No separate charge against the assets of the VAA is made by us for this service. Principal Underwriter Lincoln Financial Distributors, Inc. ("LFD"), an affiliate of Lincoln Life, serves as principal underwriter (the "Principal Underwriter") for the contracts, as described in the prospectus. The Principal Underwriter offers the contracts to the public on a continuous basis and anticipates continuing to offer the contracts, but reserves the right to discontinue the offering. The Principal Underwriter offers the contracts through sales representatives, who are associated with Lincoln Financial Advisors Corporation, our affiliate. The Principal Underwriter also may enter into selling agreements with other broker-dealers ("Selling Firms") for the sale of the contracts. Sales representatives of Selling Firms are appointed as our insurance agents. Prior to September 15, 2005, LFA was the Principal Underwritier, and they paid $4,129,656 and $3,750,709 to Lincoln Sales Representatives and Selling Firms in 2004, and 2005, respectively, as sales compensation with respect to the contracts. LFA retained no underwriting commissions for the sale of the contracts. After September 15, 2005, Lincoln Life was the Principal Underwriter, and they paid $1,100,062, $3,514,035 and $3,254,787 to LFA and Selling Firms in 2005, 2006 and 2007, respectively, as sales compensation with respect to the contracts. The Principal Underwriter retained no underwriting commissions for sale of the contracts. Purchase of Securities Being Offered The variable annuity contracts are offered to the public through licensed insurance agents who specialize in selling our products; through independent insurance brokers; and through certain securities brokers/dealers selected by us whose personnel are legally authorized to sell annuity products. There are no special purchase plans for any class of prospective buyers. However, under certain limited circumstances described in the prospectus under the section Charges and Other Deductions, any applicable account fee and/or surrender charge may be reduced or waived. Both before and after the annuity commencement date, there are exchange privileges between subaccounts, and from the VAA to the general account (if available) 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. The offering of the contracts is continuous. Annuity Payouts Variable Annuity Payouts Variable annuity payouts will be determined on the basis of: o the dollar value of the contract on the annuity commencement date less any applicable premium tax; o the annuity tables contained in the contract; o the type of annuity option selected; and B-2 o the investment results of the fund(s) selected. In order to determine the amount of variable annuity payouts, we make the following calculation: o first, we determine the dollar amount of the first payout; o second, we credit the contract with a fixed number of annuity units based on the amount of the first payout; and o third, we calculate the value of the annuity units each period thereafter. These steps are explained below. The dollar amount of the first periodic variable annuity payout is determined by applying the total value of the accumulation units credited under the contract valued as of the annuity commencement date (less any premium taxes) to the annuity tables contained in the contract. The first variable annuity payout 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 the 1983 Table "a" Individual Annuity Mortality Table modified, with an assumed investment return at the rate of 1%, 2%, 3%, 4%, 5%, or 6% per annum, depending on the terms of your contract. 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 assumed interest rate is the measuring point for subsequent annuity payouts. If the actual net investment rate (annualized) exceeds the assumed interest rate, the payout will increase at a rate equal to the amount of such excess. Conversely, if the actual rate is less than the assumed interest rate, 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. We may use sex-distinct annuity tables in contracts that are not associated with employer sponsored plans and where not prohibited by law. At an 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 periodic payouts is determined by multiplying the contractowner's fixed number of annuity units in each subaccount by the appropriate annuity unit value for the valuation date ending 14 days prior to 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 determined by multiplying the subaccount annuity unit value for the immediately preceding valuation date by the product of: o The net investment factor of the subaccount for the valuation period for which the annuity unit value is being determined, and o 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 prior to the payment 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 We may require proof of age, sex, or survival of any payee upon whose age, sex, or survival payments depend. Determination of Accumulation and Annuity Unit Value A description of the days on which accumulation and annuity units will be valued is given in the prospectus. The New York Stock Exchange's (NYSE) most recent announcement (which is subject to change) states that it will be closed on weekends and on these holidays: New Year's Day, Martin Luther King 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. It may also be closed on other days. Since the portfolios of some of the fund and series will consist of securities primarily listed on foreign exchanges or otherwise traded outside the United States, those securities may be traded (and the net asset value of those fund and series and of the variable account could therefore be significantly affected) on days when the investor has no access to those funds and series. Advertising The Lincoln National Life Insurance Company (Lincoln Life) is ranked and rated by independent financial rating services, including Moody's, Standard & Poor's, Duff & Phelps and A.M. Best Company. The purpose of these ratings is to reflect the financial strength or B-3 claims-paying ability of Lincoln Life. The ratings are not intended to reflect the investment experience or financial strength of the VAA. We may advertise these ratings from time to time. In addition, we may include in certain advertisements, endorsements in the form of a list of organizations, individuals or other parties which recommend Lincoln Life or the policies. Furthermore, we may occasionally include in advertisements comparisons of currently taxable and tax deferred investment programs, based on selected tax brackets, or discussions of alternative investment vehicles and general economic conditions. More About the S&P 500 Index. Investors look to indexes as a standard of market performance. Indexes are model portfolios, that is, groups of stocks or bonds selected to represent an entire market. The S&P 500 Index is a widely used measure of large US company stock performance. It consists of the common stocks of 500 major corporations selected according to size, frequency and ease by which their stocks trade, and range and diversity of the American economy. The LVIP SSgA S&P 500 Index Fund seeks to approximate as closely as possible, before fees and expenses, the total return of the S&P 500 Index. To accomplish this objective the fund's sub-adviser, SSgA Funds Management, Inc. ("SFM"), attempts to buy and sell all of the index's securities in the same proportion as they are reflected in the S&P 500 Index, although the fund reserves the right not to invest in every security in the S&P 500 Index if it is not practical to do so under the circumstances. SFM does not seek to beat the S&P 500 Index and does not seek temporary defensive positions when markets appear to be overvalued. SFM makes no attempt to apply economic, financial or market analysis when managing the fund. Including a security among the fund's holdings implies no opinion as to its attractiveness as an investment. The fund may invest in stock index futures and options on stock index futures as a substitute for a comparable market position in the underlying securities. A stock index future obligates one party to deliver (and the other party to take), effectively, an amount of cash equal to a specific dollar amount times the difference between the value of a specific stock index at the close of the last trading day of the contract and the price at which the agreement is made. No physical delivery of the underlying stocks in the index is made. Instead, the buyer and seller settle the difference in cash between the contract price and the market price on the agreed upon date. The buyer pays the difference if the actual price is lower than the contract price and the seller pays the difference if the actual price is higher. There can be no assurance that a liquid market will exist at the time when the fund seeks to close out a futures contract or a futures option position. Lack of a liquid market may prevent liquidation of an unfavorable position. The fund is not sponsored, endorsed, sold or promoted by Standard & Poor's, a division of The McGraw-Hill Companies, Inc. ("S&P"). S&P makes no representation or warranty, express or implied, to the owners of the fund or any member of the public regarding the advisability of investing in securities generally or in the fund particularly or the ability of the S&P 500 Index to track general stock market performance. S&P's only relationship to the fund is the licensing of certain trademarks and trade names of S&P and of the S&P 500 Index which is determined, composed and calculated by S&P without regard to the fund. S&P has no obligation to take the needs of the fund or its shareholders into consideration in determining, composing or calculating the S&P 500 Index. S&P is not responsible for and has not participated in the determination of the prices and amount of the fund or the timing of the issuance or sale of the fund or in the determination or calculation of the equation by which the fund is to be converted into cash. S&P has no obligation or liability in connection with the administration, marketing or trading of the fund. S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN AND S&P SHALL HAVE NO LIABILITY FOR ANY ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR IMPLIED, AS TO RESULTS TO BE OBTAINED BY THE FUND OR ITS SHAREHOLDERS, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN. S&P MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH RESPECT TO THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL S&P HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES. Compound Interest Illustrations - These will emphasize several advantages of the variable annuity contract. For example, but not by way of illustration, the literature may emphasize the potential tax savings through tax deferral; the potential advantage of the variable annuity account over the fixed account; and the compounding effect when a client makes regular deposits to his or her contract. Internet - An electronic communications network which may be used to provide information regarding Lincoln Life, performance of the subaccounts and advertisement literature. Annuity Payout Illustrations. These will provide an initial benefit payment based in part on the annuitant, the contract value and the fixed and/or variable annuity payout option elected. In addition, variable annuity payout illustrations may show the historical results of a variable payout in a subaccount of the VAA. Dollar-Cost Averaging Illustrations. These illustrations will generally discuss the price-leveling effect of making regular purchases in the same subaccounts over a period of time, to take advantage of the trends in market prices of the portfolio securities purchased for those subaccounts. B-4 Additional Services Dollar Cost Averaging (DCA) - You may systematically transfer, on a monthly basis, amounts from certain subaccounts, or the fixed side of the contract into the subaccounts over a period of 1, 2 or 3 years. The minimum amount to be dollar cost averaged is $10,000 for 1 year, and $25,000 for 2 years or 3 years. You may elect to participate in the DCA program at the time of application or at anytime before the annuity commencement date by completing an election form available from us. Once elected, the program will remain in effect until the earlier of: o the annuity commencement date; o the value of the amount being DCA'd is depleted; or o you cancel the program by written request or by telephone if we have your telephone authorization on file. We reserve the right to discontinue this program at any time. DCA does not assure a profit or protect against loss. GVA III fixed account restrictions may apply. Systematic Transfer - The systematic transfer service is only available to GVA III participants. This service allows you to fully liquidate your fixed account balance over four years in five annual installments and transfer the amounts into one or more of the subaccounts. You may change the receiving subaccount allocation at any time. A distribution or a non-scheduled transfer from the fixed account may cancel the systematic transfer program prematurely. The program will also be cancelled prematurely if the fixed account balance falls to $0. Account Sweep - The account sweep service allows you to keep a designated amount (the baseline amount) in one subaccount or the fixed account, and automatically transfer the excess to other variable subaccount(s) of your choice. The transfers may take place monthly, quarterly, semi-annually or annually. A $10,000 minimum balance in the holding account is required in order to begin this service. For account sweep to occur, the holding account balance must exceed the designated baseline amount by at least $50. You may change the receiving subaccount allocation at any time. Deposits to or distributions from the holding account will not adjust your baseline amount, but may affect the amount of money available to be transferred. A new account sweep program is required to change the designated baseline amount. GVA III fixed account restrictions may apply. Portfolio Rebalancing - Portfolio rebalancing is an option, which, if elected by the contractowner, restores to a pre-determined level the percentage of the contract value, allocated to each variable subaccount or the fixed account. This pre-determined level will be the allocation initially selected when the contract was purchased, unless subsequently changed. The portfolio rebalancing allocation may be changed at any time by submitting a written request to us. If portfolio rebalancing is elected, all purchase payments allocated to the variable subaccounts must be subject to portfolio rebalancing. Portfolio rebalancing may take place on either a quarterly, semi-annual or annual basis, as selected by the contractowner. You may choose to either rebalance within your designated investment accounts, or to rebalance your designated investment account based on your total account value within the group annuity contract. This second selection will move 100% of your balance based on your allocated percentages. For portfolio rebalancing to occur, the total transfer amount must be $50 or more. If this minimum transfer amount is not available, the transfer will not occur. You may change the designated investment accounts' allocations or percentages at any time. The portfolio rebalancing program will be cancelled prematurely if the selected rebalancing account balance falls to $0. GVA III fixed account restrictions may apply. Sales literature may reference the Group Variable Annuity newsletter which is a newsletter distributed quarterly to clients of the VAA. The contents of the newsletter will be a commentary on general economic conditions and, on some occasions, referencing matters in connection with the Group Variable Annuity. Sales literature and advertisements may reference these and other similar reports from Best's or other similar publications which report on the insurance and financial services industries. Other Information Due to differences in redemption rates, tax treatment or other considerations, the interests of contractowners under the variable life accounts could conflict with those of contractowners under the VAA. In those cases, where assets from variable life and variable annuity separate accounts are invested in the same fund(s) (i.e., where mixed funding occurs), the Boards of Directors of the fund involved will monitor for any material conflicts and determine what action, if any, should be taken. If it becomes necessary for any separate account to replace shares of any fund with another investment, that fund may have to liquidate securities on a disadvantageous basis. Refer to the prospectus for each fund for more information about mixed funding. Financial Statements Financial statements of the VAA and the consolidated financial statements of Lincoln Life appear on the following pages. B-5 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY S-1 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2007, 2006 AND 2005 S-2 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY CONSOLIDATED BALANCE SHEETS (IN MILLIONS, EXCEPT SHARE DATA)
AS OF DECEMBER 31, ------------------- 2007 2006 -------- --------- ASSETS Investments: Available-for-sale securities, at fair value: Fixed maturity (amortized cost: 2007 -- $53,250; 2006 -- $53,846) $ 53,405 $ 54,697 Equity (cost: 2007 -- $132; 2006 -- $205) 134 218 Trading securities 2,533 2,820 Mortgage loans on real estate 7,117 7,344 Real estate 258 409 Policy loans 2,798 2,755 Derivative investments 172 245 Other investments 986 783 -------- -------- Total investments 67,403 69,271 Cash and invested cash 1,395 1,762 Deferred acquisition costs and value of business acquired 8,574 7,609 Premiums and fees receivable 382 331 Accrued investment income 801 838 Reinsurance recoverables 7,939 7,949 Goodwill 3,539 3,514 Other assets 2,030 1,765 Separate account assets 82,263 71,777 -------- -------- Total assets $174,326 $164,816 ======== ======== LIABILITIES AND STOCKHOLDER'S EQUITY LIABILITIES Future contract benefits $ 13,619 $ 13,645 Other contract holder funds 58,168 58,718 Short-term debt 173 21 Long-term debt 1,675 1,439 Reinsurance related derivative liability 211 218 Funds withheld reinsurance liabilities 1,862 1,816 Deferred gain on indemnity reinsurance 696 760 Payables for collateral under securities loaned 1,135 1,504 Other liabilities 2,083 2,073 Separate account liabilities 82,263 71,777 -------- -------- Total liabilities 161,885 151,971 -------- -------- CONTINGENCIES AND COMMITMENTS (SEE NOTE 13) STOCKHOLDER'S EQUITY Common stock-- 10,000,000 shares, authorized, issued and outstanding 9,105 9,088 Retained earnings 3,283 3,341 Accumulated other comprehensive income 53 416 -------- -------- Total stockholder's equity 12,441 12,845 -------- -------- Total liabilities and stockholder's equity $174,326 $164,816 ======== ========
See accompanying notes to the Consolidated Financial Statements S-3 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF INCOME (IN MILLIONS)
FOR THE YEARS ENDED DECEMBER 31, --------------------------- 2007 2006 2005 ------- ------- ------- REVENUES Insurance premiums $ 1,560 $ 1,118 $ 67 Insurance fees 2,994 2,439 1,575 Net investment income 4,188 3,869 2,592 Realized loss (112) (2) (16) Amortization of deferred gain on indemnity reinsurance 83 76 77 Other revenues and fees 325 289 316 ------- ------- ------- Total revenues 9,038 7,789 4,611 ------- ------- ------- BENEFITS AND EXPENSES Interest credited 2,398 2,241 1,506 Benefits 2,329 1,757 616 Underwriting, acquisition, insurance and other expenses 2,472 2,086 1,544 Interest and debt expenses 96 84 78 ------- ------- ------- Total benefits and expenses 7,295 6,168 3,744 ------- ------- ------- Income before taxes 1,743 1,621 867 Federal income taxes 504 460 223 ------- ------- ------- Net income $ 1,239 $ 1,161 $ 644 ======= ======= =======
See accompanying notes to the Consolidated Financial Statements S-4 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (IN MILLIONS)
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 2007 2006 2005 -------- -------- ------- COMMON STOCK Balance at beginning-of-year $ 9,088 $ 2,125 $ 2,106 Lincoln National Corporation purchase price (9) 6,932 -- Stock compensation/issued for benefit plans 26 31 19 -------- -------- ------- Balance at end-of-year 9,105 9,088 2,125 -------- -------- ------- RETAINED EARNINGS Balance at beginning-of-year 3,341 2,748 2,304 Cumulative effect of adoption of SOP 05-1 (41) -- -- Cumulative effect of adoption of FIN 48 (14) -- -- Comprehensive income 876 1,124 315 Less other comprehensive loss, net of tax (363) (37) (329) -------- -------- ------- Net income 1,239 1,161 644 Dividends declared (1,242) (568) (200) -------- -------- ------- Balance at end-of-year 3,283 3,341 2,748 -------- -------- ------- NET UNREALIZED GAIN ON AVAILABLE-FOR-SALE SECURITIES Balance at beginning-of-year 421 452 781 Change during the year (345) (31) (329) -------- -------- ------- Balance at end-of-year 76 421 452 -------- -------- ------- NET UNREALIZED GAIN ON DERIVATIVE INSTRUMENTS Balance at beginning-of-year (9) 7 14 Change during the year (10) (16) (7) -------- -------- ------- Balance at end-of-year (19) (9) 7 -------- -------- ------- MINIMUM PENSION LIABILITY ADJUSTMENT Balance at beginning-of-year -- (6) (13) Change during the year -- 6 7 -------- -------- ------- Balance at end-of-year -- -- (6) -------- -------- ------- FUNDED STATUS OF EMPLOYEE BENEFIT PLANS Balance at beginning-of-year 4 -- -- Change during the year (8) 4 -- -------- -------- ------- Balance at end-of-year (4) 4 -- -------- -------- ------- Total stockholder's equity at end-of-year $ 12,441 $ 12,845 $ 5,326 ======== ======== =======
See accompanying notes to the Consolidated Financial Statements S-5 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (IN MILLIONS)
For the Years Ended December 31, --------------------------- 2007 2006 2005 ------- ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 1,239 $ 1,161 $ 644 Adjustments to reconcile net income to net cash provided by operating activities: Deferred acquisition costs and value of business acquired deferrals and interest, net of amortization (1,101) (722) (430) Change in premiums and fees receivable (53) 16 54 Change in accrued investment income 13 21 (4) Change in contract accruals 574 170 (1,082) Net trading securities purchases, sales and maturities 316 165 (72) Gain on reinsurance embedded derivative/trading securities (2) (4) (5) Change in contract holder funds 453 741 1,893 Change in net periodic benefit accruals (5) (3) (11) Change in amounts recoverable from reinsurers (539) 199 101 Change in federal income tax accruals 310 150 148 Stock-based compensation expense 26 31 19 Depreciation, amortization and accretion, net 64 54 64 Increase in funds withheld liability 46 105 131 Realized loss on investments and derivative instruments 114 6 21 Amortization of deferred gain on indemnity reinsurance (83) (76) (77) Other (71) (706) (601) ------- ------- ------- Net adjustments 62 147 149 ------- ------- ------- Net cash provided by operating activities 1,301 1,308 793 ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Available-for-sale securities: Purchases (8,606) (9,323) (5,725) Sales 3,453 5,328 3,767 Maturities 4,087 3,326 2,392 Purchases of other investments (2,018) (696) (1,008) Sales or maturities of other investments 1,880 585 1,151 Increase (decrease) in cash collateral on loaned securities (369) 538 45 Cash acquired from Jefferson-Pilot merger -- 154 -- Other (84) 58 9 ------- ------- ------- Net cash provided by (used in) investing activities (1,657) (30) 631 ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Payment of long-term debt -- -- (47) Issuance of long-term debt 375 140 -- Net increase (decrease) in short-term debt 13 (13) 2 Universal life and investment contract deposits 9,481 7,444 4,783 Universal life and investment contract withdrawals (6,645) (6,660) (3,755) Investment contract transfers (2,448) (1,821) (1,483) Dividends paid (787) (568) (200) ------- ------- ------- Net cash used in financing activities (11) (1,478) (700) ------- ------- ------- Net increase (decrease) in cash and invested cash (367) (200) 724 ------- ------- ------- Cash and invested cash at beginning-of-year 1,762 1,962 1,238 ------- ------- ------- Cash and invested cash at end-of-period $ 1,395 $ 1,762 $ 1,962 ======= ======= =======
See accompanying notes to the Consolidated Financial Statements S-6 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF OPERATIONS The Lincoln National Life Insurance Company ("LNL" or the "Company," which also may be referred to as "we," "our" or "us"), a wholly-owned subsidiary of Lincoln National Corporation ("LNC" or the "Parent Company"), is domiciled in the state of Indiana. We own 100% of the outstanding common stock of one insurance company subsidiary, Lincoln Life & Annuity Company of New York ("LLANY"). We also own several non-insurance companies, including Lincoln Financial Distributors ("LFD") and Lincoln Financial Advisors ("LFA"), LNC's wholesaling and retailing business units, respectively. LNL's principal businesses consist of underwriting annuities, deposit-type contracts and life insurance through multiple distribution channels. LNL is licensed and sells its products throughout the United States and several U.S. territories (see Note 20). BASIS OF PRESENTATION The accompanying consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). On April 3, 2006, LNC completed its merger with Jefferson-Pilot Corporation ("Jefferson-Pilot"). On February 15, 2007, the North Carolina Department of Insurance approved the merger of Jefferson-Pilot Life Insurance Company ("JPL") into LNL with LNL being the survivor and Jefferson Pilot LifeAmerica Insurance Company ("JPLA") into LLANY, with JPLA being the survivor. JPLA then changed its name to LLANY. The effective date of these transactions was April 2, 2007. On May 3, 2007, LNL made a dividend to LNC that transferred ownership of our formerly wholly-owned subsidiary, First Penn-Pacific Life Insurance Company ("FPP"), to LNC. On July 2, 2007, the Nebraska Insurance Department approved the merger of Jefferson Pilot Financial Insurance Company ("JPFIC"), formerly a wholly-owned subsidiary of Jefferson-Pilot, into LNL. Statement of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations" ("SFAS 141"), excludes transfers of net assets or exchanges of shares between entities under common control, and notes that certain provisions under Accounting Principles Board ("APB") Opinion No. 16, "Business Combinations," provide a source of guidance for such transactions. In accordance with APB Opinion No. 16, the consolidated financial statements are presented as if on April 3, 2006, LNL completed the merger with JPL, JPLA and JPFIC, and has included the results of operations and financial condition of JPL, JPLA and JPFIC in our consolidated financial statements beginning on April 3, 2006 and all comparative financial statements are restated and presented as if the entities had been previously combined, in a manner similar to a pooling-of-interests. The consolidated financial statements for the period from January 1, 2006 through April 2, 2006 and for the year ended December 31, 2005 exclude the results of operations and financial condition of JPL, JPLA and JPFIC. The consolidated financial statements include the results of operations and financial condition of FPP from January 1, 2007 through May 3, 2007 and for the years ended December 31, 2006 and 2005. FPP's results subsequent to May 3, 2007 are excluded from these consolidated financial statements. The insurance subsidiaries also submit financial statements to insurance industry regulatory authorities. Those financial statements are prepared on the basis of statutory accounting practices ("SAP") and are significantly different from financial statements prepared in accordance with GAAP. See Note 18 for additional discussion on SAP. Certain amounts reported in prior years' consolidated financial statements have been reclassified to conform to the presentation adopted in the current year including a $2.1 billion increase to common stock offset by a decrease to retained earnings for each of the years ended December 31, 2006, 2005, and 2004 to properly classify historical capital contributions received and stock compensation expense incurred. These reclassifications have no effect on net income or stockholder's equity of the prior years. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of LNL and all other entities in which we have a controlling financial interest. All material intercompany accounts and transactions have been eliminated in consolidation. ACCOUNTING ESTIMATES AND ASSUMPTIONS The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses for the reporting period. Those estimates are inherently subject to change and actual results could differ from those estimates. Included among the material (or potentially material) reported amounts and disclosures that require extensive use of estimates are: fair value of certain invested assets and derivatives, asset valuation allowances, deferred policy acquisition costs ("DAC"), goodwill, value of business acquired ("VOBA"), future contract benefits and other contract holder funds, deferred front-end loads ("DFEL"), pension plans, income taxes and the potential effects of resolving litigated matters. BUSINESS COMBINATIONS For all business combination transactions excluding mergers of entities under common control as discussed above initiated after June 30, 2001, the purchase method of accounting has been used, and accordingly, the assets and liabilities of the acquired company have been recorded at their estimated fair values as of the merger date. The fair values are subject to adjustment of the initial allocation for a one-year period as more information relative to the fair values as of the acquisition date becomes available. The consolidated financial statements include the results of operations of any acquired company since the acquisition date. AVAILABLE-FOR-SALE SECURITIES Securities classified as available-for-sale consist of fixed maturity and equity securities and are stated at fair value with unrealized gains and losses included as a separate component of S-7 accumulated other comprehensive income ("OCI"), net of associated DAC, VOBA, other contract holder funds and deferred income taxes. The fair value of actively traded securities is based on quoted market prices from observable market data or estimates from independent pricing services. In cases where this information is not available, such as for privately placed securities, fair value is estimated using an internal pricing matrix. This matrix relies on management's judgment concerning: 1) the discount rate used in calculating expected future cash flows; 2) credit quality; 3) industry sector performance; and 4) expected maturity. Dividends and interest income, recorded in net investment income, are recognized when earned. Amortization of premiums and accretion of discounts on investments in debt securities are reflected in net investment income over the contractual terms of the investments in a manner that produces a constant effective yield. Realized gains and losses on the sale of investments are determined using the specific identification method. LNC regularly reviews available-for-sale securities for impairments in value deemed to be other-than-temporary. The cost basis of securities that are determined to be other-than-temporarily impaired is written down to current fair value with a corresponding charge to realized loss in net income. A write-down for impairment can be recognized for both credit-related events and for change in fair value due to changes in interest rates. Once a security is written down to fair value through net income, any subsequent recovery in value cannot be recognized in net income until the security is sold. However, in the event that the security is written down due to an interest-rate related impairment, the write-down is accreted through investment income over the life of the security. In evaluating whether a decline in value is other-than-temporary, LNC considers several factors including, but not limited to: 1) the severity (generally if greater than 20%) and duration (generally if greater than six months) of the decline; 2) our ability and intent to hold the security for a sufficient period of time to allow for a recovery in value; 3) the cause of the decline; and 4) fundamental analysis of the liquidity, business prospects and overall financial condition of the issuer. TRADING SECURITIES Trading securities consist of fixed maturity and equity securities in designated portfolios, which support modified coinsurance ("Modco") and coinsurance with funds withheld ("CFW") reinsurance arrangements. Investment results for these portfolios, including gains and losses from sales, are passed directly to the reinsurers pursuant to contractual terms of the reinsurance arrangements. Trading securities are carried at fair value and changes in fair value, offset by corresponding changes in the fair value of embedded derivative liabilities associated with the underlying reinsurance arrangements, are recorded in net investment income as they occur. For asset-backed and mortgage-backed securities, included in the trading and available-for-sale fixed maturity securities portfolios, we recognize income using a constant effective yield based on anticipated prepayments and the estimated economic life of the securities. When actual prepayments differ significantly from originally anticipated prepayments, the effective yield is recalculated prospectively to reflect actual payments to date plus anticipated future payments. Any adjustments resulting from changes in effective yield are reflected in net investment income. MORTGAGE LOANS ON REAL ESTATE Mortgage loans on real estate are carried at unpaid principal balances adjusted for amortization of premiums and accretion of discounts and are net of valuation allowances. Interest income is accrued on the principal balance of the loan based on the loan's contractual interest rate. Premiums and discounts are amortized using the effective yield method over the life of the loan. Interest income and amortization of premiums and discounts are reported in net investment income along with mortgage loan fees, which are recorded as they are incurred. Loans are considered impaired when it is probable that, based upon current information and events, we will be unable to collect all amounts due under the contractual terms of the loan agreement. When we determine that a loan is impaired, a valuation allowance is established for the excess carrying value of the loan over its estimated value. The loan's estimated value is based on: 1) the present value of expected future cash flows discounted at the loan's effective interest rate; 2) the loan's observable market price; or 3) the fair value of the loan's collateral. Valuation allowances are maintained at a level we believe is adequate to absorb estimated probable credit losses. Our periodic evaluation of the adequacy of the allowance for losses is based on our past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay (including the timing of future payments), the estimated value of the underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. We do not accrue interest on impaired loans and loans 90 days past due and any interest received on these loans is either applied to the principal or recorded in net investment income when received, depending on the assessment of the collectability of the loan. Mortgage loans deemed to be uncollectible are charged against the allowance for losses and subsequent recoveries, if any, are credited to the allowance for losses. All mortgage loans that are impaired have an established allowance for credit losses. Changes in valuation allowances are reported in realized loss on our Consolidated Statements of Income. REAL ESTATE Real estate includes both real estate held for the production of income and real estate held-for-sale. Real estate held for the production of income is carried at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful life of the asset. We periodically review properties held for the production of income for impairment and properties whose carrying values are greater than their projected undiscounted cash flows are written down to estimated fair value, with impairment losses reported in realized loss on our Consolidated Statements of Income. The estimated fair value of real estate is generally computed using the present value of expected future cash flows from the real estate discounted at a rate commensurate with the underlying risks. S-8 Real estate classified as held-for-sale is stated at the lower of depreciated cost or fair value less expected disposition costs at the time classified as held-for-sale. Real estate is not depreciated while it is classified as held-for-sale. Also, valuation allowances for losses are established, as appropriate, for real estate held-for-sale and any changes to the valuation allowances are reported in realized loss on our Consolidated Statements of Income. Real estate acquired through foreclosure proceedings is recorded at fair value at the settlement date. POLICY LOANS Policy loans are carried at unpaid principal balances. SECURITIES LENDING Securities loaned are treated as collateralized financing transactions, and a liability is recorded equal to the cash collateral received, which is typically greater than the market value of the related securities loaned. This liability is included within payables for collateral under securities loaned on our Consolidated Balance Sheets. Our pledged securities are included in fixed maturities on our Consolidated Balance Sheets. We generally obtain collateral in an amount equal to 102% and 105% of the fair value of the domestic and foreign securities, respectively. We value collateral daily and obtain additional collateral when deemed appropriate. The cash received in our securities lending program is typically invested in cash equivalents, short-term investments or fixed maturity securities. Income and expenses associated with these transactions are recorded as investment income and investment expenses within net investment income on our Consolidated Statements of Income. REVERSE REPURCHASE AGREEMENTS Reverse repurchase agreements are treated as collateralized financing transactions and a liability is recorded equal to the cash collateral received. This liability is included within payables for collateral under securities loaned on our Consolidated Balance Sheets. Our pledged securities are included in fixed maturities on our Consolidated Balance Sheets. We obtain collateral in an amount equal to 95% of the fair value of the securities, and our agreements with third parties contain contractual provisions to allow for additional collateral to be obtained when necessary. The cash received in our reverse repurchase program is typically invested in fixed maturity securities. Income and expenses associated with these transactions are recorded as investment income and investment expenses within net investment income on our Consolidated Statements of Income. REALIZED LOSS Realized loss includes realized gains and losses from the sale of investments, derivative gains and losses, gains and losses on the sale of subsidiaries and businesses and net gains and losses on reinsurance embedded derivative and trading securities on Modco and CFW reinsurance arrangements. Realized loss is recognized in net income, net of associated amortization of DAC, VOBA, deferred sales inducements ("DSI") and DFEL and changes in other contract holder funds. Realized loss is also net of allocations of investment gains and losses to certain contract holders and certain reinsurance arrangements for which we have a contractual obligation. DERIVATIVE INSTRUMENTS We hedge certain portions of our exposure to interest rate risk, foreign currency exchange risk, equity market risk and credit risk by entering into derivative transactions. All of our derivative instruments are recognized as either assets or liabilities on our Consolidated Balance Sheets at estimated fair value. The accounting for changes in the estimated fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, we must designate the hedging instrument based upon the exposure being hedged: as a cash flow hedge, a fair value hedge or a hedge of a net investment in a foreign operation. As of December 31, 2007 and 2006, we had derivative instruments that were designated and qualified as cash flow hedges and fair value hedges. In addition, we had derivative instruments that were economic hedges but were not designated as hedging instruments under SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of OCI and reclassified into net income in the same period or periods during which the hedged transaction affects net income. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of designated future cash flows of the hedged item (hedge ineffectiveness), if any, is recognized in net income during the period of change. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in net income during the period of change in estimated fair values. For derivative instruments not designated as hedging instruments but are economic hedges, the gain or loss is recognized in net income during the period of change in the corresponding income statement line as the transaction being hedged. See Note 5 for additional discussion of our derivative instruments. CASH AND CASH EQUIVALENTS Cash and invested cash are carried at cost and include all highly liquid debt instruments purchased with a maturity of three months or less. DAC, VOBA, DSI AND DFEL Commissions and other costs of acquiring universal life insurance, variable universal life insurance, traditional life insurance, annuities and other investment contracts, which vary with and are primarily related to the production of new business, have been deferred (i.e., DAC) to the extent recoverable. The methodology for determining the amortization of DAC varies by product type based on two different accounting pronouncements: SFAS No. 97, "Accounting and Reporting by Insurance S-9 Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments" ("SFAS 97") and SFAS No. 60, "Accounting and Reporting by Insurance Enterprises" ("SFAS 60"). Under SFAS 97, acquisition costs for universal life and variable universal life insurance and investment-type products, which include fixed and variable deferred annuities, are generally amortized over the lives of the policies in relation to the incidence of estimated gross profits ("EGPs") from surrender charges, investment, mortality net of reinsurance ceded and expense margins and actual realized gain or loss on investments. Contract lives for universal and variable universal life policies are estimated to be 30 years, based on the expected lives of the policies. Contract lives for fixed and variable deferred annuities are 14 to 20 years for the traditional, long surrender charge period products and 8 to 10 years for the more recent short-term or no surrender charge variable products. The front-end load annuity product has an assumed life of 25 years. Longer lives are assigned to those blocks that have demonstrated favorable lapse experience. Under SFAS 60, acquisition costs for traditional life insurance products, which include individual whole life, group business and term life insurance contracts, are amortized over periods of 10 to 30 years on either a straight-line basis or as a level percent of premium of the related policies depending on the block of business. There is currently no DAC balance or related amortization under SFAS 60 for fixed and variable payout annuities. For all SFAS 97 and SFAS 60 contracts, amortization is based on assumptions consistent with those used in the development of the underlying contract form adjusted for emerging experience and expected trends. VOBA is an intangible asset that reflects the estimated fair value of in-force contracts in a life insurance company acquisition and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the business in-force at the acquisition date. VOBA is amortized over the expected lives of the block of insurance business in relation to the incidence of estimated profits expected to be generated on universal life, variable universal life and investment-type products, (i.e., variable deferred annuities) and over the premium paying period for insurance products, (i.e., traditional life insurance products). Amortization is based upon assumptions used in pricing the acquisition of the block of business and is adjusted for emerging experience. Accordingly, amortization periods and methods of amortization for VOBA vary depending upon the particular characteristics of the underlying blocks of acquired insurance business. VOBA is amortized in a manner consistent with DAC. Both DAC and VOBA amortization is reported within underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income. The carrying amounts of DAC and VOBA are adjusted for the effect of realized gains and losses and the effects of unrealized gains and losses on debt securities classified as available-for-sale. Amortization expense of DAC and VOBA reflects an assumption for an expected level of credit-related investment losses. When actual credit-related investment losses are realized, we recognize a true-up to our DAC and VOBA amortization within realized gains and losses reflecting the incremental impact of actual versus expected credit-related investment losses. These actual to expected amortization adjustments can create volatility period-to-period in net realized gains and losses. Bonus credits and excess interest for dollar cost averaging contracts are considered DSI, and the unamortized balance is reported in other assets on our Consolidated Balance Sheets. DSI is amortized over the expected life of the contract as an expense in interest credited on our Consolidated Statements of Income. Amortization is computed using the same methodology and assumptions used in amortizing DAC. Contract sales charges that are collected in the early years of an insurance contract are deferred (referred to as "DFEL"), and are amortized into income over the life of the contract in a manner consistent with that used for DAC. The deferral and amortization of DFEL is reported within insurance fees on our Consolidated Statements of Income. See Note 2 for discussion of the adoption and impact of Statement of Position ("SOP") 05-1, "Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts" ("SOP 05-1"). On a quarterly basis, LNC may record an adjustment to the amounts included on our Consolidated Balance Sheets for DAC, VOBA, DSI and DFEL with an offsetting benefit or charge to revenues or expenses for the impact of the difference between the estimates of future gross profits used in the prior quarter and the emergence of actual and updated estimates of future gross profits in the current quarter ("retrospective unlocking"). In addition, in the third quarter of each year, LNC conducts an annual comprehensive review of the assumptions and the projection models used for our estimates of future gross profits underlying the amortization of DAC, VOBA, DSI and DFEL and the calculations of the embedded derivatives and reserves for annuity and life insurance products with certain guarantees. These assumptions include investment margins, mortality, retention and rider utilization. Based on LNC's review, the cumulative balances of DAC, VOBA, DSI and DFEL are adjusted with an offsetting benefit or charge to revenues or amortization expense to reflect such change ("prospective unlocking"). The distinction between these two types of unlocking is that retrospective unlocking is driven by the emerging experience period-over-period, while prospective unlocking is driven by changes in assumptions or projection models related to estimated future gross profits. DAC, VOBA, DSI and DFEL are reviewed periodically to ensure that the unamortized portion does not exceed the expected recoverable amounts. No significant impairments occurred during the three years ended December 31, 2007. S-10 REINSURANCE Our insurance companies enter into reinsurance agreements with other companies in the normal course of business. Assets and liabilities and premiums and benefits from certain reinsurance contracts that grant statutory surplus relief to other insurance companies are netted on our Consolidated Balance Sheets and Consolidated Statements of Income, respectively, because there is a right of offset. All other reinsurance agreements are reported on a gross basis on our Consolidated Balance Sheets as an asset for amounts recoverable from reinsurers or as a component of other liabilities for amounts, such as premiums, owed to the reinsurers, with the exception of Modco agreements for which the right of offset also exists. Premiums, benefits and DAC are reported net of insurance ceded. GOODWILL We recognize the excess of the purchase price over the fair value of net assets acquired as goodwill. Goodwill is not amortized, but is reviewed at least annually for indications of value impairment, with consideration given to financial performance and other relevant factors. In addition, certain events, including a significant adverse change in legal factors or the business climate, an adverse action or assessment by a regulator or unanticipated competition, would cause us to review the carrying amounts of goodwill for impairment. When an impairment occurs, the carrying amounts are written down and a charge is recorded against net income using a combination of fair value and discounted cash flows. No impairments occurred during the three years ended December 31, 2007. SPECIFICALLY IDENTIFIABLE INTANGIBLE ASSETS Specifically identifiable intangible assets, net of accumulated amortization are reported in other assets. The carrying values of specifically identifiable intangible assets are reviewed periodically for indicators of impairment in value that are other-than-temporary, including unexpected or adverse changes in the following: 1) the economic or competitive environments in which the company operates; 2) profitability analyses; 3) cash flow analyses; and 4) the fair value of the relevant business operation. If there was an indication of impairment, then the cash flow method would be used to measure the impairment, and the carrying value would be adjusted as necessary. Sales force intangibles are attributable to the value of the distribution system acquired in the Individual Markets - Life Insurance segment. These assets are amortized on a straight-line basis over their useful life of 25 years. PROPERTY AND EQUIPMENT Property and equipment owned for company use is included in other assets on our Consolidated Balance Sheets and is carried at cost less allowances for depreciation. Provisions for depreciation of investment real estate and property and equipment owned for company use are computed principally on the straight-line method over the estimated useful lives of the assets, which include buildings, computer hardware and software and other property and equipment. IMPAIRMENT OF LONG-LIVED ASSETS We periodically review the carrying value of our long-lived assets, including property and equipment, for impairment whenever events or circumstances indicate that the carrying amount of such assets may not be fully recoverable. For long-lived assets to be held and used, impairments are recognized when the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. An impairment loss is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. Long-lived assets to be disposed of by abandonment or in an exchange for a similar productive long-lived asset are classified as held-for-use until disposed of. Long-lived assets to be sold are classified as held-for-sale and are no longer depreciated. Certain criteria have to be met in order for the long-lived asset to be classified as held-for-sale, including that a sale is probable and expected to occur within one year. Long-lived assets classified as held-for-sale are recorded at the lower of their carrying amount or fair value less cost to sell. SEPARATE ACCOUNT ASSETS AND LIABILITIES Separate account assets and liabilities represent segregated funds administered and invested by our insurance subsidiaries for the exclusive benefit of pension and variable life and annuity contract holders. Separate account assets are carried at fair value and the related liabilities are measured at an equivalent amount to the separate account assets. Investment risks associated with market value changes are borne by the contract holders, except to the extent of minimum guarantees made by us with respect to certain accounts. See Note 10 for additional information regarding arrangements with contractual guarantees. The revenues earned by our insurance subsidiaries for administrative and contract holder maintenance services performed for these separate accounts are included in insurance fees on our Consolidated Statements of Income. FUTURE CONTRACT BENEFITS AND OTHER CONTRACT HOLDER FUNDS The liabilities for future contract benefits and claim reserves for universal and variable universal life insurance policies consist of contract account balances that accrue to the benefit of the contract holders, excluding surrender charges. The liabilities for future insurance contract benefits and claim reserves for traditional life policies are computed using assumptions for investment yields, mortality and withdrawals based principally on generally accepted actuarial methods and assumptions at the time of contract issue. Investment yield assumptions for traditional direct individual life reserves for all contracts range from 2.25% to 7.00% depending on the time of contract issue. The investment yield assumptions for immediate and deferred paid-up annuities range from 0.75% to 13.50%. These investment yield assumptions are intended to represent an estimation of the interest rate experience for the period that these contract benefits are payable. S-11 The liabilities for future claim reserves for variable annuity products containing guaranteed minimum death benefit ("GMDB") features are calculated by multiplying the benefit ratio (present value of total expected GMDB payments over the life of the contract divided by the present value of total expected assessments over the life of the contract) by the cumulative assessments recorded from the contract inception through the balance sheet date less the cumulative GMDB payments plus interest. The change in the reserve for a period is the benefit ratio multiplied by the assessments recorded for the period less GMDB claims paid in the period plus interest. If experience or assumption changes result in a new benefit ratio, the reserves are adjusted to reflect the changes in a manner similar to the unlocking of DAC, VOBA, DFEL and DSI. With respect to our future contract benefits and other contract holder funds, we continually review: 1) overall reserve position; 2) reserving techniques; and 3) reinsurance arrangements. As experience develops and new information becomes known, liabilities are adjusted as deemed necessary. The effects of changes in estimates are included in the operating results for the period in which such changes occur. The business written or assumed by us includes participating life insurance contracts, under which the contract holder is entitled to share in the earnings of such contracts via receipt of dividends. The dividend scale for participating policies is reviewed annually and may be adjusted to reflect recent experience and future expectations. As of December 31, 2007 and 2006, participating policies comprised approximately 1.5% and 1.3%, respectively, of the face amount of insurance in force, and dividend expenses were $85 million for the years ended December 31, 2007 and 2006, and $78 million for the year ended December 31, 2005. Universal life and variable universal life products with secondary guarantees represented approximately 32% and 34% of permanent life insurance in force as of December 31, 2007 and 2006, respectively, and approximately 73% and 77% of sales for these products for the years ended December 31, 2007 and 2006, respectively. Liabilities for the secondary guarantees on universal life-type products are calculated by multiplying the benefit ratio (present value of total expected secondary guarantee benefits over the life of the contract divided by the present value of total expected assessments over the life of the contract) by the cumulative assessments recorded from contract inception through the balance sheet date less the cumulative secondary guarantee benefit payments plus interest. If experience or assumption changes result in a new benefit ratio, the reserves are adjusted to reflect the changes in a manner similar to the unlocking of DAC, VOBA, DFEL and DSI. The accounting for secondary guarantee benefits impacts, and is impacted by, EGPs used to calculate amortization of DAC, VOBA, DFEL and DSI. BORROWED FUNDS LNL's short-term borrowings are defined as borrowings with contractual or expected maturities of one year or less. Long-term borrowings have contractual or expected maturities greater than one year. Any premium or discount on borrowed funds is amortized over the term of the borrowings. COMMITMENTS AND CONTINGENCIES Contingencies arising from environmental remediation costs, regulatory judgments, claims, assessments, guarantees, litigation, recourse reserves, fines, penalties and other sources are recorded when deemed probable and reasonably estimable. PREMIUMS AND FEES ON INVESTMENT PRODUCTS AND UNIVERSAL LIFE INSURANCE PRODUCTS Investment products consist primarily of individual and group variable and fixed deferred annuities. Interest-sensitive life insurance products include universal life insurance, variable universal life insurance and other interest-sensitive life insurance policies. These products include life insurance sold to individuals, corporate-owned life insurance and bank-owned life insurance. Revenues for investment products and universal life insurance products consist of net investment income, asset-based fees, cost of insurance charges, percent of premium charges, contract administration charges and surrender charges that have been assessed and earned against contract account balances and premiums received during the period. The timing of revenue recognition as it relates to fees assessed on investment contracts is determined based on the nature of such fees. Asset based fees cost of insurance and contract administration charges are assessed on a daily or monthly basis and recognized as revenue when assessed and earned. Percent of premium charges are assessed at the time of premium payment and recognized as revenue when assessed and earned. Certain amounts assessed that represent compensation for services to be provided in future periods are reported as unearned revenue and recognized in income over the periods benefited. Surrender charges are recognized upon surrender of a contract by the contract holder in accordance with contractual terms. PREMIUMS ON TRADITIONAL LIFE INSURANCE PRODUCTS Traditional life insurance products include those products with fixed and guaranteed premiums and benefits and consist primarily of whole life insurance, limited-payment life insurance, term life insurance and certain annuities with life contingencies. Premiums for traditional life insurance products are recognized as revenue when due from the contract holder. OTHER REVENUES AND FEES Other revenues and fees primarily consist of amounts earned by our retail distributor, LFA, from sales of third party insurance and investment products. Such revenue is recorded as earned at the time of sale. BENEFITS Benefits for universal life and other interest-sensitive life insurance products include benefit claims incurred during the period in excess of contract account balances. Benefits also includes the change in reserves for life insurance products with secondary guarantee benefits and annuity products with guaranteed benefits, such as GMDB, and the change in fair values of guarantees for annuity products with guaranteed minimum S-12 withdrawal benefits ("GMWB") and guaranteed income benefits ("GIB"). For traditional life, group health and disability income products, benefits and expenses, other than DAC and VOBA, are recognized when incurred in a manner consistent with the related premium recognition policies. INTEREST CREDITED Interest credited includes interest credited to contract holder account balances. Interest crediting rates associated with funds invested in our general account during 2005 through 2007 ranged from 3.00% to 9.00%. INTEREST AND DEBT EXPENSES Interest and debt expenses includes interest on short-term commercial paper, long-term senior debt that we issue and junior subordinated debentures issued to affiliated trusts. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Pursuant to the accounting rules for LNC's obligations to employees under LNC's various pension and other postretirement benefit plans, LNC is required to make a number of assumptions to estimate related liabilities and expenses. LNC uses assumptions for the weighted-average discount rate and expected return on plan assets. The discount rate assumptions are determined using an analysis of current market information and the projected benefit flows associated with these plans. The expected long-term rate of return on plan assets is initially established at the beginning of the plan year based on historical and projected future rates of return and is the average rate of earnings expected on the funds invested or to be invested in the plan. The calculation of our accumulated postretirement benefit obligation also uses an assumption of weighted-average annual rate of increase in the per capita cost of covered benefits, which reflects a health care cost trend rate. See Note 16 for more information on our accounting for employee benefit plans. STOCK-BASED COMPENSATION LNC expenses the fair value of stock awards included in LNC's incentive compensation plans. As of the date LNC's Board of Directors approves stock awards, the fair value of stock options is determined using a Black-Scholes options valuation methodology. The fair value of other stock awards is based upon the market value of the stock. The fair value of the awards is expensed over the service period, which generally corresponds to the vesting period, and is recognized as an increase to common stock in stockholder's equity. Stock-based compensation expense is reflected in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income. For additional information on stock-based incentive compensation see Note 17. INCOME TAXES We and our eligible subsidiaries have elected to file consolidated Federal and state income tax returns with LNC and certain LNC subsidiaries. Pursuant to an intercompany tax sharing agreement with LNC, we provide for income taxes on a separate return filing basis. The tax sharing agreement also provides that we 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. Deferred income taxes are recognized, based on enacted rates, when assets and liabilities have different values for financial statement and tax reporting purposes. A valuation allowance is recorded to the extent required to reduce the deferred tax asset to an amount that we expect, more likely than not, will be realized. See Note 6 for additional information. - -------------------------------------------------------------------------------- 2. NEW ACCOUNTING STANDARDS ADOPTION OF NEW ACCOUNTING STANDARDS SOP 05-1 -- ACCOUNTING BY INSURANCE ENTERPRISES FOR DEFERRED ACQUISITION COSTS IN CONNECTION WITH MODIFICATIONS OR EXCHANGES OF INSURANCE CONTRACTS In September 2005, the American Institute of Certified Public Accountants issued SOP 05-1, which provides guidance on accounting for DAC on internal replacements of insurance and investment contracts other than those specifically described in SFAS 97. An internal replacement, defined by SOP 05-1, is a modification in product benefits, features, rights or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement or rider to a contract, or by the election of a feature or coverage within a contract. Contract modifications that result in a substantially unchanged contract will be accounted for as a continuation of the replaced contract. Contract modifications that result in a substantially changed contract should be accounted for as an extinguishment of the replaced contract. Unamortized DAC, VOBA, DFEL and DSI from the replaced contract must be written-off. SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. We adopted SOP 05-1 effective January 1, 2007 by recording decreases to the following categories (in millions) on our Consolidated Balance Sheets: ASSETS DAC $31 VOBA 35 Other assets -- DSI 3 --- Total assets $69 === LIABILITIES AND STOCKHOLDER'S EQUITY Future contract benefits -- GMDB annuity reserves $ 4 Other contract holder funds -- DFEL 2 Other liabilities -- income tax liabilities 22 --- Total liabilities 28 --- Retained earnings 41 --- Total liabilities and stockholder's equity $69 ===
The adoption of this new guidance primarily impacted our Individual Markets -- Annuities and Employer Markets -- Group Protection businesses and our accounting policies regarding the assumptions for lapsation used in the amortization of DAC S-13 and VOBA. In addition, the adoption of SOP 05-1 resulted in an approximately $17 million increase to underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income for the year ended December 31, 2007, which was attributable to changes in DAC and VOBA deferrals and amortization. FASB INTERPRETATION NO. 48 -- ACCOUNTING FOR UNCERTAINTY IN INCOME TAXES -- AN INTERPRETATION OF FASB STATEMENT NO. 109 In June 2006, the FASB issued FASB Interpretation ("FIN") No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 prescribes a comprehensive model for how companies should recognize, measure, present and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. FIN 48 requires companies to determine whether it is "more likely than not" that an individual tax position will be sustained upon examination by the appropriate taxing authority prior to any part of the benefit being recognized in the financial statements. Such tax positions shall initially and subsequently be measured as the largest amount of tax benefit that is greater than fifty percent likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. In addition, FIN 48 expands disclosure requirements to include additional information related to unrecognized tax benefits, including accrued interest and penalties, and uncertain tax positions where the estimate of the tax benefit may change significantly in the next twelve months. FIN 48 is effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 effective January 1, 2007 by recording an increase in the liability for unrecognized tax benefits of $14 million on our Consolidated Balance Sheets, offset by a reduction to the beginning balance of retained earnings. See Note 6 for more information regarding our adoption of FIN 48. SFAS NO. 155 -- ACCOUNTING FOR CERTAIN HYBRID FINANCIAL INSTRUMENTS -- AN AMENDMENT OF FASB STATEMENTS NO. 133 AND 140 In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140" ("SFAS 155"), which permits fair value remeasurement for a hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation. Under SFAS 155, an entity may make an irrevocable election to measure a hybrid financial instrument at fair value, in its entirety, with changes in fair value recognized in earnings. SFAS 155 also: (a) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; (b) eliminates the interim guidance in SFAS 133 Implementation Issue No. D1, "Application of Statement 133 to Beneficial Interests in Securitized Financial Assets," and establishes a requirement to evaluate beneficial interests in securitized financial assets to identify interests that are either freestanding derivatives or hybrid financial instruments that contain an embedded derivative requiring bifurcation; (c) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and (d) eliminates restrictions on a qualifying special-purpose entity's ability to hold passive derivative financial instruments that pertain to beneficial interests that are or contain a derivative financial instrument. In December 2006, the FASB issued Derivative Implementation Group ("DIG") Statement 133 Implementation Issue No. B40, "Embedded Derivatives: Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets" ("DIG B40"). Since SFAS 155 eliminated the interim guidance related to securitized financial assets, DIG B40 provides a narrow scope exception for securitized interests that contain only an embedded derivative related to prepayment risk. Under DIG B40, a securitized interest in prepayable financial assets would not be subject to bifurcation if: (a) the right to accelerate the settlement of the securitized interest cannot be controlled by the investor and (b) the securitized interest itself does not contain an embedded derivative for which bifurcation would be required other than an embedded derivative that results solely from the embedded call options in the underlying financial assets. Any other terms in the securitized financial asset that may affect cash flow in a manner similar to a derivative instrument would be subject to the requirements of paragraph 13(b) of SFAS 133. The guidance in DIG B40 is to be applied upon the adoption of SFAS 155. We adopted the provisions of SFAS 155 and DIG B40 on January 1, 2007. Prior period restatement was not permitted. The adoption of SFAS 155 did not have a material impact on our financial condition or results of operations. SFAS NO. 158 -- EMPLOYERS' ACCOUNTING FOR DEFINED BENEFIT PENSION AND OTHER POSTRETIREMENT PLANS -- AN AMENDMENT OF FASB STATEMENTS NO. 87, 88, 106 AND 132(R) In September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans - an amendment of FASB Statements No. 87, 88, 106 and 132(R)" ("SFAS 158"). The guidance requires us to recognize on the balance sheets the funded status of our defined benefit postretirement plans as either an asset or liability, depending on the plans' funded status, with changes in the funded status recognized through OCI. The funded status is measured as the difference between the fair value of the plan assets and the projected benefit obligation, for pension plans, or the accumulated postretirement benefit obligation for postretirement benefit plans. Prior service costs or credits and net gains or losses which are not recognized in current net periodic benefit cost, pursuant to SFAS No. 87, "Employers' Accounting for Pensions" or SFAS No. 106, "Employers' Accounting for Postretirement Benefits Other Than Pensions," must be recognized in OCI, net of tax, in the period in which they occur. As these items are recognized in net periodic benefit cost, the amounts accumulated in OCI are adjusted. Under SFAS 158, disclosure requirements have also been expanded to separately provide information on the prior service costs or credits and net gains and losses recognized in OCI and their effects on net periodic benefit costs. Retroactive application of SFAS 158 was not permitted. We applied the recognition provisions of SFAS 158 as of December 31, 2006 by recording an increase in the asset of $38 million and an increase in the S-14 liability of $34 million, offset by an increase in accumulated OCI of $4 million. STAFF ACCOUNTING BULLETIN NO. 108 -- CONSIDERING THE EFFECTS OF PRIOR YEAR MISSTATEMENTS WHEN QUANTIFYING MISSTATEMENTS IN CURRENT YEAR FINANCIAL STATEMENTS In September 2006, the U.S. Securities and Exchange Commission ("SEC") staff issued Staff Accounting Bulletin ("SAB") No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements" ("SAB 108"). SAB 108 provides guidance for evaluating the effects of prior year uncorrected errors when quantifying misstatements in the current year financial statements. Under SAB 108, the impact of correcting misstatements occurring in the current period and those that have accumulated over prior periods must both be considered when quantifying the impact of misstatements in current period financial statements. SAB 108 is effective for fiscal years ending after November 15, 2006, and may be adopted by either restating prior financial statements or recording the cumulative effect of initially applying the approach as adjustments to the carrying values of assets and liabilities as of January 1, 2006, with an offsetting adjustment to retained earnings. We adopted the provisions of SAB 108 as of December 31, 2006. The adoption of SAB 108 did not have a material effect on our financial statements. SFAS NO. 123(R) -- SHARE-BASED PAYMENT In December 2004, the FASB issued SFAS No. 123 (revised 2004), "Share-Based Payment" ("SFAS 123(R)"), which is a revision of SFAS No. 123, "Accounting for Stock-based Compensation" ("SFAS 123"). SFAS 123(R) requires us to recognize at fair value all costs resulting from share-based payments to employees, except for equity instruments held by employee share ownership plans. Similar to SFAS 123, under SFAS 123(R), the fair value of share-based payments is recognized as a reduction to earnings over the period an employee is required to provide service in exchange for the award. We had previously adopted the retroactive restatement method under SFAS No. 148, "Accounting for Stock-based Compensation - -Transition and Disclosure," and restated all periods presented to reflect stock-based employee compensation cost under the fair value accounting method for all employee awards granted, modified or settled in fiscal years beginning after December 15, 1994. Effective January 1, 2006, we adopted SFAS 123(R), using the modified prospective transition method. Under that transition method, compensation cost recognized in 2006 includes: (a) compensation cost for all share-based payments granted prior to but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123 and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123(R). Results from prior periods have not been restated. The adoption of SFAS 123(R) did not have a material effect on our income before federal income taxes and net income. SFAS 123(R) eliminates the alternative under SFAS 123 permitting the recognition of forfeitures as they occur. Expected forfeitures, resulting from the failure to satisfy service or performance conditions, must be estimated at the grant date, thereby recognizing compensation expense only for those awards expected to vest. In accordance with SFAS 123(R), we have included estimated forfeitures in the determination of compensation costs for all share-based payments. Estimates of expected forfeitures must be reevaluated at each balance sheet date, and any change in the estimates will be recognized retrospectively in net income in the period of the revised estimates. Prior to the adoption of SFAS 123(R), we presented all tax benefits of deductions resulting from the exercise of stock options as operating cash flows on our Statements of Cash Flows. SFAS 123(R) requires the cash flows from tax benefits resulting from tax deductions in excess of the compensation costs recognized to be classified as financing cash flows. Our excess tax benefits are classified as financing cash flows, prospectively, on our Statements of Cash Flows for the years ended December 31, 2007 and 2006. We issue share-based compensation awards under an authorized plan, subject to specific vesting conditions. Generally, compensation expense is recognized ratably over a three-year vesting period, but recognition may be accelerated upon the occurrence of certain events. For awards that specify an employee will vest upon retirement and an employee is eligible to retire before the end of the normal vesting period, we record compensation expense over the period from the grant date to the date of retirement eligibility. As a result of adopting SFAS 123(R), we have revised the prior method of recording unrecognized compensation expense upon retirement and use the non-substantive vesting period approach for all new share-based awards granted after January 1, 2006. Under the non-substantive vesting period approach, we recognize compensation cost immediately for awards granted to retirement-eligible employees, or ratably over a period from the grant date to the date retirement eligibility is achieved. If we would have applied the non-substantive vesting period approach to all share based compensation awards granted prior to January 1, 2006, it would not have a material effect on our results of operations or financial position. See Note 17 for more information regarding our stock-based compensation plans. FASB STAFF POSITION SFAS 115-1 AND SFAS 124-1 -- THE MEANING OF OTHER-THAN-TEMPORARY IMPAIRMENT AND ITS APPLICATION TO CERTAIN INVESTMENTS In November 2005, the FASB issued FASB Staff Position ("FSP") Nos. SFAS 115-1 and SFAS 124-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments" ("FSP 115-1"). The guidance in FSP 115-1 nullifies the accounting and measurement provisions of Emerging Issues Task Force ("EITF") No. 03-1 - "The Meaning of Other-Than-Temporary Impairments and Its Application to Certain Investments" and supersedes EITF Topic No. D-44 "Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value." S-15 FSP 115-1 was effective for reporting periods beginning after December 15, 2005, on a prospective basis. Our existing policy for recognizing other-than-temporary impairments is consistent with the guidance in FSP 115-1, and includes the recognition of other-than-temporary impairments of securities resulting from credit related issues as well as declines in fair value related to rising interest rates, where we do not have the intent to hold the securities until either maturity or recovery. We adopted FSP 115-1 effective January 1, 2006. The adoption of FSP 115-1 did not have a material effect on our financial condition or results of operations. FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS SFAS NO. 157 -- FAIR VALUE MEASUREMENTS In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements" ("SFAS 157"), which defines fair value, establishes a framework for measuring fair value under current accounting pronouncements that require or permit fair value measurement and enhances disclosures about fair value instruments. SFAS 157 retains the exchange price notion, but clarifies that exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability (exit price) in the principal market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be paid to acquire the asset or receive a liability (entry price). Fair value measurement is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset, or nonperformance risk which would include the reporting entity's own credit risk. SFAS 157 establishes a three-level fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value. The highest priority, Level 1, is given to quoted prices in active markets for identical assets or liabilities. Level 2 inputs are observable inputs, other than quoted prices included in Level 1, for the asset or liability. Level 3 inputs, the lowest priority, include unobservable inputs in situations where there is little or no market activity for the asset or liability and the reporting entity makes estimates and assumptions related to the pricing of the asset or liability, including assumptions regarding risk. We have certain guaranteed benefit features that, prior to January 1, 2008, were recorded using fair value pricing. These benefits will continue to be measured on a fair value basis with the adoption of SFAS 157, utilizing a number for Level 3, with some Level 2 inputs, which are reflective of the hypothetical market participant perspective for fair value measurement. In addition, SFAS 157 expands the disclosure requirements for annual and interim reporting to focus on the inputs used to measure fair value, including those measurements using significant unobservable inputs, and the effects of the measurements on earnings. We adopted SFAS 157 for all of our financial instruments effective January 1, 2008 and expect to record a charge of between $25 million and $75 million to net income attributable to changes in the fair value of guaranteed benefit reserves and indexed annuities reported in our Individual Markets - Annuities segment. SFAS NO. 159 -- THE FAIR VALUE OPTION FOR FINANCIAL ASSETS AND FINANCIAL LIABILITIES In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" ("SFAS 159"), which allows an entity to make an irrevocable election, on specific election dates, to measure eligible items at fair value. The election to measure an item at fair value may be determined on an instrument by instrument basis, with certain exceptions. If the fair value option is elected, unrealized gains and losses will be recognized in earnings at each subsequent reporting date, and any upfront costs and fees related to the item will be recognized in earnings as incurred. In addition, the presentation and disclosure requirements of SFAS 159 are designed to assist in the comparison between entities that select different measurement attributes for similar types of assets and liabilities. SFAS 159 applies to fiscal years beginning after November 15, 2007, with early adoption permitted for an entity that has also elected to apply the provisions of SFAS 157. At the effective date, the fair value option may be elected for eligible items that exist on that date. Effective January 1, 2008, we elected not to adopt the fair value option for any financial assets or liabilities that existed as of January 1, 2008. SFAS NO. 141(R) -- BUSINESS COMBINATIONS In December 2007, the FASB issued SFAS No. 141(R) "Business Combinations" ("SFAS 141(R)") - a revision to SFAS 141, which aims to improve the relevance, representational faithfulness and comparability of the information that a reporting entity provides in its financial reports about a business combination and its effects. SFAS 141(R) retains the fundamental requirements of SFAS 141, broadens its scope by applying the acquisition method to all transactions and other events in which one entity obtains control over one or more other businesses, and requires, among other things, that assets acquired and liabilities assumed be measured at fair value as of the acquisition date, liabilities related to contingent consideration be recognized at the acquisition date and remeasured at fair value in each subsequent reporting period, acquisition-related costs be expensed as incurred and that income be recognized if the fair value of the net assets acquired exceeds the fair value of the consideration transferred. SFAS 141(R) applies to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period on or after December 15, 2008. SFAS NO. 160 -- NONCONTROLLING INTERESTS IN CONSOLIDATED FINANCIAL STATEMENTS -- AN AMENDMENT OF ACCOUNTING RESEARCH BULLETIN NO. 51 In December 2007, the FASB issued SFAS No. 160 "Noncontrolling Interests in Consolidated Financial Statements - an amendment of Accounting Research Bulletin No. 51A" ("SFAS 160"), which aims to improve the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards surrounding noncontrolling interests, or minority interests, which are the portions of equity in a subsidiary not attributable, directly or indirectly, to a parent. The ownership interests in S-16 subsidiaries held by parties other than the parent shall be clearly identified, labeled and presented in the consolidated statement of financial position within equity, but separate from the parent's equity. The amount of consolidated net income attributable to the parent and to the noncontrolling interest must be clearly identified and presented on the face of the consolidated statement of income. Changes in a parent's ownership interest while the parent retains its controlling financial interest in its subsidiary must be accounted for consistently as equity transactions. A parent's ownership interest in a subsidiary changes if the parent purchases additional ownership interests in its subsidiary or sells some of its ownership interests in its subsidiary and if the subsidiary reacquires some of its ownership interests or issues additional ownership interests. When a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary must be initially measured at fair value. The gain or loss on the deconsolidation of the subsidiary is measured using the fair value of any noncontrolling equity investment rather than the carrying amount of that retained investment. Entities must provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. We expect to adopt SFAS 160 effective January 1, 2009, and are currently evaluating the effects of SFAS 160 on our consolidated financial condition and results of operations. DERIVATIVE IMPLEMENTATION GROUP STATEMENT 133 IMPLEMENTATION ISSUE NO. E23 -- ISSUES INVOLVING THE APPLICATION OF THE SHORTCUT METHOD UNDER PARAGRAPH 68 In December 2007, the FASB issued DIG Statement 133 Implementation Issue No. E23, "Issues Involving the Application of the Shortcut Method under Paragraph 68" ("DIG E23"), which gives clarification to the application of the shortcut method of accounting for qualifying fair value hedging relationship involving an interest-bearing financial instrument and/or an interest rate swap, originally outlined in paragraph 68 in SFAS 133. DIG E23 clarifies that the shortcut method may be applied to a qualifying fair value hedge when the relationship is designated on the trade date of both the swap and the hedged item (for example, debt), even though the hedged item is not recognized for accounting purposes until the transaction settles (that is, until its settlement date), provided that the period of time between the trade date and the settlement date of the hedged item is within established conventions for that marketplace. DIG E23 also clarifies that Paragraph 68(b) is met for an interest rate swap that has a non-zero fair value at the inception of the hedging relationship provided that the swap was entered into at the hedge's inception for a transaction price of zero and the non-zero fair value is due solely to the existence of a bid-ask spread in the entity's principal market (or most advantageous market, as applicable) under SFAS 157. The interest rate swap would be reported at its fair value as determined under SFAS 157. DIG E23 is effective for hedging relationships designated on or after January 1, 2008. The adoption of DIG E23 is not expected to have a material impact on our consolidated financial condition or results of operations. FSP FAS140-3 -- ACCOUNTING FOR TRANSFERS OF FINANCIAL ASSETS AND REPURCHASE FINANCING TRANSACTIONS In February 2008, the FASB issued FSP No. FAS 140-3, "Accounting for Transfers of Financial Assets and Repurchase Financing Transactions" ("FSP 140-3"). The guidance in FSP 140-3 provides accounting and reporting standards for transfers of financial assets. This FSP applies to a repurchase financing, which is a repurchase agreement that relates to a previously transferred financial asset between the same counterparties (or consolidated affiliates of either counterparty), that is entered into contemporaneously with, or in contemplation of, the initial transfer. FSP 140-3 shall be effective for financial statements issued for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years and shall be applied prospectively to initial transfers and repurchase financings for which the initial transfer is executed on or after the beginning of the fiscal year in which FSP 140-3 is initially applied. We are evaluating the expected effect on our consolidated financial condition and results of operations. - -------------------------------------------------------------------------------- 3. ACQUISITION AND DIVIDEND OF FPP JEFFERSON-PILOT MERGER On April 3, 2006, LNC completed its merger with Jefferson-Pilot by acquiring 100% of the outstanding shares of Jefferson-Pilot in a transaction accounted for under the purchase method of accounting prescribed by SFAS 141. At that time, JPL, JPLA and JPFIC became wholly-owned by LNC. SFAS 141 requires that the total purchase price be allocated to the assets acquired and liabilities assumed based on their fair values at the merger date. The associated fair values of JPL, JPLA and JPFIC at April 3, 2006 were "pushed down" to LNL's consolidated financial statements in accordance with push down accounting rules. The fair value of the specifically identifiable net assets acquired in the merger was $4.3 billion. Goodwill of $2.6 billion resulted from the excess of purchase price over the fair value of the net assets. The amount of goodwill that was expected to be deductible for tax purposes was approximately $23 million. LNC paid a premium over the fair value of the net assets for a number of potential strategic and financial benefits that are expected to be realized as a result of the merger including, but not limited to, the following: - - Greater size and scale with improved earnings diversification and strong financial flexibility; - - Broader, more balanced product portfolio; - - Larger distribution organization; and - - Value creation opportunities through expense savings and revenue enhancements across business units. S-17 The following table summarizes the fair values of the net assets acquired (in millions) as of the acquisition date:
FAIR VALUE ---------- Investments $ 27,384 Reinsurance recoverables 1,193 Value of business acquired 2,489 Goodwill 2,622 Other assets 1,135 Separate account assets 2,574 Future contract benefits and other contract holder funds (26,677) Income tax liabilities (382) Accounts payable, accruals and other liabilities (841) Separate accounts liabilities (2,574) ---------- Total purchase price $ 6,923 ==========
The goodwill (in millions) resulting from the merger was allocated to the following segments:
GOODWILL -------- Individual Markets: Life Insurance $ 1,346 Annuities 1,002 -------- Total Individual Markets 2,348 Employer Markets: Group Protection 274 -------- Total goodwill $ 2,622 ========
DIVIDEND OF FPP On May 3, 2007, LNL made a dividend to LNC that transferred ownership of our formerly wholly-owned subsidiary, FPP, to LNC. The following table summarizes the dividend of FPP to LNC (in millions):
DIVIDENDED VALUE ---------- Investments $ 1,809 Cash and invested cash 20 Deferred acquisition costs and value of business acquired 246 Premiums and fees receivable 2 Accrued investment income 24 Reinsurance recoverables 669 Goodwill 2 Future contract benefits (705) Other contract holder funds (1,509) Other liabilities (66) ---------- Total dividend of FPP $ 492 ==========
The caption dividends declared, in the accompanying Consolidated Statements of Stockholder's Equity, includes the $492 million dividend of FPP presented above. 4. INVESTMENTS AVAILABLE-FOR-SALE SECURITIES The amortized cost, gross unrealized gains and losses and fair value of available-for-sale securities (in millions) were as follows:
AS OF DECEMBER 31, 2007 ---------------------------------------- GROSS UNREALIZED AMORTIZED ---------------- FAIR COST GAINS LOSSES VALUE --------- ----- ------ ------- Corporate bonds $ 42,041 $1,049 $ 904 $42,186 U.S. Government bonds 153 14 -- 167 Foreign government bonds 586 39 4 621 Asset and mortgage-backed securities 10,224 146 195 10,175 State and municipal bonds 143 2 -- 145 Redeemable preferred stocks 103 9 1 111 --------- ----- ------ ------- Total fixed maturity securities 53,250 1,259 1,104 53,405 Equity securities 132 9 7 134 --------- ----- ------ ------- Total available-for-sale securities $ 53,382 $1,268 $1,111 $53,539 ========= ====== ====== =======
S-18
AS OF DECEMBER 31, 2006 ---------------------------------------- GROSS UNREALIZED AMORTIZED ---------------- FAIR COST GAINS LOSSES VALUE --------- ------ ------ ------- Corporate bonds $ 44,049 $1,043 $ 283 $44,809 U.S. Government bonds 218 7 -- 225 Foreign government bonds 689 58 2 745 Asset and mortgage-backed securities 8,607 88 69 8,626 State and municipal bonds 194 2 2 194 Redeemable preferred stocks 89 9 -- 98 --------- ------ ------ ------- Total fixed maturity securities 53,846 1,207 356 54,697 Equity securities 205 15 2 218 --------- ------ ------ ------- Total available-for-sale securities $ 54,051 $1,222 $ 358 $54,915 ========= ====== ====== =======
The amortized cost and fair value of fixed maturity available-for-sale securities by contractual maturities (in millions) were as follows:
AS OF DECEMBER 31, 2007 ------------------------ AMORTIZED FAIR COST VALUE --------- ------- Due in one year or less $ 2,261 $ 2,267 Due after one year through five years 11,217 11,489 Due after five years through ten years 15,437 15,315 Due after ten years 14,111 14,159 --------- ------- Subtotal 43,026 43,230 Asset and mortgage-backed securities 10,224 10,175 --------- ------- Total available-for-sale fixed maturity securities $ 53,250 $53,405 ========= =======
Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations. The fair value and gross unrealized losses of available-for-sale securities (in millions), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:
AS OF DECEMBER 31, 2007 ----------------------------------------------------------- LESS THAN OR EQUAL TO GREATER THAN TWELVE MONTHS TWELVE MONTHS TOTAL ------------------- ------------------ ------------------- GROSS GROSS GROSS FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSSES VALUE LOSSES VALUE LOSSES ------- ---------- ------ ---------- ------- ---------- Corporate bonds $11,038 $ 657 $4,142 $ 247 $15,180 $ 904 U.S. Government bonds -- -- 3 -- 3 -- Foreign government bonds 81 4 -- -- 81 4 Asset and mortgage-backed securities 2,194 142 1,793 53 3,987 195 State and municipal bonds 29 -- 15 -- 44 -- Redeemable preferred stocks 13 1 -- -- 13 1 ------- ---------- ------ ---------- ------- ---------- Total fixed maturity securities 13,355 804 5,953 300 19,308 1,104 Equity securities 61 7 -- -- 61 7 ------- ---------- ------ ---------- ------- ---------- Total available-for-sale securities $13,416 $ 811 $5,953 $ 300 $19,369 $ 1,111 ======= ========== ====== ========== ======= ========== Total number of securities in an unrealized loss position 2,263 ==========
S-19
AS OF DECEMBER 31, 2006 ------------------------------------------------------------ LESS THAN OR EQUAL TO GREATER THAN TWELVE MONTHS TWELVE MONTHS TOTAL ------------------- ------------------ ------------------- GROSS GROSS GROSS FAIR UNREALIZED FAIR UNREALIZED FAIR UNREALIZED VALUE LOSSES VALUE LOSSES VALUE LOSSES ------- ---------- ------ ---------- ------- ---------- Corporate bonds $ 8,643 $ 115 $4,892 $ 168 $13,535 $ 283 U.S. Government bonds 43 -- -- -- 43 -- Foreign government bonds 56 1 62 1 118 2 Asset and mortgage-backed securities 1,911 13 2,227 56 4,138 69 State and municipal bonds 20 1 44 1 64 2 Redeemable preferred stocks -- -- 1 -- 1 -- ------- ---------- ------ ---------- ------- ---------- Total fixed maturity securities 10,673 130 7,226 226 17,899 356 Equity securities 50 2 -- -- 50 2 ------- ---------- ------ ---------- ------- ---------- Total available-for-sale securities $10,723 $ 132 $7,226 $ 226 $17,949 $ 358 ======= ========== ====== ========== ======= ========== Total number of securities in an unrealized loss position 1,451 ==========
The fair value, gross unrealized losses (in millions) and number of available-for-sale securities, where the fair value had declined below amortized cost by greater than 20%, were as follows:
AS OF DECEMBER 31, 2007 ------------------------------ GROSS NUMBER FAIR UNREALIZED OF VALUE LOSSES SECURITIES ------ ---------- ---------- Less than six months $ 133 $ 48 22 Six months or greater, but less than nine months 425 137 30 Nine months or greater, but less than twelve months 363 109 17 Twelve months or greater 182 79 57 ------ ---------- ---------- Total available-for-sale securities $1,103 $ 373 126 ====== ========== ==========
AS OF DECEMBER 31, 2006 ------------------------------ GROSS NUMBER FAIR UNREALIZED OF VALUE LOSSES SECURITIES ------ ---------- ---------- Less than six months $ -- $ -- $ 5 Six months or greater, but less than nine months -- -- 2 Nine months or greater, but less than twelve months -- -- 1 Twelve months or greater 9 3 12 ----- ---------- ---------- Total available-for-sale securities $ 9 $ 3 20 ===== ========== ==========
As described more fully in Note 1, LNC regularly reviews our investment holdings for other-than-temporary impairments. Based upon this review, the cause of the decline being principally attributable to changes in interest rates and credit spreads during the holding period and our current ability and intent to hold securities in an unrealized loss position for a period of time sufficient for recovery, LNC believes that these securities were not other-than-temporarily impaired as of December 31, 2007 and 2006. TRADING SECURITIES Trading securities at fair value retained in connection with Modco and CFW reinsurance arrangements (in millions) consisted of the following:
AS OF DECEMBER 31, -------------------- 2007 2006 ------ ------ Corporate bonds $1,817 $2,140 U.S. Government bonds 366 331 Foreign government bonds 45 45 Asset and mortgage-backed securities: Mortgage pass-through securities 21 24 Collateralized mortgage obligations 153 111 Commercial mortgage-backed securities 104 133 Other asset-backed securities -- 8 State and municipal bonds 17 18 Redeemable preferred stocks 8 8 ------ ------ Total fixed maturity securities 2,531 2,818 Equity securities 2 2 ------ ------ Total trading securities $2,533 $2,820 ====== ======
The portion of market adjustment for trading securities still held at December 31, 2007, 2006 and 2005 was a loss of $8 million, $48 million and $70 million, respectively. MORTGAGE LOANS ON REAL ESTATE Mortgage loans on real estate principally involve commercial real estate. The commercial loans are geographically diversified throughout the United States, with the largest concentrations in California and Texas, which accounted for approximately 29% of mortgage loans as of December 31, 2007. S-20 NET INVESTMENT INCOME The major categories of net investment income (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ---------------------- 2007 2006 2005 ------ ------ ------ Available-for-sale fixed maturity securities $3,264 $2,979 $1,959 Available-for-sale equity securities 19 11 7 Trading securities 163 181 176 Mortgage loans on real estate 491 466 288 Real estate 53 37 48 Policy loans 172 158 118 Invested cash 49 53 46 Other investments 155 147 61 ------ ------ ------ Investment income 4,366 4,032 2,703 Less investment expense 178 163 111 ------ ------ ------ Net investment income $4,188 $3,869 $2,592 ====== ====== ======
REALIZED LOSS The detail of the realized loss (in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, --------------------- 2007 2006 2005 ----- ----- ----- Available-for-sale fixed maturity securities: Gross gains $ 120 $ 119 $ 111 Gross losses (176) (97) (89) Available-for-sale equity securities: Gross gains 3 2 10 Gross losses (111) -- -- Gain on other investments 22 5 1 Associated amortization of DAC, VOBA, DSI, DFEL and changes in other contract holder funds 29 (37) (53) ----- ----- ----- Total realized loss on investments, excluding trading securities (113) (8) (20) Loss on derivative instruments, excluding reinsurance embedded derivatives (2) 2 (2) Associated amortization of DAC, VOBA, DSI, DFEL and changes in other contract holder funds 1 -- 1 ----- ----- ----- Total realized loss on investments and derivative instruments (114) (6) (21) Gain on reinsurance embedded derivative/trading securities 2 4 5 ----- ----- ----- Total realized loss $(112) $ (2) $ (16) ===== ===== ===== Write-downs for other-than-temporary impairments included in realized loss on investments above $(257) $ (62) $ (18) ===== ===== =====
SECURITIES LENDING The carrying values of the securities pledged under securities lending agreements were $655 million and $1.0 billion as of December 31, 2007 and 2006. The fair values of these securities were $634 million and $989 million as of December 31, 2007 and 2006, respectively. REVERSE REPURCHASE AGREEMENTS The carrying values of securities pledged under reverse repurchase agreements were $480 million as of December 31, 2007 and 2006. The fair values of these securities were $502 million and $500 million as of December 31, 2007 and 2006, respectively. INVESTMENT COMMITMENTS As of December 31, 2007, our investment commitments for fixed maturity securities, limited partnerships, real estate and mortgage loans on real estate were $1.2 billion, which includes $281 million of standby commitments to purchase real estate upon completion and leasing. CONCENTRATIONS OF FINANCIAL INSTRUMENTS As of December 31, 2007 and 2006, we did not have a significant concentration of financial instruments in a single investee, industry or geographic region of the U.S. CREDIT-LINKED NOTES As of December 31, 2007 and 2006, other contract holder funds on our Consolidated Balance Sheets included $1.2 billion and $700 million, respectively, outstanding in funding agreements. We invested the proceeds of $850 million received for issuing three funding agreements in 2006 and 2007 into three separate credit-linked notes originated by third party companies and $300 million of such agreements were assumed as a result of the merger of Jefferson-Pilot into LNL. The $850 million of credit-linked notes are classified as asset-backed securities and are included in our fixed maturity securities on our Consolidated Balance Sheets. The $300 million of investments which were assumed as a result of the merger were classified as corporate bonds and are included in our fixed maturity securities on our Consolidated Balance Sheets. We earn a spread between the coupon received on the credit-linked note and the interest credited on the funding agreement. Our credit linked notes were created using a trust that combines highly rated assets with credit default swaps to produce a multi-class structured security. The asset backing two of these credit-linked notes is a mid-AA rated asset-backed security secured by a pool of credit card receivables. The third credit-linked note is backed by a pool of assets which are guaranteed by MBIA, Inc, a financial guarantor and are mid-AA rated. Our affiliate, Delaware Investments, actively manages the credit default swaps in the underlying portfolio. Consistent with other debt market instruments, we are exposed to credit losses within the structure of the credit-linked notes, which could result in principal losses to our investments if the issuers of the debt market instruments default on their obligations. However, we have attempted to protect our investments from credit losses through the multi-tiered class structure of the credit-linked note, which requires the S-21 subordinated classes of the investment pool to absorb all of the initial credit losses. We own the mezzanine tranche of these investments, which currently carries a mid-AA rating. To date, there have been no defaults in any of the underlying collateral pools. Similar to other debt market instruments our maximum principal loss is limited to our original investment of $850 million as of December 31, 2007. The fair market value of these investments has declined, causing unrealized losses. As of December 31, 2007, we had unrealized losses of $190 million on the $850 million in credit linked notes. As described more fully in Note 1, we regularly review our investment holdings for other-than-temporary impairments. Based upon this review, we believe that these securities were not other-than-temporarily impaired as of December 31, 2007 and 2006. The following summarizes information regarding our investments in these securities (dollars in millions):
AMOUNT AND DATE OF ISSUANCE --------------------------------- $400 $200 $250 DECEMBER APRIL APRIL 2006 2007 2007 -------- ------- ------- Amount of subordination(1) $ 2,184 $ 410 $ 1,167 Maturity 12/20/16 3/20/17 6/20/17 Current rating of tranche(1) AA Aa2 AA Number of entities(1) 125 100 102 Number of countries(1) 20 21 14
- ---------- (1) As of December 31, 2007. - -------------------------------------------------------------------------------- 5. DERIVATIVE INSTRUMENTS TYPES OF DERIVATIVE INSTRUMENTS AND DERIVATIVE STRATEGIES We maintain an overall risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate risk, foreign currency exchange risk, equity market risk and credit risk. We assess these risks by continually identifying and monitoring changes in interest rate exposure, foreign currency exposure, equity market exposure and credit exposure that may adversely impact expected future cash flows and by evaluating hedging opportunities. Derivative instruments that are currently used as part of our interest rate risk management strategy include interest rate swaps and interest rate caps. Derivative instruments that are used as part of our foreign currency risk management strategy include foreign currency swaps. Call options on LNC stock and call options on the S&P 500 Index(R) are used as part of our equity market risk management strategy. We also use credit default swaps as part of our credit risk management strategy. As of December 31, 2007 and 2006, we had derivative instruments that were designated and qualified as cash flow hedges. We also had derivative instruments that were economic hedges, but were not designated as hedging instruments under SFAS 133. See Note 1 for a detailed discussion of the accounting treatment for derivative instruments. Our derivative instruments are monitored by LNC's risk management committee as part of that committee's oversight of our derivative activities. LNC's risk management committee is responsible for implementing various hedging strategies that are developed through its analysis of financial simulation models and other internal and industry sources. The resulting hedging strategies are incorporated into our overall risk management strategies. Our hedging strategy is designed to mitigate the risk and income statement volatility caused by changes in the equity markets, interest rates and volatility associated with the LINCOLN SMARTSECURITY(R) Advantage GMWB feature, the 4LATER(R) Advantage GIB feature and the i4LIFE(R) Advantage GIB feature that is available in our variable annuity products. This GMWB feature offers the contract holder a guarantee equal to the initial deposit adjusted for any subsequent purchase payments or withdrawals. There are one-year and five-year step-up options, which allow the contract holder to step up the guarantee. GMWB features are considered to be derivatives under SFAS 133, resulting in the guarantees being recognized at estimated fair value, with changes in estimated fair value being reported in net income. The hedging strategy is designed such that changes in the value of the hedge contracts move in the opposite direction of changes in the value of the embedded derivative of the GMWB and GIB. As part of our current hedging program, contract holder behavior, available equity, interest rate and volatility in market conditions are monitored on a daily basis. We rebalance our hedge positions based upon changes in these factors as needed. While we actively manage our hedge positions, our hedge positions may not be totally effective to offset changes in assets and liabilities caused by movements in these factors due to, among other things, differences in timing between when a market exposure changes and corresponding changes to the hedge positions, extreme swings in the equity markets and interest rates, market volatility, contract holder behavior, divergence between the performance of the underlying funds and the hedging indices, divergence between the actual and expected performance of the hedge instruments, or our ability to purchase hedging instruments at prices consistent with our desired risk and return trade-off. We have certain Modco and CFW reinsurance arrangements with embedded derivatives related to the withheld assets of the related funds. These derivatives are considered total return swaps with contractual returns that are attributable to various assets and liabilities associated with these reinsurance arrangements. Changes in the estimated fair value of these derivatives are recorded in net income as they occur. Offsetting these amounts S-22 are corresponding changes in the estimated fair value of trading securities in portfolios that support these arrangements. We also distribute indexed annuity contracts. These contracts permit the holder to elect an interest rate return or an equity market component, where interest credited to the contracts is linked to the performance of the S&P 500 Index(R). Contract holders may elect to rebalance index options at renewal dates, either annually or biannually. At each renewal date, we have the opportunity to re-price the indexed component by establishing participation rates, subject to minimum guarantees. We purchase S&P 500 Index(R) call options that are highly correlated to the portfolio allocation decisions of our contract holders, such that we are economically hedged with respect to equity returns for the current reset period. The mark-to-market of the options held impacts net investment income and generally offsets the change in value of the embedded derivative within the indexed annuity, which is recorded as a component of interest credited to contract holders. SFAS 133 requires that we calculate fair values of index options we may purchase in the future to hedge contract holder index allocations in future reset periods. These fair values represent an estimate of the cost of the options we will purchase in the future, discounted back to the date of the Consolidated Balance Sheets, using current market indicators of volatility and interest rates. Changes in the fair values of these liabilities are included in interest credited. The notional amounts of contract holder fund balances allocated to the equity-index options were $2.9 billion and $2.4 billion as of December 31, 2007 and 2006, respectively. We have derivative instruments with off-balance-sheet risks whose notional or contract amounts exceed the credit exposure. Outstanding derivative instruments with off-balance-sheet risks, shown in notional amounts along with their carrying values and estimated fair values (in millions), were as follows:
AS OF DECEMBER 31, ---------------------------------------------- ASSETS (LIABILITIES) ---------------------- NOTIONAL AMOUNTS CARRYING OR FAIR VALUE ------------------ ---------------------- 2007 2006 2007 2006 ------ ------ ----- ----- Cash flow hedges Interest rate swap agreements $1,372 $1,188 $ (5) $ 8 Foreign currency swaps 366 86 (17) (7) Call options (based on LNC stock) -- -- 1 4 ------ ------ ----- ----- Total cash flow hedges 1,738 1,274 (21) 5 ------ ------ ----- ----- All other derivative instruments Interest rate cap agreements 4,100 5,950 2 3 Credit default swaps 60 20 -- -- Call options (based on LNC stock) 1 1 13 18 Call options (based on S&P 500 Index(R)) 2,858 2,357 149 185 ------ ------ ----- ----- Total other derivative instruments 7,019 8,328 164 206 Embedded derivatives per SFAS 133 -- -- (412) (132) ------ ------ ----- ----- Total derivative instruments(1) $8,757 $9,602 $(269) $ 79 ====== ====== ===== =====
- ---------- (1) Total derivative instruments as of December 31, 2007 were composed of an asset of $172 million recorded in derivative investments, a $230 million liability recorded in other contract holder funds and a liability of $211 million recorded in reinsurance related derivative liability on our Consolidated Balance Sheets. Total derivative instruments as of December 31, 2006 were composed of an asset of $245 million recorded in derivative investments, a $52 million contra-liability recorded in future contract benefits and a liability of $218 million recorded in reinsurance related derivative liability on our Consolidated Balance Sheets. DERIVATIVE INSTRUMENTS DESIGNATED AS CASH FLOW HEDGES We designate and account for the following as cash flow hedges, when they have met the requirements of SFAS 133: 1) interest rate swap agreements; 2) foreign currency swaps; and 3) call options on LNC stock. We recognized a gain (loss) of $1 million and $(1) for the years ended December 31, 2007 and 2006, in net income as a component of realized investment gains and losses, related to the ineffective portion of cash flow hedges. We recognized a loss of $2 million for the year ended December 31, 2007, a gain of $2 million for the year ended December 31, 2006 and a loss of $2 million for the year ended December 31, 2005 in OCI related to the change in market value on derivative instruments that were designated and qualify as cash flow hedges. Gains and losses on derivative contracts that qualify as cash-flow hedges are reclassified from accumulated OCI to current period earnings. As of December 31, 2007, $4 million of the deferred net gains on derivative instruments in accumulated OCI were expected to be reclassified to earnings during 2008. This reclassification is primarily due to the receipt of interest payments associated with variable rate securities and forecasted purchases, S-23 payment of interest on our senior debt, the receipt of interest payments associated with foreign currency securities and the periodic vesting of stock appreciation rights ("SARs"). For the years ended December 31, 2007, 2006 and 2005, there were no material reclassifications to earnings due to hedged firm commitments no longer deemed probable or due to hedged forecasted transactions that had not occurred by the end of the originally specified time period. INTEREST RATE SWAP AGREEMENTS We use a portion of our interest rate swap agreements to hedge our exposure to floating rate bond coupon payments, replicating a fixed rate bond. An interest rate swap is a contractual agreement to exchange payments at one or more times based on the actual or expected price level, performance or value of one or more underlying interest rates. We are required to pay the counterparty the stream of variable interest payments based on the coupon payments from the hedged bonds, and in turn, receive a fixed payment from the counterparty, at a predetermined interest rate. The net receipts/payments from these interest rate swaps are recorded in net investment income. Gains or losses on interest rate swaps hedging our interest rate exposure on floating rate bond coupon payments are reclassified from accumulated OCI to net income as the related bond interest is accrued. The open interest rate swap positions as of December 31, 2007 expire in 2008 through 2026. FOREIGN CURRENCY SWAPS We use foreign currency swaps, which are traded over-the-counter, to hedge some of the foreign exchange risk of investments in fixed maturity securities denominated in foreign currencies. A foreign currency swap is a contractual agreement to exchange the currencies of two different countries at a specified rate of exchange in the future. Gains or losses on foreign currency swaps hedging foreign exchange risk exposure on foreign currency bond coupon payments are reclassified from accumulated OCI to net income as the related bond interest is accrued. The open foreign currency swap positions as of December 31, 2007 expire in 2014 through 2022. CALL OPTIONS (BASED ON LNC STOCK) We use call options on LNC stock to hedge the expected increase in liabilities arising from SARs granted on LNC stock. Upon option expiration, the payment, if any, is the increase in LNC stock price over the strike price of the option applied to the number of contracts. Call options hedging vested SARs are not eligible for hedge accounting and are marked-to-market through net income. Call options hedging non-vested SARs are eligible for hedge accounting and are accounted for as cash flow hedges of the forecasted vesting of the SAR liabilities. To the extent that the cash flow hedges are effective, changes in the fair value of the call options are recorded in accumulated OCI. Amounts recorded in OCI are reclassified to net income upon vesting of the related SARs. Our call option positions will be maintained until such time the related SARs are either exercised or expire and our SARs liabilities are extinguished. The SARs expire five years from the date of grant. ALL OTHER DERIVATIVE INSTRUMENTS We use various other derivative instruments for risk management and income generation purposes that either do not qualify for hedge accounting treatment or have not currently been designated by us for hedge accounting treatment. INTEREST RATE CAP AGREEMENTS The interest rate cap agreements entitle us to receive quarterly payments from the counterparties on specified future reset dates, contingent on future interest rates. For each cap, the amount of such quarterly payments, if any, is determined by the excess of a market interest rate over a specified cap rate multiplied by the notional amount divided by four. The purpose of our interest rate cap agreement program is to provide a level of protection from the effect of rising interest rates for our annuity business, within both our Individual Markets and Employer Markets businesses. The interest rate cap agreements provide an economic hedge of the annuity line of business. However, the interest rate cap agreements do not qualify for hedge accounting under SFAS 133. The open interest rate cap agreements as of December 31, 2007 expire in 2008 through 2011. CREDIT DEFAULT SWAPS We buy credit default swaps to hedge against a drop in bond prices due to credit concerns of certain bond issuers. A credit default swap allows us to put the bond back to the counterparty at par upon a default event by the bond issuer. A default event is defined as bankruptcy, failure to pay, obligation acceleration or restructuring. Our credit default swaps are not currently qualified for hedge accounting under SFAS 133, as amounts are insignificant. As of December 31, 2007, we had no outstanding purchased credit default swaps. We also sell credit default swaps to offer credit protection to investors. The credit default swaps hedge the investor against a drop in bond prices due to credit concerns of certain bond issuers. A credit default swap allows the investor to put the bond back to us at par upon a default event by the bond issuer. A default event is defined as bankruptcy, failure to pay, obligation acceleration or restructuring. The open credit default swaps as of December 31, 2007 expire in 2010 through 2012. CALL OPTIONS (BASED ON LNC STOCK) We use call options on our stock to hedge the expected increase in liabilities arising from SARs granted on our stock. Call options hedging vested SARs are not eligible for hedge accounting treatment under SFAS 133. Mark-to-market changes are recorded in net income in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income. CALL OPTIONS (BASED ON S&P 500 INDEX(R)) We use indexed annuity contracts to permit the holder to elect an interest rate return or an equity market component, where interest credited to the contracts is linked to the performance of the S&P 500 Index(R). Contract holders may elect to rebalance index options at renewal dates, either annually or biannually. At each renewal date, we have the opportunity to re-price the indexed component by establishing participation rates, subject to minimum guarantees. We purchase call options that are highly correlated to the portfolio allocation S-24 decisions of our contract holders, such that we are economically hedged with respect to equity returns for the current reset period. The mark-to-market of the options held impacts net investment income and generally offsets the change in value of the embedded derivative within the indexed annuity, which is recorded as a component of interest credited on our Consolidated Statements of Income. The open positions as of December 31, 2007 expire in 2008 through 2009. We also calculate fair values of index options we may purchase in the future to hedge contract holder index allocations in future reset periods. These fair values represent an estimate of the cost of the options we will purchase in the future, discounted back to the date of the Consolidated Balance Sheets, using current market indicators of volatility and interest rates. Changes in the fair values of these liabilities are included as a component of interest credited on our Consolidated Statements of Income. EMBEDDED DERIVATIVES DEFERRED COMPENSATION PLANS We have certain deferred compensation plans that have embedded derivative instruments. The liability related to these plans varies based on the investment options selected by the participants. The liability related to certain investment options selected by the participants is marked-to-market through net income in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income. MODCO AND CFW ARRANGEMENTS We are involved in various Modco and CFW reinsurance arrangements that have embedded derivatives. The change in fair value of the embedded derivatives, as well as the gains or losses on trading securities supporting these arrangements, are recorded in net income as realized gains or losses on our Consolidated Statements of Income. VARIABLE ANNUITY PRODUCTS We have certain variable annuity products with GMWB and GIB features that are embedded derivatives. The change in fair value of the embedded derivatives flows through net income as benefits on our Consolidated Statements of Income. As of December 31, 2007 and 2006, we had approximately $18.9 billion and $13.8 billion, respectively, of separate account values that were attributable to variable annuities with a GMWB feature. As of December 31, 2007 and 2006, we had approximately $4.9 billion and $2.7 billion, respectively, of separate account values that were attributable to variable annuities with a GIB feature. All of the outstanding contracts with a GIB feature are still in the accumulation phase. We implemented a hedging strategy designed to mitigate the income statement volatility caused by changes in the equity markets, interest rates, and volatility associated with GMWB and GIB features. The hedging strategy is designed such that changes in the value of the hedge contracts move in the opposite direction of changes in the value of the embedded derivatives of the GMWB and GIB contracts subject to the hedging strategy. While we actively manage our hedge positions, these hedge positions may not be totally effective in offsetting changes in the embedded derivative due to, among other things, differences in timing between when a market exposure changes and corresponding changes to the hedge positions, extreme swings in the equity markets and interest rates, market volatility, contract holder behavior, divergence between the performance of the underlying funds and the hedging indices, divergence between the actual and expected performance of the hedge instruments and our ability to purchase hedging instruments at prices consistent with our desired risk and return trade-off. AVAILABLE-FOR-SALE SECURITIES We own various debt securities that either: 1) contain call options to exchange the debt security for other specified securities of the borrower, usually common stock; or 2) contain call options to receive the return on equity-like indexes. These embedded derivatives have not been qualified for hedge accounting treatment under SFAS 133; therefore, the change in fair value of the embedded derivatives flows through net investment income. ADDITIONAL DERIVATIVE INFORMATION Income other than realized gains and losses for the agreements and contracts described above amounted to $7 million, $78 million and $14 million during the years ended December 31, 2007, 2006 and 2005, respectively. We have used certain other derivative instruments in the past for hedging purposes. Although other derivative instruments may have been used in the past, derivative types that were not outstanding from January 1, 2005 through December 31, 2007 are not discussed in this disclosure. CREDIT RISK We are exposed to credit loss in the event of nonperformance by our counterparties on various derivative contracts. However, we do not anticipate nonperformance by any of the counterparties. The credit risk associated with such agreements is minimized by purchasing such agreements from financial institutions with long-standing, superior performance records. Additionally, we maintain a policy of requiring all derivative contracts to be governed by an International Swaps and Derivatives Association ("ISDA") Master Agreement. We and LNC are required to maintain minimum ratings as a matter of routine practice in negotiating ISDA agreements. Under some ISDA agreements we have agreed to maintain certain financial strength or claims-paying ratings. A downgrade below these levels could result in termination of the derivatives contract at which time any amounts payable by us would be dependent on the market value of the underlying derivative contract. In certain transactions, we and the counterparty have entered into a collateral support agreement requiring us to post collateral upon significant downgrade. We do not believe the inclusion of termination or collateralization events pose any material threat to our liquidity position. The amount of such exposure is essentially the net replacement cost or market value less collateral held for such agreements with each counterparty if the net market value is in our favor. As of December 31, 2007 and 2006, the exposure was $164 million and $176 million, respectively. S-25 - -------------------------------------------------------------------------------- 6. FEDERAL INCOME TAXES The federal income tax expense (in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------ 2007 2006 2005 ---- ---- ---- Current $372 $244 $111 Deferred 132 216 112 ---- ---- ---- Total federal income tax expense $504 $460 $223 ==== ==== ====
The effective tax rate on pre-tax income was lower than the prevailing corporate federal income tax rate. Included in tax-preferred investment income was a separate account dividend received deduction benefit of $88 million, $80 million and $55 million for the years ended December 31, 2007, 2006 and 2005, respectively, exclusive of any prior years' tax return resolution. A reconciliation of the effective tax rate differences (dollars in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------------ 2007 2006 2005 ----- ----- ----- Tax rate of 35% times pre-tax income $ 610 $ 568 $ 303 Effect of: Tax-preferred investment income (88) (80) (63) Tax credits (22) (21) (14) Other 4 (7) (3) ----- ----- ----- Provision for income taxes $ 504 $ 460 $ 223 ===== ===== ===== Effective tax rate 29% 28% 26% ===== ===== =====
The federal income tax liability (in millions), which is included in other liabilities on our Consolidated Balance Sheets, was as follows:
AS OF DECEMBER 31, 2007 2006 ---- ---- Current $390 $ 13 Deferred 239 615 ---- ---- Total federal income tax liability $629 $628 ==== ====
Significant components of our deferred tax assets and liabilities (in millions) were as follows:
AS OF DECEMBER 31, -------------------- 2007 2006 ------ ------ DEFERRED TAX ASSETS Future contract benefits and other contract holder funds $1,904 $1,473 Reinsurance deferred gain 244 265 Net operating and capital loss carryforwards -- 23 Modco embedded derivative 74 76 Postretirement benefits other than pensions 8 7 Compensation and benefit plans 175 149 Ceding commission asset 7 9 Other 139 147 ------ ------ Total deferred tax assets 2,551 2,149 ------ ------ DEFERRED TAX LIABILITIES DAC 1,962 1,555 Net unrealized gain on available-for-sale securities 47 306 Net unrealized gain on trading securities 71 74 Present value of business in-force 589 619 Other 121 210 ------ ------ Total deferred tax liabilities 2,790 2,764 ------ ------ Net deferred tax liability $ 239 $ 615 ====== ======
LNL and its affiliates, with the exception of JPL, JPFIC and JPLA as noted below, are part of a consolidated federal income tax filing with LNC. JPL filed a separate federal income tax return until its merger with LNL on April 2, 2007. JPFIC filed a separate federal income tax return until its merger into LNL on July 2, 2007. JPLA was part of a consolidated federal income tax filing with JPFIC until its merger into LNL on April 2, 2007. We are required to establish a valuation allowance for any gross deferred tax assets that are unlikely to reduce taxes payable in future years' tax returns. As of December 31, 2007 and 2006, we concluded that it was more likely than not that all gross deferred tax assets will reduce taxes payable in future years. Accordingly, no valuation allowance was necessary as of December 31, 2007 and 2006. Under prior federal income tax law, one-half of the excess of a life insurance company's income from operations over its taxable investment income was not taxed, but was set aside in a special tax account designated as "Policyholders Surplus." On October 22, 2004, President Bush signed into law the "American Jobs Creation Act of 2004." In 2005 and 2006, the additional tax imposed on distributions from the special tax account, "Policyholders Surplus," was suspended. In addition, the statute provided that distributions made during the two-year suspension period would first reduce the Policyholders Surplus account balance. Our 2005 and 2006 dividend activity S-26 along with that of our insurance subsidiaries eliminated the account balance during the suspension period. As discussed in Note 2, we adopted FIN 48 on January 1, 2007 and had unrecognized tax benefits of $272 million, of which $134 million, if recognized, would impact our income tax expense and our effective tax rate. We anticipate a change to our unrecognized tax benefits within the next 12 months in the range of $0 to $12 million. A reconciliation of the unrecognized tax benefits (in millions) was as follows:
FOR THE YEAR ENDED DECEMBER 31, 2007 ------------ Balance at beginning-of-year $ 272 Increases for prior year tax positions 5 Decreases for prior year tax positions (1) Increases for current year tax positions 21 Decreases for current year tax positions (7) ------------ Balance at end-of-year $ 290 ============
We recognize interest and penalties accrued, if any, related to unrecognized tax benefits as a component of tax expense. During the years ended December 31, 2007, 2006 and 2005, we recognized interest and penalty expense related to uncertain tax positions of $19 million, $13 million and $3 million, respectively. We had accrued interest and penalty expense related to the unrecognized tax benefits of $64 million and $45 million as of December 31, 2007 and 2006, respectively. The LNC consolidated group is subject to annual tax examinations from the Internal Revenue Service ("IRS"). During the first quarter of 2006, the IRS completed its examination for the tax years 1999 through 2002 with assessments resulting in a payment that was not material to the results of operations. In addition to taxes assessed and interest, the payment included a deposit relating to a portion of the assessment, which LNC continues to challenge. LNC believes this portion of the assessment is inconsistent with existing law and is protesting it through the established IRS appeals process. We do not anticipate that any adjustments that might result from such audits would be material to our results of operations or financial condition. The LNC consolidated group is currently under audit by the IRS for years 2003 and 2004. The former Jefferson-Pilot Corporation and its subsidiaries are currently under examination by the IRS for the years 2004 and 2005. - -------------------------------------------------------------------------------- 7. DAC, VOBA and DSI Changes in DAC (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, --------------------------- 2007 2006 2005 ------- ------- ------- Balance at beginning-of-year $ 4,577 $ 3,676 $ 2,904 Cumulative effect of adoption of SOP 05-1 (31) -- -- Dividend of FPP (246) -- -- Deferrals 2,002 1,479 934 Amortization, net of interest: Unlocking 29 25 111 Other amortization (710) (651) (538) Adjustment related to realized (gains) losses on available-for-sale securities and derivatives 48 (38) (48) Adjustment related to unrealized losses on available-for-sale securities and derivatives 96 86 313 ------- ------- ------- Balance at end-of-year $ 5,765 $ 4,577 $ 3,676 ======= ======= =======
For the year ended December 31, 2007, the unlocking total includes $26 million in prospective unlocking from updates to assumptions for experience, $(50) million in model refinements and $53 million in retrospective unlocking. For the year ended December 31, 2006, the unlocking total includes $(9) million in prospective unlocking from updates to assumptions for experience, $(2) million in model refinements and $36 million in retrospective unlocking. For the year ended December 31, 2005, the unlocking total includes $90 million in prospective unlocking from updates to assumptions for experience and $21 million in retrospective unlocking. Changes in VOBA (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------------- 2007 2006 2005 ------- ------- ----- Balance at beginning-of-year $ 3,032 $ 742 $ 819 Cumulative effect of adoption of SOP 05-1 (35) -- -- Business acquired 14 2,478 -- Deferrals 46 96 -- Amortization: Unlocking 25 9 (11) Other amortization (416) (347) (111) Accretion of interest 125 111 45 Adjustment related to realized gains on available-for-sale securities and derivatives (6) (9) -- Adjustment related to unrealized (gains) losses on available-for-sale securities and derivatives 24 (48) -- ------- ------- ----- Balance at end-of-year $ 2,809 $ 3,032 $ 742 ======= ======= =====
For the year ended December 31, 2007, the unlocking total includes $14 million in prospective unlocking from updates to assumptions for experience, $(2) million in model refinements and $13 million in retrospective unlocking. For the year ended December 31, 2006, the unlocking total includes $5 million in S-27 prospective unlocking from updates to assumptions for experience and $4 million in retrospective unlocking. For the year ended December 31, 2005, the unlocking total includes $(9) million in prospective unlocking from updates to assumptions for experience and $(2) million in retrospective unlocking. Estimated future amortization of VOBA (in millions), net of interest, as of December 31, 2007 was as follows: 2008 $ 276 2009 252 2010 238 2011 208 2012 191 Thereafter 1,668 ----- Total $2,833 ======
Changes in DSI (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, --------------------- 2007 2006 2005 ----- ----- ----- Balance at beginning-of-year $ 194 $ 129 $ 85 Cumulative effect of adoption of SOP 05-1 (3) -- -- Deferrals 117 86 60 Amortization, net of interest: Unlocking 2 4 3 Other amortization (31) (25) (19) ----- ----- ----- Balance at end-of-year $ 279 $ 194 $ 129 ===== ===== =====
For the year ended December 31, 2007, the unlocking total includes $2 million in prospective unlocking from updates to assumptions for experience, $(1) million in model refinements and $1 million in retrospective unlocking. For the year ended December 31, 2006, the unlocking total includes $1 million in prospective unlocking from updates to assumptions for experience and $3 million in retrospective unlocking. For the year ended December 31, 2005, the unlocking total includes $2 million in prospective unlocking from updates to assumptions for experience and $1 million in retrospective unlocking. - -------------------------------------------------------------------------------- 8. REINSURANCE Reinsurance transactions included in insurance premiums (in millions), excluding amounts attributable to the indemnity reinsurance transaction with Swiss Re Life & Health America, Inc. ("Swiss Re"), were as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------------- 2007 2006 2005 ------- ------- ----- Reinsurance assumed $ 12 $ 8 $ 1 Reinsurance ceded (1,063) (1,021) (767) ------- ------- ----- Net reinsurance premiums and fees $(1,051) $(1,013) $(766) ======= ======= ===== Reinsurance recoveries netted against benefits $ 1,249 $ 904 $ 722 ======= ======= =====
We cede insurance to other companies. The portion of risks exceeding our retention limits is reinsured with other insurers. We seek reinsurance coverage within the businesses that sell life insurance in order to limit our exposure to mortality losses and enhance our capital management. Under our reinsurance program, we reinsure approximately 45% to 50% of the mortality risk on newly issued non-term life insurance contracts and approximately 40% to 45% of total mortality risk including term insurance contracts. Our policy for this program is to retain no more than $10 million on a single insured life issued on fixed and variable universal life insurance contracts. Additionally, the retention per single insured life for term life insurance and for corporate owned life insurance is $2 million for each type of insurance. Portions of our deferred annuity business have been reinsured on a Modco basis with other companies to limit our exposure to interest rate risks. As of December 31, 2007, the reserves associated with these reinsurance arrangements totaled $1.3 billion. To cover products other than life insurance, we acquire other insurance coverages with retentions and limits. We obtain reinsurance from a diverse group of reinsurers, and we monitor concentration as well as financial strength ratings of our principal reinsurers. Our reinsurance operations were acquired by Swiss Re in December 2001, through a series of indemnity reinsurance transactions. Swiss Re represents our largest reinsurance exposure. Under the indemnity reinsurance agreements, Swiss Re reinsured certain of our liabilities and obligations. As we are not relieved of our legal liability to the ceding companies, the liabilities and obligations associated with the reinsured contracts remain on our Consolidated Balance Sheets with a corresponding reinsurance receivable from Swiss Re, which totaled $4.0 billion at December 31, 2007. Swiss Re has funded a trust, with a balance of $1.8 billion as of December 31, 2007, to support this business. In addition to various remedies that we would have in the event of a default by Swiss Re, we continue to hold assets in support of certain of the transferred reserves. These assets consist of those reported as trading securities and certain mortgage loans. Our liabilities for funds withheld and embedded derivatives as of December 31, 2007, included $1.9 billion and $200 million, respectively, related to the business reinsured by Swiss Re. We recorded the gain related to the indemnity reinsurance transactions on the business sold to Swiss Re as a deferred gain S-28 in the liability section of our Consolidated Balance Sheets in accordance with the requirements of SFAS No. 113, "Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts" ("SFAS 113"). The deferred gain is being amortized into income at the rate that earnings on the reinsured business are expected to emerge, over a period of 15 years. During 2007, 2006 and 2005 we amortized $55 million, $49 million and $49 million, after-tax, respectively, of deferred gain on the sale of the reinsurance operation. Because of ongoing uncertainty related to personal accident business, the reserves related to these exited business lines carried on our Consolidated Balance Sheets as of December 31, 2007, may ultimately prove to be either excessive or deficient. For instance, in the event that future developments indicate that these reserves should be increased, under SFAS 113 we would record a current period non-cash charge to record the increase in reserves. Because Swiss Re is responsible for paying the underlying claims to the ceding companies, we would record a corresponding increase in reinsurance recoveries from Swiss Re. However, SFAS 113 does not permit us to take the full benefit in earnings for the recording of the increase in the reinsurance recoveries in the period of the change. Rather, we would increase the deferred gain recognized upon the closing of the indemnity reinsurance transaction with Swiss Re and would report a cumulative amortization "catch-up" adjustment to the deferred gain balance as increased earnings recognized in the period of change. Any amount of additional increase to the deferred gain above the cumulative amortization "catch-up" adjustment must continue to be deferred and will be amortized into income in future periods over the remaining period of expected run-off of the underlying business. We would not transfer any cash to Swiss Re as a result of these developments. In the second quarter of 2007, we recognized increased reserves on the business sold and recognized a deferred gain that is being amortized into income at the rate that earnings are expected to emerge within a 15 year period. This adjustment resulted in a non-cash charge of $13 million, after-tax, to increase reserves, which was partially offset by a cumulative "catch-up" adjustment to the deferred gain amortization of $5 million, after-tax, for a total decrease to net income of $8 million. The impact of the accounting for reserve adjustments related to this reinsurance treaty is excluded from our definition of income from operations. - -------------------------------------------------------------------------------- 9. GOODWILL AND SPECIFICALLY IDENTIFIABLE INTANGIBLE ASSETS The changes in the carrying amount of goodwill (in millions) by reportable segment were as follows:
FOR THE YEAR ENDED DECEMBER 31, 2007 -------------------------------------------- BALANCE AT PURCHASE DIVIDEND BALANCE BEGINNING- ACCOUNTING OF AT END- OF-YEAR ADJUSTMENTS FPP OF-YEAR ---------- ----------- -------- ------- Individual Markets: Life Insurance $ 2,181 $ 20 $ (2) $ 2,199 Annuities 1,032 14 -- 1,046 Employer Markets: Retirement Products 20 -- -- 20 Group Protection 281 (7) -- 274 ---------- ----------- -------- ------- Total goodwill $ 3,514 $ 27 $ (2) $ 3,539 ========== =========== ======== =======
FOR THE YEAR ENDED DECEMBER 31, 2006 -------------------------------------------- BALANCE AT PURCHASE DIVIDEND BALANCE BEGINNING- ACCOUNTING OF AT END- OF-YEAR ADJUSTMENTS FPP OF-YEAR ---------- ----------- -------- ------- Individual Markets: Life Insurance $ 855 $ 1,326 $ -- $ 2,181 Annuities 44 988 -- 1,032 Employer Markets: Retirement Products 20 -- -- 20 Group Protection -- 281 -- 281 ---------- ----------- -------- ------- Total goodwill $ 919 $ 2,595 $ -- $ 3,514 ========== =========== ======== =======
S-29 The gross carrying amounts and accumulated amortization (in millions) for each major specifically identifiable intangible asset class by reportable segment were as follows:
AS OF DECEMBER 31, ---------------------------------------------- 2007 2006 ---------------------- ---------------------- GROSS GROSS CARRYING ACCUMULATED CARRYING ACCUMULATED AMOUNT AMORTIZATION AMOUNT AMORTIZATION -------- ------------ -------- ------------ Individual Markets -- Life Insurance: Sales force $ 100 $ 7 $ 100 $ 3 Employer Markets -- Retirement Products: Mutual fund contract rights(1) 3 -- -- -- -------- ------------ -------- ------------ Total $ 103 $ 7 $ 100 $ 3 ======== ============ ======== ============
- ---------- (1) No amortization recorded as the intangible asset has indefinite life. Future estimated amortization of specifically identifiable intangible assets (in millions) as of December 31, 2007 was as follows: 2008 $ 4 2009 4 2010 4 2011 4 2012 4 Thereafter 73 --- Total $93 ===
- -------------------------------------------------------------------------------- 10. SEPARATE ACCOUNTS AND GUARANTEED BENEFIT FEATURES We issue variable contracts through our separate accounts for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contract holder (traditional variable annuities). We also issue variable annuity and life contracts through separate accounts that include various types of GMDB, GMWB and GIB features. The GMDB features include those where we contractually guarantee to the contract holder either (a) return of no less than total deposits made to the contract less any partial withdrawals ("return of net deposits"), (b) total deposits made to the contract less any partial withdrawals plus a minimum return ("minimum return"), or (c) the highest contract value on any contract anniversary date through age 80 minus any payments or withdrawals following the contract anniversary ("anniversary contract value"). Information in the event of death on the GMDB features outstanding (dollars in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------- 2007 2006 -------- -------- RETURN OF NET DEPOSIT Separate account value $ 44,833 $ 38,306 Net amount at risk(1) 93 65 Average attained age of contract holders 55 years 54 years MINIMUM RETURN Separate account value $ 355 $ 405 Net amount at risk(1) 25 34 Average attained age of contract holders 68 years 67 years Guaranteed minimum return 5% 5% ANNIVERSARY CONTRACT VALUE Separate account value $ 25,537 $ 22,487 Net amount at risk(1) 359 193 Average attained age of contract holders 64 years 64 years
- ---------- (1) Represents the amount of death benefit in excess of the current account balance at the balance sheet date. S-30 The determination of GMDB liabilities is based on models that involve a range of scenarios and assumptions, including those regarding expected market rates of return and volatility, contract surrender rates and mortality experience. The following summarizes the balances of and changes in the liabilities for GMDB (in millions), which were recorded in future contract benefits on our Consolidated Balance Sheets:
FOR THE YEARS ENDED DECEMBER 31, ------------------- 2007 2006 ----- ----- Balance at beginning-of-year $ 23 $ 15 Cumulative effect of adoption of SOP 05-1 (4) -- Changes in reserves 25 14 Benefits paid (6) (6) ----- ----- Balance at end-of-year $ 38 $ 23 ===== =====
The changes to the benefit reserves amounts above are reflected in benefits on our Consolidated Statements of Income. Also included in benefits are the results of the hedging program, which included losses of $2 million and $5 million for GMDB in 2007 and 2006, respectively. We utilize a delta hedging strategy for variable annuity products with a GMDB feature, which uses futures on U.S.-based equity market indices to hedge against movements in equity markets. The hedging strategy is designed so that changes in the value of the hedge contracts move in the opposite direction of equity market driven changes in the reserve for GMDB contracts subject to the hedging strategy. While we actively manage our hedge positions, these hedge positions may not be totally effective to offset changes in the reserve due to, among other things, differences in timing between when a market exposure changes and corresponding changes to the hedge positions, extreme swings in the equity markets and interest rates, market volatility, contract holder behavior, divergence between the performance of the underlying funds and the hedging indices, divergence between the actual and expected performance of the hedge instruments or our ability to purchase hedging instruments at prices consistent with our desired risk and return trade-off. Account balances of variable annuity contracts with guarantees (in millions) were invested in separate account investment options as follows:
AS OF DECEMBER 31, --------------------- 2007 2006 ------- ------- ASSET TYPE Domestic equity $44,982 $39,260 International equity 8,076 5,905 Bonds 8,034 6,399 Money market 6,545 5,594 ------- ------- Total $67,637 $57,158 ======= ======= Percent of total variable annuity separate account values 97% 87%
- -------------------------------------------------------------------------------- 11. OTHER CONTRACT HOLDER FUNDS Details of other contract holder funds (in millions) were as follows:
AS OF DECEMBER 31, --------------------- 2007 2006 ------- ------- Account values and other contract holder funds $56,668 $57,383 Deferred front-end loads 768 572 Contract holder dividends payable 524 531 Premium deposit funds 113 130 Undistributed earnings on participating business 95 102 ------- ------- Total other contract holder funds $58,168 $58,718 ======= =======
S-31 - -------------------------------------------------------------------------------- 12. SHORT-TERM AND LONG-TERM DEBT Details underlying short-term and long-term debt (in millions) were as follows:
AS OF DECEMBER 31, -------------------- 2007 2006 ------ ------ Short-term debt(1) $ 18 $ 21 Note due LNC, due September 2008 155 -- ------ ------ Total short-term debt $ 173 $ 21 ====== ====== Long-term debt: Note due LNC, due September 2008 $ -- $ 139 LIBOR + 1.00% note, due 2037 375 -- Surplus Notes due LNC: 9.76% surplus note, due 2024 50 50 6.56% surplus note, due 2028 500 500 6.03% surplus note, due 2028 750 750 ------ ------ Total surplus notes 1,300 1,300 ------ ------ Total long-term debt $1,675 $1,439 ====== ======
- ---------- (1) The short-term debt represents short-term notes payable to LNC. A consolidated subsidiary of LNL issued a note for an amount not to exceed $150 million to LNC in 2006. Also in 2006, the Board of Directors of LNC issued a Board Certificate guaranteeing that the consolidated subsidiary of LNL will maintain capital and surplus sufficient to meet the statutory surplus requirements of the insurance regulatory authority for the consolidated subsidiary of LNL and provide funds in cash to the consolidated subsidiary of LNL to ensure the timely payment of its obligations. Pursuant to that Board Certificate, as of December 31, 2007, $155 million had been advanced to us. This note calls for us to pay the principal amount of the notes on or before September 30, 2008 and interest to be paid monthly at a rate equal to the Federal Reserve Board's 30 day AA- financial commercial paper rate plus ten basis points. On October 9, 2007, we issued a note of $375 million to LNC. This note calls for us to pay the principal amount of the note on or before October 9, 2037 and interest to be paid quarterly at an annual rate of LIBOR + 1.00%. During 2007, our surplus note for $50 million to HARCO Capital Corporation was transferred to LNC. This note calls for us to pay the principal amount of the note on or before September 30, 2024 and interest to be paid semiannually at an annual rate of 9.76%. Subject to approval by the Indiana Insurance Commissioner, LNC also has a right to redeem the note for immediate repayment in total or in part twice per year. Any payment of interest or repayment of principal may be paid only if we have obtained the prior written approval of the Indiana Insurance Commissioner, have adequate earned surplus funds for such payment and if such payment would not cause us to violate the statutory capital requirements as set forth in the General Statutes of Indiana. We issued a surplus note for $500 million to LNC in 1998. This note calls for us to pay the principal amount of the notes on or before March 31, 2028 and interest to be paid quarterly at an annual rate of 6.56%. Subject to approval by the Indiana Insurance Commissioner, LNC also has a right to redeem the note for immediate repayment in total or in part once per year on the anniversary date of the note. Any payment of interest or repayment of principal may be paid only out of our statutory earnings, only if our statutory capital surplus exceeds our statutory capital surplus as of the date of note issuance of $2.3 billion, and subject to approval by the Indiana Insurance Commissioner. We issued a surplus note for $750 million to LNC in 1998. This note calls for us to pay the principal amount of the notes on or before December 31, 2028 and interest to be paid quarterly at an annual rate of 6.03%. Subject to approval by the Indiana Insurance Commissioner, LNC also has a right to redeem the note for immediate repayment in total or in part once per year on the anniversary date of the note. Any payment of interest or repayment of principal may be paid only out of our statutory earnings, only if our statutory capital surplus exceeds our statutory capital surplus as of the date of note issuance of $2.4 billion, and subject to approval by the Indiana Insurance Commissioner. - -------------------------------------------------------------------------------- 13. CONTINGENCIES AND COMMITMENTS CONTINGENCIES REGULATORY AND LITIGATION MATTERS Federal and state regulators continue to focus on issues relating to fixed and variable insurance products, including, but not limited to, suitability, replacements and sales to seniors. Like others in the industry, we have received inquiries including requests for information regarding sales to seniors from the Financial Industry Regulation Authority. We are in the process of responding to these inquiries. We continue to cooperate fully with such authority. In the ordinary course of its business, LNL is involved in various pending or threatened legal proceedings, including purported class actions, arising from the conduct of business. In some instances, these proceedings include claims for unspecified or substantial punitive damages and similar types of relief in addition to amounts for alleged contractual liability or requests for equitable relief. After consultation with legal counsel and a review of available facts, it is management's opinion that these proceedings, after consideration of any reserves and rights to indemnification, ultimately will be resolved without materially affecting the consolidated financial position of LNL. However, given the large and indeterminate amounts sought in certain of these proceedings and the inherent difficulty in predicting the outcome of such legal proceedings, it is possible S-32 that an adverse outcome in certain matters could be material to our operating results for any particular reporting period. COMMITMENTS LEASES We lease our home office in Fort Wayne, Indiana through sale-leaseback agreements. The agreements provide for a 25-year lease period with options to renew for six additional terms of five years each. The agreements also provide us with the right of first refusal to purchase the properties during the terms of the lease, including renewal periods, at a price defined in the agreements. We also have the option to purchase the leased properties at fair market value as defined in the agreements on the last day of the initial 25-year lease period ending in 2009 or the last day of any of the renewal periods. In 2006, we exercised the right and option to extend the Fort Wayne lease for two extended terms such that the lease shall expire in 2019. We retain our right and option to exercise the remaining four extended terms of 5 years each in accordance with the lease agreement. Total rental expense on operating leases for the years ended December 31, 2007, 2006 and 2005 was $56 million, $47 million and $55 million, respectively. Future minimum rental commitments (in millions) as of December 31, 2007 were as follows: 2008 $ 47 2009 32 2010 21 2011 16 2012 12 Thereafter 33 - ---- ---- Total $161 ====
INFORMATION TECHNOLOGY COMMITMENT In February 1998, LNC signed a seven-year contract with IBM Global Services for information technology services for the Fort Wayne operations. In February 2004, LNC completed renegotiations and extended the contract through Febru-ary 2010. Annual costs are dependent on usage but are expected to be approximately $8 million. VULNERABILITY FROM CONCENTRATIONS As of December 31, 2007, we did not have a concentration of: 1) business transactions with a particular customer or lender; 2) sources of supply of labor or services used in the business; or 3) a market or geographic area in which business is conducted that makes it vulnerable to an event that is at least reasonably possible to occur in the near term and which could cause a severe impact to our financial position. Although we do not have any significant concentration of customers, our American Legacy Variable Annuity product offered in our Individual Markets - Annuities segment is significant to this segment. The American Legacy Variable Annuity product accounted for 46%, 48% and 48% of Individual Markets - Annuities variable annuity product deposits in December 31, 2007, 2006 and 2005, respectively, and represented approximately 66%, 67% and 67% of our total Individual Markets - Annuities variable annuity product account values as of December 31, 2007, 2006 and 2005 respectively. In addition, fund choices for certain of our other variable annuity products offered in our Individual Markets - -Annuities segment include American Fund Insurance Series(SM)("AFIS") funds. For the Individual Markets - Annuities segment, AFIS funds accounted for 55%, 58% and 57% of variable annuity product deposits in 2007, 2006 and 2005 respectively and represented 75% of the segment's total variable annuity product account values as of December 31, 2007, 2006 and 2005. OTHER CONTINGENCY MATTERS State guaranty funds assess insurance companies to cover losses to contract holders of insolvent or rehabilitated companies. Mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. We have accrued for expected assessments net of estimated future premium tax deductions. GUARANTEES We have guarantees with off-balance-sheet risks having contractual values of $2 million and $3 million as of December 31, 2007 and 2006, respectively, whose contractual amounts represent credit exposure. We have sold commercial mortgage loans through grantor trusts, which issued pass-through certificates. We have agreed to repurchase any mortgage loans which remain delinquent for 90 days at a repurchase price substantially equal to the outstanding principal balance plus accrued interest thereon to the date of repurchase. In case of default by borrowers, we have recourse to the underlying real estate. It is management's opinion that the value of the properties underlying these commitments is sufficient that in the event of default, the impact would not be material to us. These guarantees expire in 2009. S-33 - -------------------------------------------------------------------------------- 14. STOCKHOLDER'S EQUITY STOCKHOLDER'S EQUITY All authorized and issued shares of LNL are owned by LNC. ACCUMULATED OCI The following summarizes the components and changes in accumulated OCI (in millions):
FOR THE YEARS ENDED DECEMBER 31, --------------------- 2007 2006 2005 ----- ----- ----- UNREALIZED GAINS ON AVAILABLE-FOR-SALE SECURITIES Balance at beginning-of-year $ 421 $ 452 $ 781 Other comprehensive income (loss): Unrealized holding losses arising during the year (871) (96) (805) Change in DAC, VOBA and other contract holder funds 177 29 269 Income tax benefit 243 23 188 Change in foreign currency exchange rate adjustment 18 5 5 Less: Reclassification adjustment for gains (losses) included in net income (164) 24 32 Associated amortization of DAC, VOBA, DSI, DFEL and changes in other contract holder funds 29 (37) (53) Income tax benefit 47 5 7 ----- ----- ----- Balance at end-of-year $ 76 $ 421 $ 452 ===== ===== =====
FOR THE YEARS ENDED DECEMBER 31, ------------------- 2007 2006 2005 ---- ---- ---- UNREALIZED GAINS (LOSSES) ON DERIVATIVE INSTRUMENTS Balance at beginning-of-year $ (9) $ 7 $ 14 Other comprehensive income (loss): Unrealized holding gains (losses) arising during the year 14 (22) 5 Change in DAC, VOBA and other contract holder funds (6) 1 (7) Income tax benefit 11 2 (6) Change in foreign currency exchange rate adjustment (30) 4 -- Less: Reclassification adjustment for (gains) losses included in net income (2) 2 (2) Associated amortization of DAC, VOBA, DSI, DFEL and changes in other contract holder funds 1 -- 1 Income tax expense -- (1) -- ---- ---- ---- Balance at end-of-year $(19) $ (9) $ 7 ==== ==== ==== MINIMUM PENSION LIABILITY ADJUSTMENT Balance at beginning-of-year $ -- $ (6) $(13) Other comprehensive income (loss): Adjustment arising during the year -- 6 7 ---- ---- ---- Balance at end-of-year $ -- $ -- $ (6) ==== ==== ==== FUNDED STATUS OF EMPLOYEE BENEFIT PLANS Balance at beginning-of-year $ 4 $ -- $ -- Other comprehensive income (loss): Adjustment arising during the year (13) -- -- Income tax benefit 5 -- -- Adjustment for adoption of SFAS 158, net of tax -- 4 -- ---- ---- ---- Balance at end-of-year $ (4) $ 4 $ -- ==== ==== ====
S-34 - -------------------------------------------------------------------------------- 15. UNDERWRITING, ACQUISITION, INSURANCE, RESTRUCTURING AND OTHER EXPENSES Details underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, --------------------------- 2007 2006 2005 ------- ------- ------- Commissions $ 2,051 $ 1,527 $ 899 General and administrative expenses 1,234 1,093 965 DAC and VOBA deferrals and interest, net of amortization (1,101) (722) (430) Other intangibles amortization 4 3 -- Taxes, licenses and fees 192 158 81 Merger-related expenses 92 27 29 ------- ------- ------- Total $ 2,472 $ 2,086 $ 1,544 ======= ======= =======
All restructuring charges are included in underwriting, acquisition, insurance and other expenses primarily within Other Operations on our Consolidated Statements of Income in the year incurred and are reflected within merger-related expenses in the table above. 2006 RESTRUCTURING PLAN Upon completion of LNC's merger with Jefferson-Pilot, a restructuring plan was implemented relating to the integration of LNC's legacy operations with those of Jefferson-Pilot. The realignment will enhance productivity, efficiency and scalability while positioning LNC and its affiliates for future growth. Details underlying reserves for restructuring charges (in millions) were as follows:
TOTAL ----- Restructuring reserve at December 31, 2006 $ 7 Amounts incurred in 2007 Employee severance and termination benefits 6 Other 14 ----- Total 2007 restructuring charges 20 Amounts expended in 2007 (25) Restructuring reserve at December 31, 2007 $ 2 Additional amounts expended in 2007 that do not qualify as restructuring charges $ 72 Total expected costs 180 Expected completion date: 4th Quarter 2009
The total expected costs include both restructuring charges and additional expenses that do not qualify as restructuring charges that are associated with the integration activities. In addition, involuntary employee termination benefits were recorded in goodwill as part of the purchase price allocation, see Note 3. Merger integration costs relating to employee severance and termination benefits of $13 million were included in other liabilities in the purchase price allocation. In the first quarter of 2007, an additional $9 million was recorded to goodwill and other liabilities as part of the final adjustment to the purchase price allocation related to employee severance and termination benefits. - -------------------------------------------------------------------------------- 16. EMPLOYEE BENEFIT PLANS Our employees, other than our U.S. insurance agents, are included in LNC's various benefit plans that provide for pension and other postretirement benefit plans, 401(k) and profit sharing plans and deferred compensation plans. Our U.S. insurance agents are included in various plans sponsored by either LNL or LNC, including pension and other postretirement benefit plans, 401(k) and profit sharing plans and deferred compensation plans. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS LNC maintains funded defined benefit pension plans for most of its U.S. employees, including those of LNL, and prior to January 1, 1995, most full-time agents, including those of LNL. All benefits accruing under the defined benefit plan for agents were frozen as of December 31, 1994. On May 1, 2007, LNC announced plans to change the retirement benefits provided to employees, including those of LNL, including the "freeze" or cessation of benefit accruals under LNC's primary traditional defined benefit pension plans. The freeze became effective December 31, 2007. This prospective change in benefits will not impact any of the pension retirement benefits that were accrued up through December 31, 2007. Effective January 1, 2002, the employees' pension plan was converted to a cash balance formula. Eligible employees retiring before 2012 will have their benefits, which were frozen effective December 31, 2007, calculated under both the old final average pay formula and the cash balance formula and will receive the greater of the two calculations. Employees retiring in 2012 or after will receive their frozen benefit under the cash balance formula. Benefits under the cash balance formula will continue to accrue interest credits. Benefits under the final average pay formula are based on total years of service and the highest 60 months of compensation during the last 10 years of employment. Under the cash balance formula, employees have guaranteed account balances that earn annual benefit credits and interest credits each year. Annual benefit credits are based on years of service and base salary plus bonus. As a result of the merger with Jefferson-Pilot, LNC maintains funded defined benefit pension plans for the former U.S. employees and agents of Jefferson-Pilot. Eligible retiring employees receive benefits based on years of service and final average earnings. The plans were funded through group annuity contracts with LNL. The assets of the plans were those of the related contracts, and were primarily held our separate accounts. During the fourth quarter of 2007, the group annuity S-35 contracts were liquidated. The assets were moved to a tax-exempt trust and are invested as described in the Plan Assets section below. The plans are funded by contributions to tax-exempt trusts. Our funding policy is consistent with the funding requirements of Federal law and regulations. Contributions were intended to provide not only the benefits attributed to service to date, but also those expected to be earned in the future. Effective January 1, 2005, LNC amended the employees' pension plan to include 100% of eligible bonus amounts as compensation under the cash balance formula only. During 2006 and 2007, LNC sponsored three types of unfunded, nonqualified, defined benefit plans for certain U.S. employees and agents, including those of LNL: the Salary Continuation Plan for Executives of Lincoln National Corporation and Affiliates (the "ESC"), the Jefferson-Pilot Executive Special Supplemental Benefit Plan (the "ESSB") and supplemental retirement plans, a salary continuation plan and supplemental executive retirement plans. As a result of the merger with Jefferson-Pilot, LNC also sponsored an unfunded, nonqualified supplemental retirement plan for certain former employees of Jefferson-Pilot. The supplemental retirement plans provided defined benefit pension benefits in excess of limits imposed by Federal tax law. The ESC and ESSB were terminated effective December 31, 2007. The accrued benefits under the ESC and the ESSB on that date were converted to actuarial equivalent lump sum amounts and credited to special opening accounts (the "ESC Opening Balance Account" and the "ESSB Opening Balance Account") in the Lincoln National Corporation Deferred Compensation & Supplemental/Excess Retirement Plan (the "DC SERP"), which was formerly known as The Lincoln National Corporation Executive Deferred Compensation Plan for Employees. In both cases, the accrued benefits were calculated as if our executives had received a distribution at age 62, reduced under the relevant age 62 early retirement reduction factors provided under each plan (as if the executive had remained employed until age 62). The supplemental executive retirement plan provided defined pension benefits for certain executives who became our employees as a result of the acquisition of a block of individual life insurance and annuity business from CIGNA Corporation ("CIGNA"). Effective January 1, 2000, this plan was amended to freeze benefits payable under this plan and a second supplemental executive retirement plan was established for this same group of executives. The benefits payable to the executives under this plan will not be less than they would have been under the pre-acquisition plan. The benefit is based on an average compensation figure that is not less than the minimum three-year average compensation figure in effect for these executives as of December 31, 1999. Any benefits payable from this plan are reduced by benefits payable from our employees' defined benefit pension plan. LNC also sponsors unfunded plans that provide postretirement medical, dental and life insurance benefits to full-time U.S. employees who, depending on the plan, have worked for LNC for 10 years and attained age 55 (age 60 for agents), including those of LNL. Medical and dental benefits are also available to spouses and other dependents of employees and agents. For medical and dental benefits, limited contributions are required from individuals who 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. Effective April 1, 2004, the employees' postretirement plan was amended to provide that employees and agents not attaining age 50 by that date will not be eligible to receive life insurance benefits when they retire. Life insurance benefits for retirees are noncontributory for employees and agents that attained the age of 50 by April 1, 2004 and meet the eligibility requirements at the time they retire; however, these participants can elect supplemental contributory life benefits up to age 70. Effective July 1, 1999, the agents' postretirement plan was amended to require agents retiring on or after that date to pay the full medical and dental premium costs. Beginning January 1, 2002, the employees' postretire-ment plan was amended to require employees not yet age 50 with five years of service by the end of 2001 to pay the full medical and dental premium cost when they retire. Effective January 1, 2008, the postretirement plan providing benefits to former employees of Jefferson-Pilot was amended such that only employees attaining age 55 and having 10 years of service by December 31, 2007 who retire on or after age 60 with 15 years of service will be eligible to receive life insurance benefits when they retire. S-36 OBLIGATIONS, FUNDED STATUS AND ASSUMPTIONS Information (in millions) with respect to our defined benefit plan asset activity and defined benefit plan obligations subsequent to the adoption of SFAS 158 was as follows:
AS OF AND FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------- 2007 2006 2007 2006 ----- ----- ---- ---- OTHER PENSION BENEFITS POSTRETIREMENT BENEFITS ------------------- -------------------------- CHANGE IN PLAN ASSETS Fair value at beginning-of-year $ 141 $ 93 $ -- $ -- Actual return on plan assets 8 15 -- -- Company contributions (1) -- 2 2 Benefits paid (8) (7) (2) (2) Purchase accounting adjustments -- 40 -- -- ----- ----- ---- ---- Fair value at end-of-year 140 141 -- -- ----- ----- ---- ---- CHANGE IN BENEFIT OBLIGATION Balance at beginning-of-year 117 92 19 22 Interest cost 7 6 1 1 Plan participants' contributions -- -- 1 1 Actuarial gains -- (3) (4) (3) Benefits paid (8) (7) (3) (2) Purchase accounting adjustments -- 29 -- -- ----- ----- ---- ---- Balance at end-of-year 116 117 14 19 ----- ----- ---- ---- Funded status of the plans $ 24 $ 24 $(14) $(19) ===== ===== ==== ==== AMOUNTS RECOGNIZED ON THE CONSOLIDATED BALANCE SHEETS Other assets $ 25 $ 25 $ -- $ -- Other liabilities (1) (1) (14) (19) ----- ----- ---- ---- Net amount recognized $ 24 $ 24 $(14) $(19) ===== ===== ==== ==== AMOUNTS RECOGNIZED IN ACCUMULATED OCI, NET OF TAX Net (gain) loss $ 8 $ (2) $ (4) $ (2) ----- ----- ---- ---- Net amount recognized $ 8 $ (2) $ (4) $ (2) ===== ===== ==== ==== WEIGHTED-AVERAGE ASSUMPTIONS Weighted-average discount rate 6.00% 5.75% 6.00% 5.75% Expected return on plan assets 8.00% 8.00% 0.00% 0.00% RATE OF INCREASE IN COMPENSATION Salary continuation plan 4.00% 4.00% 4.00% 4.00%
We use December 31 as the measurement date for the pension and postretirement plans. The expected return on plan assets was determined based on historical and expected future returns of the various asset classes, using the target plan allocations. LNC reevaluates this assumption at an interim date each plan year. For 2008, the expected return on plan assets for the pension plan will be 8%. The calculation of the accumulated postretirement benefits obligation assumes a weighted-average annual rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) of 12% for 2007. It further assumes the rate will gradually decrease to 5% by 2017 and remain at that level in future periods. The health care cost trend rate assumption has a significant effect on the amounts reported. A one-percentage point increase and decrease in assumed health care cost trend rates would have an immaterial effect on accumulated postretirement benefit obligations and total service and interest cost components. S-37 Information for our pension plans with accumulated benefit obligations in excess of plan assets (in millions) was as follows:
AS OF DECEMBER 31, ------------------ 2007 2006 ---- ---- Accumulated benefit obligation $ 1 $ 1 Projected benefit obligation 1 1 Fair value of plan assets(1) -- --
- ---------- (1) The plan is unfunded. COMPONENTS OF NET PERIODIC BENEFIT COST The components of net defined benefit pension plan and postretirement benefit plan expense (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------------------- PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS --------------------- ------------------------------ 2007 2006 2005 2007 2006 2005 ---- ---- ---- ---- ---- ---- Interest cost $ 7 $ 6 $ 5 $ 1 $ 1 $ 1 Expected return on plan assets (11) (9) (6) -- -- -- Recognized net actuarial (gain) loss -- 1 1 (1) -- -- ---- ---- ---- ---- ---- ---- Net periodic benefit expense (recovery) $ (4) $(2) $ -- $ -- $ 1 $ 1 ==== === ==== ==== ==== ====
LNC maintains a defined contribution plan for its U.S. financial planners and advisors ("agents"), including those of LNL. Contributions to this plan are based on a percentage of the agents' annual compensation as defined in the plan. Effective January 1, 1998, LNC assumed the liabilities for a non-contributory defined contribution plan covering certain highly compensated former CIGNA agents and employees. Contributions to this plan are made annually based upon varying percentages of annual eligible earnings as defined in the plan. Contributions to this plan are in lieu of any contributions to the qualified agent defined contribution plan. Effective January 1, 2000, this plan was expanded to include certain highly compensated LNC agents. The combined expenses for these plans were $4 million for the year ended December 31, 2007 and $3 million for the years ended December 31, 2006 and 2005. These expenses reflect both the contribution as well as changes in the measurement of the liabilities under these plans. PLAN ASSETS Our pension plan asset allocations by asset category (in millions) based on estimated fair values were as follows:
AS OF DECEMBER 31, ------------------ 2007 2006 ---- ---- Equity securities 52% 66% Fixed income securities 48% 32% Cash and cash equivalents 0% 2% ---- ---- Total plan asset allocations 100% 100% ==== ====
The primary investment objective of our defined benefit pension plan is for capital appreciation with an emphasis on avoiding undue risk. Investments can be made using the following asset classes: domestic and international equity, fixed income securities, real estate and other asset classes the investment managers deem prudent. Three- and five-year time horizons are utilized as there are inevitably short-run fluctuations, which will cause variations in investment performance. Each managed fund is expected to rank in the upper 50% of similar funds over the three-year periods and above an appropriate index over five-year periods. Managers are monitored for adherence to guidelines, changes in material factors and legal or regulatory actions. Managers not meeting these criteria will be subject to additional due diligence review, corrective action or possible termination. The following short-term ranges have been established for weightings in the various asset categories:
WEIGHTING RANGE --------------- TARGET RANGE ------ ----- Domestic large cap equity 35% 30%-40% International equity 15% 10%-20% Fixed income 50% 45%-55% Cash equivalents 0% 0%-5%
Within the broad ranges provided above, we currently target asset weightings as follows: domestic equity allocations (35%) are split into large cap growth (15%), large cap value (15%) and small cap (5%). Fixed income allocations are weighted between core fixed income and long term bonds to track changes in the plan's liability duration. The performance of the plan and the managed funds are monitored on a quarterly basis relative to the plan's objectives. The performance of the managed fund is measured against the following indices: Russell 1000, Europe, Australia and Far East, Lehman Aggregate and Citi-group 90-day T-Bill. LNC reviews this investment policy on an annual basis. The expected return on plan assets was determined based on historical and expected future returns of the various asset classes, using the plan target allocations. LNC reevaluates this assumption at an interim date each plan year. S-38 Prior to 2007, our plan assets were principally managed by LNC's Investment Management segment. During 2007, the management of the equity portion of the plan assets was transferred to third-party managers. LNC's Investment Management segment continues to manage the plan's fixed income securities, which comprise approximately 50% of plan assets. PLAN CASH FLOWS LNC does not expect to contribute to the qualified defined benefit pension plans in 2008. LNC expects to fund approximately the following amounts (in millions) for benefit payments for LNC's unfunded non-qualified defined benefit plan and postretirement benefit plan:
PENSION PLANS POSTRETIREMENT PLANS ------------------------------- ------------------------------ NON- QUALIFIED NOT DEFINED REFLECTING REFLECTING BENEFIT MEDICARE MEDICARE MEDICARE PENSION PART D PART D PART D PLANS SUBSIDY SUBSIDY SUBSIDY --------- ---------- -------- ---------- 2008 $ -- $1 $(1) $2 2009 -- 1 (1) 2 2010 -- 1 (1) 2 2011 -- 1 (1) 2 2012 -- 1 (1) 2 Thereafter -- 6 (1) 7
401(k), MONEY PURCHASE AND PROFIT SHARING PLANS LNC also sponsors contributory defined contribution plans for eligible U.S. employees and agents, including those of LNL. These plans include 401(k) plans and defined contribution money purchase plans for eligible agents of the former Jefferson-Pilot. LNC's contribution to both the employees' and agents' 401(k) plans, excluding the former Jefferson-Pilot agents, is equal to 50% of each participant's pre-tax contribution, not to exceed 6% of eligible compensation, and is invested as directed by the participant. As of April 3, 2006, LNC's contributions to the employees' 401(k) plan on behalf of the former Jefferson-Pilot employees were the same as the contribution provided to eligible Lincoln participants. LNC's contributions to the agents' 401(k) Plan on behalf of the former Jefferson-Pilot agents is equal to 10% of each participant's pre-tax contributions, not to exceed 6% of eligible compensation. An additional discretionary contribution of up to 100% may be made with respect to a participant's pre-tax contribution (up to 6% of base pay plus cash bonus). The amount of discretionary contribution varies according to whether LNC has met certain performance-based criteria as determined by the Compensation Committee of LNC's Board of Directors. On May 1, 2007, simultaneous with LNC's announcement of the freeze of the primary defined benefit pension plans, LNC announced a number of enhancements to their employees' 401(k) plan effective January 1, 2008. For all participants, including those of LNL, a number of new features will apply: 1) an increase in the basic employer match from $0.50 per each $1.00 that a participant contributes each pay period, up to 6% of eligible compensation, to $1.00 per each $1.00 that a participant contributes each pay period, up to 6% of eligible compensation (the 50% match will become a 100% match); 2) a guaranteed "core" employer contribution of 4% of eligible compensation per pay period which will be made regardless of whether the eligible employee elects to defer salary into the Plan; and 3) certain eligible employees will also qualify for a "transition" employer contribution between 0.2% and 8.0% of eligible compensation per pay. Eligibility to receive the additional transition employer contributions will be based on a combination of age and years of service, with a minimum 10-year service requirement for legacy LNC employees and a minimum 5-year service requirement for former Jefferson-Pilot employees. Eligibility for transition employer contributions will be determined based on age and service on December 31, 2007 (i.e., participants will not "grow" into transition credits thereafter). Transition employer contributions will cease on December 31, 2017. The discretionary employer match feature will be eliminated effective January 1, 2008. The Jefferson-Pilot Life Insurance Company Agents' Retirement Plan is a money purchase plan for eligible agents that provides for an employer contribution equal to 5% of a participant's eligible compensation. Expense for the 401(k) and profit sharing plans was $31 million, $22 million and $25 million for the years ended December 31, 2007, 2006 and 2005, respectively. DEFERRED COMPENSATION PLANS LNC sponsors the DC SERP for certain U.S. employees, including those of LNL, and deferred compensation plans for certain agents, including those of LNL. Plan participants may elect to defer payment of a portion of their compensation as defined by the plans. Plan participants may select from a menu of "phantom" investment options (identical to those offered under LNC's qualified savings plans) used as investment measures for calculating the investment return notionally credited to their deferrals. Under the terms of these plans, LNC agrees to pay out amounts based upon the aggregate performance of the investment measures selected by the participant. LNC makes matching contributions to these plans based upon amounts placed into the deferred compensation plans by individuals when participants exceed applicable limits of the Internal Revenue Code. The amount of LNC's contribution is calculated in a manner similar to the employer match calculation described in the 401(k) plans section above. Expense for these plans was $11 million, $17 million and $11 million for the years ended December 31, 2007, 2006 and 2005, respectively. These expenses reflect both our employer matching contributions of $1 million, $4 million and $3 million, respectively, as well as increases in the measurement of our liabilities net of the total return swap, described in Note 5, under these plans of $10 million, $13 million and $8 million for the years ended December 31, 2007, 2006 and 2005, respectively. The terms of the deferred compensation plans provide that plan participants who select LNC stock as the measure for their investment return will receive shares of LNC stock in settlement of this portion of their accounts at the time of distribution. In addition, participants are precluded from S-39 diversifying any portion of their deferred compensation plan account that has been credited to the stock unit fund. Consequently, changes in value of our stock do not affect the expenses associated with this portion of the deferred compensation plans. LNC also sponsors a deferred compensation plan for certain eligible agents, including those of LNL. Plan participants receive contributions based on their earnings. Plan participants may select from a menu of "phantom" investment options used as investment measures for calculating the investment return notionally credited to their deferrals. Under the terms of these plans, LNC agrees to pay out amounts based upon the aggregate performance of the investment measures selected by the participant. As a result of the merger with Jefferson-Pilot, LNC also sponsors a deferred compensation plan for former agents of Jefferson-Pilot. Plan participants may elect to defer payment of a portion of their compensation, as defined by the plan. Plan participants may select from a menu of "phantom" investment options used as investment measures for calculating the investment return notionally credited to their deferrals. Under the terms of the plan, LNC agrees to pay out amounts based upon the aggregate performance of the investment measures selected by the participant. LNC does not make matching contributions to this plan, and LNC stock is not an investment option of the plan. LNC also sponsors a deferred compensation plan for certain former agents of Jefferson-Pilot that participate in the Jefferson-Pilot Life Insurance Company Agents' Retirement Plan. The Plan provides for company contributions equal to 5% of eligible compensation for earnings in excess of the limits imposed by the Federal government. The total liabilities associated with the employee and agent plans were $137 million and $158 million as of December 31, 2007 and 2006, respectively. - -------------------------------------------------------------------------------- 17. STOCK-BASED INCENTIVE COMPENSATION PLANS Our employees are included in LNC's various incentive plans that provide for the issuance of stock options, stock incentive awards, SARs, restricted stock awards, performance shares (performance-vested shares as opposed to time-vested shares) and deferred stock units - also referred to as "restricted stock units." LNC has a policy of issuing new shares to satisfy option exercises. Total compensation expense (in millions) for all of our stock-based incentive compensation plans was as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------- 2007 2006 2005 ---- ---- ---- Stock options $ 10 $ 3 $ -- Shares 3 19 14 Cash awards -- 1 1 SARs 5 (1) 2 Restricted stock 6 1 1 ---- ---- ---- Total stock-based incentive compensation expense $ 24 $ 23 $ 18 ==== ==== ==== Recognized tax benefit $ 8 $ 8 $ 6
- -------------------------------------------------------------------------------- 18. STATUTORY INFORMATION AND RESTRICTIONS We prepare financial statements on the basis of SAP prescribed or permitted by the insurance departments of LNL and LLANY's states of domicile. Prescribed SAP includes the Accounting Practices and Procedures Manual of the National Association of Insurance Commissioners ("NAIC") as well as state laws, regulations and administrative rules. Permitted SAP encompasses all accounting practices not so prescribed. SAP differs from GAAP primarily due to charging policy acquisition costs to expense as incurred instead of deferring them to the extent recoverable and amortizing them as described in Note 1 above, establishing future contract benefit liabilities using different actuarial assumptions and valuing investments on a different basis. Statutory net income was $971 million, $299 million and $544 million for the years ended December 31, 2007, 2006 and 2005. The increase in statutory net income from 2006 to 2007 was driven primarily by two factors. The first factor was the release of statutory reserves as a result of the merger of JPL and JPFIC into LNL as described in Note 1. The second factor was an internal transfer of ownership of FPP from LNL to our parent company, LNC, as referenced in Note 1. As a result of this transfer, we recognized a realized gain for the cumulative unrealized gain of our investment in FPP as the date of the transfer. Statutory capital and surplus was $5.1 billion and $3.0 billion as of December 31, 2007 and 2006, respectively. LNL is domiciled in Indiana. The state of Indiana has adopted certain prescribed accounting practices that differ from those found in NAIC SAP. We calculate reserves on universal life policies based on the Indiana universal life method, which caused statutory surplus to be higher than NAIC statutory surplus by $246 million and $227 million as of December 31, 2007 and 2006, respectively. We are also permitted by Indiana to use a more conservative valuation interest rate on certain S-40 annuities, which caused statutory surplus to be lower than NAIC statutory surplus by $14 million as of December 31, 2007 and 2006. A new statutory reserving standard, Actuarial Guideline VACARVM, is being developed by the NAIC with an expected effective date of December 31, 2008. This standard could lead to higher benefit reserves, lower risk-based capital ratios and potentially reduce future dividend capacity from our insurance subsidiaries. LNL is subject to certain insurance department regulatory restrictions as to the transfer of funds and payment of dividends to the holding company. Generally, these restrictions pose no short-term liquidity concerns for the holding company. For example, under Indiana laws and regulations, we may pay dividends to LNC without prior approval of the Indiana Insurance Commissioner (the "Commissioner"), or must receive prior approval of the Commissioner to pay a dividend if such dividend, along with all other dividends paid within the preceding twelve consecutive months, exceed the statutory limitation. The current statutory limitation is the greater of (i) 10% of the insurer's policyholders' surplus, as shown on its last annual statement on file with the Commissioner; or (ii) the insurer's statutory net gain from operations for the previous twelve months. Indiana law gives the Commissioner broad discretion to disapprove requests for dividends in excess of these limits. We paid dividends of $144 million, $568 million and $200 million to LNC during the years ended December 31, 2007, 2006 and 2005, respectively, which did not require prior approval of the Commissioner. In addition, we paid cash dividends of $626 million and a non-cash dividend of $292 million (attributable to the FPP dividend) in 2007 after approval was received from the Commissioner. Based upon anticipated ongoing positive statutory earnings and favorable credit markets, LNL expects that we could pay dividends of approximately $895 million in 2008 without prior approval from the Commissioner. - -------------------------------------------------------------------------------- 19. FAIR VALUE OF FINANCIAL INSTRUMENTS The following discussion outlines the methodologies and assumptions used to determine the fair value of our financial instruments. Considerable judgment is required to develop these fair values. Accordingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one-time, current market exchange of all of our financial instruments. FIXED MATURITY AND EQUITY SECURITIES Fair values for fixed maturity securities are based upon quoted market prices, where available. The fair value of private placements 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. For securities that are not actively traded and are not private placements, fair values are estimated using values obtained from independent pricing services. The fair values for equity securities are based on quoted market prices. MORTGAGE LOANS ON REAL ESTATE The fair value of mortgage loans on real estate is established using a discounted cash flow method based on credit rating, maturity and future income. The ratings for mortgages in good standing are based on property type, location, market conditions, occupancy, debt service coverage, loan to value, quality of tenancy, borrower and payment record. Fair values for impaired mortgage loans are based on: 1) the present value of expected future cash flows discounted at the loan's effective interest rate; 2) the loan's market price; or 3) the fair value of the collateral if the loan is collateral dependent. DERIVATIVE INSTRUMENTS We employ several different methods for determining the fair value of our derivative instruments. Fair values for derivative contracts are based on current settlement values. These values are based on: 1) quoted market prices; 2) industry standard models that are commercially available; and 3) broker quotes. These techniques project cash flows of the derivatives using current and implied future market conditions. We calculate the present value of the cash flows to determine the derivatives' current fair market value. OTHER INVESTMENTS AND CASH AND INVESTED CASH The carrying value of our assets classified as other investments and cash and invested cash on our Consolidated Balance Sheets approximates their fair value. Other investments include limited partnership and other privately held investments that are accounted for using the equity method of accounting. OTHER CONTRACT HOLDER FUNDS Future contract benefits and other contract holder funds on our Consolidated Balance Sheets include account values of investment contracts and certain guaranteed interest contracts. The fair values for the investment contracts 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. These calculations are based on interest rates currently offered on similar contracts with maturities that are consistent with those remaining for the contracts being valued. The remainder of other contract holder 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, nor have we determined the fair value of such contracts. SHORT-TERM AND LONG-TERM DEBT Fair values for our senior notes and capital securities are based on quoted market prices or estimated using discounted cash S-41 flow analysis based on our incremental borrowing rate at the balance sheet date for similar types of borrowing arrangements where quoted prices are not available. Fair values for junior subordinated debentures issued to affiliated trusts are based on quoted market prices. For short-term debt, excluding current maturities of long-term debt, the carrying value approximates fair value. GUARANTEES Our guarantees relate to mortgage loan pass-through certificates. Based on historical performance where repurchases have been negligible and the current status of the debt, none of the loans are delinquent and the fair value liability for the guarantees related to mortgage loan pass-through certificates is insignificant. INVESTMENT COMMITMENTS Fair values for commitments to make investments in fixed maturity securities (primarily private placements), limited partnerships, mortgage loans on real estate and real estate are based on the difference between the value of the committed investments as of the date of the accompanying Consolidated Balance Sheets and the commitment date. These estimates take into account changes in interest rates, the counterparties' credit standing and the remaining terms of the commitments. SEPARATE ACCOUNTS We report assets held in separate accounts at fair value. The related liabilities are reported at an amount equivalent to the separate account assets. The carrying values and estimated fair values of our financial instruments (in millions) were as follows:
AS OF DECEMBER 31, ----------------------------------------- 2007 2006 ------------------ ------------------- CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE -------- -------- -------- -------- ASSETS Available-for-sale securities: Fixed maturities $ 53,405 $ 53,405 $ 54,697 $ 54,697 Equity 134 134 218 218 Trading securities 2,533 2,533 2,820 2,820 Mortgage loans on real estate 7,117 7,291 7,344 7,530 Derivative instruments 172 172 245 245 Other investments 986 986 783 783 Cash and invested cash 1,395 1,395 1,762 1,762 LIABILITIES Other contract holder funds: Account value of certain investment contracts (21,173) (20,515) (28,628) (28,605) Remaining guaranteed interest and similar contracts (619) (619) (668) (668) Embedded derivative instruments -- living benefits (liabilities) contra liabilities (229) (229) 52 52 Reinsurance related derivative liability (211) (211) (218) (218) Short-term debt (173) (173) (21) (21) Long-term debt (1,675) (1,569) (1,439) (1,394) OFF-BALANCE-SHEET Guarantees -- (2) -- (3) Investment commitments -- -- -- (1,308)
S-42 - -------------------------------------------------------------------------------- 20. SEGMENT INFORMATION We provide products and services in two operating businesses, Individual Markets and Employer Markets, and report results through four business segments. We also have Other Operations which includes the financial data for operations that are not directly related to the business segments. Our reporting segments reflect the current manner by which our chief operating decision makers view and manage the business. The following is a brief description of these segments and Other Operations. INDIVIDUAL MARKETS The Individual Markets business provides its products through two segments: Annuities and Life Insurance. The Annuities segment provides tax-deferred investment growth and lifetime income opportunities for its clients by offering individual fixed annuities, including indexed annuities and variable annuities. The Annuities segment also offers broker-dealer services. The Life Insurance segment offers wealth protection and transfer opportunities through term insurance, a linked-benefit product (which is a universal life insurance policy linked with riders that provide for long-term care costs) and both single and survivorship versions of universal life and variable universal life. EMPLOYER MARKETS The Employer Markets business provides its products through two segments: Retirement Products and Group Protection. The Retirement Products segment includes two major lines of business: Defined Contribution and Executive Benefits. The Defined Contribution business provides employer-sponsored fixed and variable annuities and mutual fund-based programs in the 401(k), 403(b) and 457 plan marketplaces through a wide range of intermediaries including advisors, consultants, brokers, banks, wirehouses, third-party administrators and individual planners. The Executive Benefits business offers corporate-owned universal and variable universal life insurance and bank-owned universal and variable universal life insurance to small to mid-sized banks and mid to large-sized corporations, mostly through executive benefit brokers. The Group Protection segment offers group term life, disability and dental insurance to employers. OTHER OPERATIONS Other Operations includes the financial data for operations that are not directly related to the business segments, unallocated corporate items (such as investment income on investments related to the amount of statutory surplus that is not allocated to our business units and other corporate investments, interest expense on short-term and long-term borrowings, and certain expenses, including restructuring and merger-related expenses), along with the ongoing amortization of deferred gain on the indemnity reinsurance portion of the transaction with Swiss Re. Other Operations also includes the eliminations of intercompany transactions. Segment operating revenues and income (loss) from operations are internal measures used by our management to evaluate and assess the results of our segments. Operating revenues are GAAP revenues excluding net realized gains and losses and the amortization of deferred gain arising from reserve development on business sold through reinsurance. Income (loss) from operations is GAAP net income excluding net realized investment gains and losses, losses on early retirement of debt and reserve development net of related amortization on business sold through reinsurance. Our management and Board of Directors believe that operating revenues and income (loss) from operations explain the results of our ongoing businesses in a manner that allows for a better understanding of the underlying trends in our current businesses because the excluded items are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business segments, and in many instances, decisions regarding these items do not necessarily relate to the operations of the individual segments. Operating revenues and income (loss) from operations do not replace revenues and net income as the GAAP measures of our consolidated results of operations. Segment information (in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, --------------------------- 2007 2006 2005 ------- ------- ------- REVENUES Operating revenues: Individual Markets: Annuities $ 2,237 $ 1,914 $ 1,309 Life Insurance 3,696 3,178 1,840 ------- ------- ------- Total Individual Markets 5,933 5,092 3,149 ------- ------- ------- Employer Markets: Retirement Products 1,423 1,356 1,168 Group Protection 1,500 1,032 -- ------- ------- ------- Total Employer Markets 2,923 2,388 1,168 ------- ------- ------- Other Operations 285 310 309 Realized loss(1) (112) (2) (16) Amortization of deferred gain on indemnity reinsurance related to reserve developments 9 1 1 ------- ------- ------- Total revenues $ 9,038 $ 7,789 $ 4,611 ======= ======= =======
- ---------- (1) See Note 4 for the pre-tax detail of the realized loss. S-43
FOR THE YEARS ENDED DECEMBER 31, -------------------------- 2007 2006 2005 ------- ------- ----- NET INCOME Operating income: Individual Markets: Annuities $ 401 $ 323 $ 197 Life Insurance 623 470 238 ------- ------- ----- Total Individual Markets 1,024 793 435 ------- ------- ----- Employer Markets: Retirement Products 225 249 206 Group Protection 114 99 -- ------- ------- ----- Total Employer Markets 339 348 206 ------- ------- ----- Other Operations (45) 20 12 Realized loss(1) (72) (1) (10) Reserve development, net of related amortization on business sold through indemnity reinsurance (7) 1 1 ------- ------- ----- Net income $ 1,239 $ 1,161 $ 644 ======= ======= =====
- ---------- (1) See Note 4 for the pre-tax detail of the realized loss.
FOR THE YEARS ENDED DECEMBER 31, 2007 2006 2005 ------ ------ ------ NET INVESTMENT INCOME Individual Markets: Annuities $1,028 $1,033 $ 608 Life Insurance 1,762 1,502 907 ------ ------ ------ Total Individual Markets 2,790 2,535 1,515 ------ ------ ------ Employer Markets: Retirement Products 1,100 1,054 892 Group Protection 115 80 -- ------ ------ ------ Total Employer Markets 1,215 1,134 892 ------ ------ ------ Other Operations 183 200 185 ------ ------ ------ Total net investment income $4,188 $3,869 $2,592 ====== ====== ======
FOR THE YEARS ENDED DECEMBER 31, ------------------- 2007 2006 2005 ---- ---- ----- AMORTIZATION OF DAC AND VOBA, NET OF INTEREST Individual Markets: Annuities $337 $316 $ 183 Life Insurance 467 436 259 ---- ---- ----- Total Individual Markets 804 752 442 ---- ---- ----- Employer Markets: Retirement Products 112 84 63 Group Protection 31 16 -- ---- ---- ----- Total Employer Markets 143 100 63 ---- ---- ----- Other Operations -- 1 (1) ---- ---- ----- Total amortization of DAC and VOBA $947 $853 $ 504 ==== ==== =====
FOR THE YEARS ENDED DECEMBER 31, ------------------- 2007 2006 2005 ----- ---- ----- FEDERAL INCOME TAX EXPENSE (BENEFIT) Individual Markets: Annuities $ 114 $ 46 $ 40 Life Insurance 317 235 115 ----- ---- ----- Total Individual Markets 431 281 155 ----- ---- ----- Employer Markets: Retirement Products 90 97 80 Group Protection 61 53 -- ----- ---- ----- Total Employer Markets 151 150 80 ----- ---- ----- Other Operations (35) 29 (6) Realized loss (39) -- (6) Loss on early retirement of debt -- -- -- Amortization of deferred gain on idemnity reinsurance related to reserve developments (4) -- -- ----- ---- ----- Total income tax expense $ 504 $460 $223 ===== ==== ====
S-44
AS OF DECEMBER 31, ------------------ 2007 2006 -------- -------- ASSETS Individual Markets: Annuities $ 81,112 $ 70,736 Life Insurance 40,780 42,177 -------- -------- Total Individual Markets 121,892 112,913 -------- -------- Employer Markets: Retirement Products 38,271 37,274 Group Protection 1,471 1,849 -------- -------- Total Employer Markets 39,742 39,123 -------- -------- Other Operations 12,692 12,780 -------- -------- Total assets $174,326 $164,816 ======== ========
- -------------------------------------------------------------------------------- 21. TRANSACTIONS WITH AFFILIATES Cash and short-term investments at December 31, 2007 and 2006 include our participation in a cash management agreement with LNC of $420 million and $389 million, respectively. Related investment income was $30 million, $14 million and $6 million in 2007, 2006 and 2005, respectively. Short-term debt represents notes payable to LNC of $18 million and $21 million at December 31, 2007 and 2006, respectively. Total interest expense for this short-term debt was $1 million, $2 million and $1 million for the years ended December 31, 2007, 2006 and 2005, respectively. As shown in Note 12, LNC supplied funding to us totaling $1.7 billion in 2007 and $1.4 billion in 2006, in exchange for notes. The interest expense on these notes was $96 million, $84 million and $78 million for the years ended December 31, 2007, 2006 and 2005, respectively. In accordance with service agreements with LNC and other subsidiaries of LNC for personnel and facilities usage, general management services and investment management services, we receive services from and provide services to affiliated companies and also receive an allocation of corporate overhead from LNC. Corporate overhead expenses are assigned based on specific methodologies for each function. The majority of the expenses are assigned based on the following methodologies: assets by product, assets under management, weighted number of policy applications, weighted policies in force, and sales. This resulted in net payments of $99 million, $59 million and $122 million for the years ended December 31, 2007, 2006 and 2005, respectively, which is reflected in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income. Our related accounts payable to affiliates, which is included in other assets on our Consolidated Balance Sheets, was $10 million and $8 million as of December 31, 2007 and 2006, respectively. A transfer pricing arrangement is in place between LFD and Delaware Management Holdings, Inc. ("DMH"), a wholly owned subsidiary of LNC, related to the wholesaling of DMH's investment products. As a result, we received fees of $62 million, $36 million and $41 million from DMH for transfer pricing in 2007, 2006, and 2005. DMH is responsible for the management of our general account investments. We paid fees of $38 million, $57 million and $72 million for the years ended December 31, 2007, 2006 and 2005, respectively, to DMH for investment management services. These fees are reflected in net investment income on our Consolidated Statements of Income. We cede and accept reinsurance from affiliated companies. As discussed in Note 8, we cede certain Guaranteed Benefit risks (including certain GMDB and GMWB benefits) to Lincoln National Reinsurance Company (Barbados) Ltd. ("LNR Barbados"). We also cede certain risks for certain UL policies, which resulted from recent actuarial reserving guidelines, to LNR Barbados. The caption insurance premiums, on the accompanying Consolidated Statements of Income, was reduced for premiums paid on these contracts for the years ended December 31, 2007, 2006 and 2005 by $308 million, $234 million and $219 million, respectively. Future contract benefits on the accompanying Consolidated Balance Sheets have been reduced by $1.3 billion and $1.1 billion as of December 31, 2007 and 2006, respectively. Substantially all reinsurance ceded to affiliated companies is with unauthorized companies. To take a reserve credit for such reinsurance, we hold assets from the reinsurer, including funds held under reinsurance treaties, and are the beneficiary on letters of credit aggregating $1.4 billion and $1.1 billion at December 31, 2007 and 2006, respectively. The letters of credit are issued by banks and represent guarantees of performance under the reinsurance agreement, and are guaranteed by LNC. S-45 22. Supplemental Disclosures of Cash Flow Information The following summarizes our supplemental cash flow data (in millions):
FOR THE YEARS ENDED DECEMBER 31, ------------------------- 2007 2006 2005 ------- -------- ---- Interest paid $ 104 $ 85 $59 Income taxes paid 194 310 75 Significant non-cash investing and financing transactions: Business combinations: Fair value of assets acquired (includes cash and invested cash) $ 41 $ 37,356 $-- Fair value of liabilities assumed (50) (30,424) -- ------- -------- ---- Total purchase price $ (9) $ 6,932 $-- ======= ======== ==== Dividend of FPP: Carrying value of assets (includes cash and invested cash) $ 2,772 $ -- $-- Carrying value of liabilities (2,280) -- -- ------- -------- ---- Total dividend of FPP $ 492 $ -- $-- ======= ======== ====
S-46 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors The Lincoln National Life Insurance Company We have audited the accompanying consolidated balance sheets of The Lincoln National Life Insurance Company and its subsidiaries (the Company) as of December 31, 2007 and 2006, and the related consolidated statements of income, stockholder's equity and cash flows for each of the three years in the period ended December 31, 2007. These financial statements 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and 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 The Lincoln National Life Insurance Company and its subsidiaries at December 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2007, in conformity with U.S. generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, in 2007 the Company changed its method of accounting for deferred acquisition costs in connection with modifications or exchanges of insurance contracts as well as its method of accounting for uncertainty in income taxes. Also, as discussed in Note 2 of the consolidated financial statements, in 2006 the Company changed its method of accounting for defined benefit pension and other post retirement plans. /s/ Ernst & Young LLP Philadelphia, Pennsylvania March 28, 2008 S-47 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT L L-1 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT L STATEMENT OF ASSETS AND LIABILITIES DECEMBER 31, 2007
MORTALITY & EXPENSE CONTRACT CONTRACT GUARANTEE PURCHASES REDEMPTIONS CHARGES DUE FROM DUE TO PAYABLE TO THE LINCOLN THE LINCOLN THE LINCOLN NATIONAL LIFE NATIONAL LIFE NATIONAL LIFE INSURANCE INSURANCE INSURANCE SUBACCOUNT INVESTMENTS COMPANY TOTAL ASSETS COMPANY COMPANY NET ASSETS - ------------------------------------------------------------------------------------------------------------------------------------ ABVPSF Global Technology Class B $ 3,578,825 $ 4,225 $ 3,583,050 $ -- $ 292 $ 3,582,758 ABVPSF Growth Class B 1,602,455 1,307 1,603,762 -- 130 1,603,632 ABVPSF Growth and Income Class B 1,453,383 3,020 1,456,403 795 118 1,455,490 American Century VP Balanced 25,103,656 754 25,104,410 -- 2,025 25,102,385 American Funds Global Growth Class 2 6,479,115 33,308 6,512,423 -- 529 6,511,894 American Funds Growth Class 2 34,129,386 -- 34,129,386 23,801 2,749 34,102,836 American Funds Growth-Income Class 2 10,925,443 14,829 10,940,272 -- 891 10,939,381 American Funds International Class 2 24,403,607 70,254 24,473,861 -- 1,993 24,471,868 Delaware VIPT Diversified Income 4,067,023 3,560 4,070,583 -- 329 4,070,254 Delaware VIPT High Yield 1,910,586 -- 1,910,586 424 153 1,910,009 Delaware VIPT REIT Service Class 15,299,454 22,927 15,322,381 -- 1,229 15,321,152 Delaware VIPT Small Cap Value Service Class 8,069,256 14,786 8,084,042 -- 656 8,083,386 Delaware VIPT Trend Service Class 3,063,337 2,753 3,066,090 -- 245 3,065,845 Dreyfus Developing Leaders 44,349,750 4,310 44,354,060 -- 3,607 44,350,453 Dreyfus Stock Index 96,448,984 -- 96,448,984 33,304 7,834 96,407,846 DWS VIP Equity 500 Index 2,697,717 12,966 2,710,683 -- 221 2,710,462 DWS VIP Small Cap Index 2,559,422 1,404 2,560,826 -- 207 2,560,619 Fidelity VIP Asset Manager 60,443,834 -- 60,443,834 29,301 4,920 60,409,613 Fidelity VIP Contrafund Service Class 2 23,559,230 12,478 23,571,708 -- 1,914 23,569,794 Fidelity VIP Equity-Income 79,933,777 -- 79,933,777 53,893 6,443 79,873,441 Fidelity VIP Growth 129,364,558 9,588 129,374,146 -- 10,527 129,363,619 Fidelity VIP Money Market 359,101 7,850 366,951 -- -- 366,951 Janus Aspen Series Worldwide Growth 18,910,256 5,599 18,915,855 -- 1,523 18,914,332 Lincoln VIPT Baron Growth Opportunities Service Class 23,280,138 -- 23,280,138 2,566 1,871 23,275,701 Lincoln VIPT Cohen & Steers Global Real Estate 37,631 -- 37,631 -- 3 37,628 Lincoln VIPT Delaware Bond 4,643,024 7,080 4,650,104 -- 375 4,649,729 Lincoln VIPT Delaware Growth and Income 6,886,056 6,586 6,892,642 -- 558 6,892,084 Lincoln VIPT Delaware Managed 1,295,978 4,976 1,300,954 -- 100 1,300,854 Lincoln VIPT Delaware Social Awareness 20,447,129 5,029 20,452,158 -- 1,654 20,450,504 Lincoln VIPT Janus Capital Appreciation 2,348,838 3,168 2,352,006 -- 190 2,351,816 Lincoln VIPT Mondrian International Value 12,293,358 7,565 12,300,923 -- 988 12,299,935 Lincoln VIPT T. Rowe Price Structured Mid-Cap Growth 23,846,822 5,228 23,852,050 -- 1,929 23,850,121 Lincoln VIPT Wilshire 2010 Profile 50,163 404 50,567 -- 4 50,563 Lincoln VIPT Wilshire 2020 Profile 99,692 1,581 101,273 -- 8 101,265 Lincoln VIPT Wilshire 2030 Profile 91,681 436 92,117 -- 7 92,110 Lincoln VIPT Wilshire 2040 Profile 48,277 497 48,774 -- 4 48,770 Lincoln VIPT Wilshire Aggressive Profile 2,159,193 2,820 2,162,013 -- 177 2,161,836 Lincoln VIPT Wilshire Conservative Profile 3,023,331 3,278 3,026,609 -- 248 3,026,361 Lincoln VIPT Wilshire Moderate Profile 4,394,324 5,693 4,400,017 -- 354 4,399,663 Lincoln VIPT Wilshire Moderately Aggressive Profile 4,000,547 7,419 4,007,966 -- 326 4,007,640 NB AMT Mid-Cap Growth 10,377,337 9,076 10,386,413 -- 845 10,385,568 NB AMT Partners 10,631,333 -- 10,631,333 8,222 857 10,622,254 T. Rowe Price International Stock 23,477,701 7,628 23,485,329 -- 1,903 23,483,426
See accompanying notes. L-2 [THIS PAGE INTENTIONALLY LEFT BLANK]
DIVIDENDS FROM MORTALITY AND NET INVESTMENT EXPENSE INVESTMENT SUBACCOUNT INCOME GUARANTEE CHARGES INCOME (LOSS) - ------------------------------------------------------------------------------------------------------ ABVPSF Global Technology Class B $ -- $ (28,406) $ (28,406) ABVPSF Growth Class B -- (14,945) (14,945) ABVPSF Growth and Income Class B 15,163 (12,647) 2,516 American Century VP Balanced 556,356 (259,806) 296,550 American Funds Global Growth Class 2 152,857 (51,510) 101,347 American Funds Growth Class 2 259,274 (324,338) (65,064) American Funds Growth-Income Class 2 164,486 (99,897) 64,589 American Funds International Class 2 336,112 (207,807) 128,305 Delaware VIPT Diversified Income 68,823 (29,055) 39,768 Delaware VIPT High Yield 120,923 (18,430) 102,493 Delaware VIPT REIT Service Class 287,375 (223,981) 63,394 Delaware VIPT Small Cap Value Service Class 26,614 (96,886) (70,272) Delaware VIPT Trend Service Class -- (29,640) (29,640) Dreyfus Developing Leaders 422,352 (538,481) (116,129) Dreyfus Stock Index 1,738,916 (1,009,451) 729,465 DWS VIP Equity 500 Index 35,596 (25,171) 10,425 DWS VIP Small Cap Index 25,904 (27,073) (1,169) Fidelity VIP Asset Manager 3,657,384 (593,879) 3,063,505 Fidelity VIP Contrafund Service Class 2 166,407 (218,844) (52,437) Fidelity VIP Equity-Income 1,522,260 (866,615) 655,645 Fidelity VIP Growth 996,663 (1,176,608) (179,945) Fidelity VIP Money Market 12,768 -- 12,768 Janus Aspen Series Worldwide Growth 145,538 (192,215) (46,677) Lincoln VIPT Baron Growth Opportunities Service Class -- (248,424) (248,424) Lincoln VIPT Cohen & Steers Global Real Estate 200 (90) 110 Lincoln VIPT Delaware Bond 220,559 (41,789) 178,770 Lincoln VIPT Delaware Growth and Income 81,590 (69,384) 12,206 Lincoln VIPT Delaware Managed 30,780 (11,083) 19,697 Lincoln VIPT Delaware Social Awareness 182,668 (215,427) (32,759) Lincoln VIPT Janus Capital Appreciation 5,916 (21,232) (15,316) Lincoln VIPT Mondrian International Value 247,904 (115,766) 132,138 Lincoln VIPT T. Rowe Price Structured Mid-Cap Growth -- (237,404) (237,404) Lincoln VIPT Wilshire 2010 Profile 44 (56) (12) Lincoln VIPT Wilshire 2020 Profile 240 (178) 62 Lincoln VIPT Wilshire 2030 Profile 252 (239) 13 Lincoln VIPT Wilshire 2040 Profile 338 (101) 237 Lincoln VIPT Wilshire Aggressive Profile 17,282 (17,326) (44) Lincoln VIPT Wilshire Conservative Profile 51,742 (25,068) 26,674 Lincoln VIPT Wilshire Moderate Profile 55,835 (34,756) 21,079 Lincoln VIPT Wilshire Moderately Aggressive Profile 57,704 (28,788) 28,916 NB AMT Mid-Cap Growth -- (75,709) (75,709) NB AMT Partners 69,770 (111,634) (41,864) T. Rowe Price International Stock 323,604 (232,572) 91,032
See accompanying notes. L-4
DIVIDENDS NET CHANGE NET INCREASE FROM TOTAL IN UNREALIZED (DECREASE) IN NET REALIZED NET REALIZED NET REALIZED APPRECIATION NET ASSETS GAIN (LOSS) GAIN ON GAIN (LOSS) OR DEPRECIATION RESULTING FROM ON INVESTMENTS INVESTMENTS ON INVESTMENTS ON INVESTMENTS OPERATIONS - ------------------------------------------------------------------------------------------------------------------------------------ ABVPSF Global Technology Class B $ 129,521 $ -- $ 129,521 $ 341,762 $ 442,877 ABVPSF Growth Class B 52,356 -- 52,356 124,666 162,077 ABVPSF Growth and Income Class B 18,135 62,371 80,506 (45,469) 37,553 American Century VP Balanced 129,619 1,354,575 1,484,194 (742,816) 1,037,928 American Funds Global Growth Class 2 68,648 211,131 279,779 234,383 615,509 American Funds Growth Class 2 956,203 2,214,139 3,170,342 270,515 3,375,793 American Funds Growth-Income Class 2 168,329 320,049 488,378 (226,682) 326,285 American Funds International Class 2 756,588 965,335 1,721,923 1,620,593 3,470,821 Delaware VIPT Diversified Income 18,058 5,627 23,685 118,539 181,992 Delaware VIPT High Yield 1,932 -- 1,932 (87,700) 16,725 Delaware VIPT REIT Service Class 490,827 5,192,617 5,683,444 (8,944,047) (3,197,209) Delaware VIPT Small Cap Value Service Class 70,089 798,115 868,204 (1,500,994) (703,062) Delaware VIPT Trend Service Class 164,303 20,188 184,491 98,501 253,352 Dreyfus Developing Leaders (2,118,485) 7,384,234 5,265,749 (11,267,819) (6,118,199) Dreyfus Stock Index 4,129,936 -- 4,129,936 (484,354) 4,375,047 DWS VIP Equity 500 Index 68,745 -- 68,745 18,130 97,300 DWS VIP Small Cap Index 40,455 189,836 230,291 (287,093) (57,971) Fidelity VIP Asset Manager 82,236 1,700,182 1,782,418 3,221,791 8,067,714 Fidelity VIP Contrafund Service Class 2 599,473 5,686,943 6,286,416 (2,927,940) 3,306,039 Fidelity VIP Equity-Income 1,950,369 6,712,024 8,662,393 (8,566,930) 751,108 Fidelity VIP Growth 872,842 105,885 978,727 26,141,171 26,939,953 Fidelity VIP Money Market -- -- -- -- 12,768 Janus Aspen Series Worldwide Growth (227,639) -- (227,639) 1,850,930 1,576,614 Lincoln VIPT Baron Growth Opportunities Service Class 1,323,761 2,729,858 4,053,619 (3,133,202) 671,993 Lincoln VIPT Cohen & Steers Global Real Estate (154) -- (154) (3,679) (3,723) Lincoln VIPT Delaware Bond (2,577) -- (2,577) 3,840 180,033 Lincoln VIPT Delaware Growth and Income 316,313 -- 316,313 18,447 346,966 Lincoln VIPT Delaware Managed 23,421 25,824 49,245 (41,069) 27,873 Lincoln VIPT Delaware Social Awareness 368,362 -- 368,362 137,188 472,791 Lincoln VIPT Janus Capital Appreciation 74,220 -- 74,220 320,585 379,489 Lincoln VIPT Mondrian International Value 315,125 326,607 641,732 265,680 1,039,550 Lincoln VIPT T. Rowe Price Structured Mid-Cap Growth (294,007) -- (294,007) 3,366,180 2,834,769 Lincoln VIPT Wilshire 2010 Profile 18 -- 18 319 325 Lincoln VIPT Wilshire 2020 Profile 41 -- 41 751 854 Lincoln VIPT Wilshire 2030 Profile 70 -- 70 1,313 1,396 Lincoln VIPT Wilshire 2040 Profile (337) -- (337) (633) (733) Lincoln VIPT Wilshire Aggressive Profile 29,987 24,271 54,258 88,739 142,953 Lincoln VIPT Wilshire Conservative Profile 11,402 10,627 22,029 110,921 159,624 Lincoln VIPT Wilshire Moderate Profile 46,944 17,396 64,340 167,425 252,844 Lincoln VIPT Wilshire Moderately Aggressive Profile 15,474 35,213 50,687 120,726 200,329 NB AMT Mid-Cap Growth 270,274 -- 270,274 980,167 1,174,732 NB AMT Partners 611,061 1,091,804 1,702,865 (746,986) 914,015 T. Rowe Price International Stock 1,059,837 2,600,388 3,660,225 (1,111,172) 2,640,085
L-5
ABVPSF ABVPSF GLOBAL ABVPSF GROWTH AND AMERICAN TECHNOLOGY GROWTH INCOME CENTURY VP CLASS B CLASS B CLASS B BALANCED SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT - ------------------------------------------------------------------------------------------------ NET ASSETS AT JANUARY 1, 2006 $2,494,243 $1,423,914 $ 559,551 $26,657,789 Changes From Operations: - Net investment income (loss) (24,828) (14,003) 955 247,011 - Net realized gain (loss) on investments 85,104 46,855 52,983 1,757,512 - Net change in unrealized appreciation or depreciation on investments 108,575 (72,749) 64,105 190,221 ---------- ---------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 168,851 (39,897) 118,043 2,194,744 Changes From Unit Transactions: - Contract purchases 832,544 474,698 626,320 2,675,593 - Contract withdrawals (944,674) (442,906) (318,245) (4,400,926) ---------- ---------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (112,130) 31,792 308,075 (1,725,333) ---------- ---------- ---------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 56,721 (8,105) 426,118 469,411 ---------- ---------- ---------- ----------- NET ASSETS AT DECEMBER 31, 2006 2,550,964 1,415,809 985,669 27,127,200 Changes From Operations: - Net investment income (loss) (28,406) (14,945) 2,516 296,550 - Net realized gain (loss) on investments 129,521 52,356 80,506 1,484,194 - Net change in unrealized appreciation or depreciation on investments 341,762 124,666 (45,469) (742,816) ---------- ---------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 442,877 162,077 37,553 1,037,928 Changes From Unit Transactions: - Contract purchases 1,587,374 419,554 834,566 2,648,591 - Contract withdrawals (998,457) (393,808) (402,298) (5,711,334) ---------- ---------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 588,917 25,746 432,268 (3,062,743) ---------- ---------- ---------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 1,031,794 187,823 469,821 (2,024,815) ---------- ---------- ---------- ----------- NET ASSETS AT DECEMBER 31, 2007 $3,582,758 $1,603,632 $1,455,490 $25,102,385 ========== ========== ========== ===========
See accompanying notes. L-6
AMERICAN AMERICAN AMERICAN AMERICAN DELAWARE FUNDS GLOBAL FUNDS FUNDS FUNDS VIPT DELAWARE GROWTH GROWTH GROWTH-INCOME INTERNATIONAL DIVERSIFIED VIPT CLASS 2 CLASS 2 CLASS 2 CLASS 2 INCOME HIGH YIELD SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT - ---------------------------------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2006 $ 1,089,437 $24,577,604 $ 5,205,460 $11,895,642 $1,271,497 $ 359,905 Changes From Operations: - Net investment income (loss) (3,724) (44,744) 57,100 123,581 7,247 23,923 - Net realized gain (loss) on investments 26,615 578,088 192,768 459,507 4,771 2,170 - Net change in unrealized appreciation or depreciation on investments 346,232 1,898,786 708,596 1,919,830 92,749 60,499 ----------- ----------- ----------- ----------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 369,123 2,432,130 958,464 2,502,918 104,767 86,592 Changes From Unit Transactions: - Contract purchases 2,374,113 8,985,789 3,672,574 7,732,352 1,064,225 1,209,888 - Contract withdrawals (491,504) (5,640,031) (1,047,416) (3,920,950) (618,427) (325,684) ----------- ----------- ----------- ----------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 1,882,609 3,345,758 2,625,158 3,811,402 445,798 884,204 ----------- ----------- ----------- ----------- ---------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 2,251,732 5,777,888 3,583,622 6,314,320 550,565 970,796 ----------- ----------- ----------- ----------- ---------- ----------- NET ASSETS AT DECEMBER 31, 2006 3,341,169 30,355,492 8,789,082 18,209,962 1,822,062 1,330,701 Changes From Operations: - Net investment income (loss) 101,347 (65,064) 64,589 128,305 39,768 102,493 - Net realized gain (loss) on investments 279,779 3,170,342 488,378 1,721,923 23,685 1,932 - Net change in unrealized appreciation or depreciation on investments 234,383 270,515 (226,682) 1,620,593 118,539 (87,700) ----------- ----------- ----------- ----------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 615,509 3,375,793 326,285 3,470,821 181,992 16,725 Changes From Unit Transactions: - Contract purchases 3,860,790 9,930,084 4,401,419 9,020,543 2,830,649 1,863,119 - Contract withdrawals (1,305,574) (9,558,533) (2,577,405) (6,229,458) (764,449) (1,300,536) ----------- ----------- ----------- ----------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 2,555,216 371,551 1,824,014 2,791,085 2,066,200 562,583 ----------- ----------- ----------- ----------- ---------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 3,170,725 3,747,344 2,150,299 6,261,906 2,248,192 579,308 ----------- ----------- ----------- ----------- ---------- ----------- NET ASSETS AT DECEMBER 31, 2007 $ 6,511,894 $34,102,836 $10,939,381 $24,471,868 $4,070,254 $ 1,910,009 =========== =========== =========== =========== ========== =========== DELAWARE DELAWARE VIPT DELAWARE VIPT REIT SMALL CAP VIPT TREND SERVICE CLASS VALUE SERVICE SERVICE CLASS SUBACCOUNT CLASS SUBACCOUNT SUBACCOUNT - ----------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2006 $ 17,428,578 $ 5,331,621 $ 2,788,133 Changes From Operations: - Net investment income (loss) 117,840 (72,853) (30,079) - Net realized gain (loss) on investments 1,760,931 452,543 121,701 - Net change in unrealized appreciation or depreciation on investments 3,738,574 576,269 58,545 ------------ ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 5,617,345 955,959 150,167 Changes From Unit Transactions: - Contract purchases 7,541,433 4,670,027 1,137,286 - Contract withdrawals (5,091,618) (1,381,680) (1,044,223) ------------ ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 2,449,815 3,288,347 93,063 ------------ ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 8,067,160 4,244,306 243,230 ------------ ----------- ----------- NET ASSETS AT DECEMBER 31, 2006 25,495,738 9,575,927 3,031,363 Changes From Operations: - Net investment income (loss) 63,394 (70,272) (29,640) - Net realized gain (loss) on investments 5,683,444 868,204 184,491 - Net change in unrealized appreciation or depreciation on investments (8,944,047) (1,500,994) 98,501 ------------ ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS (3,197,209) (703,062) 253,352 Changes From Unit Transactions: - Contract purchases 6,335,617 3,541,607 1,138,225 - Contract withdrawals (13,312,994) (4,331,086) (1,357,095) ------------ ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (6,977,377) (789,479) (218,870) ------------ ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS (10,174,586) (1,492,541) 34,482 ------------ ----------- ----------- NET ASSETS AT DECEMBER 31, 2007 $ 15,321,152 $ 8,083,386 $ 3,065,845 ============ =========== ===========
L-7
DREYFUS DREYFUS DWS VIP DWS VIP DEVELOPING STOCK EQUITY SMALL CAP LEADERS INDEX 500 INDEX INDEX SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT - -------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2006 $ 69,657,771 $ 99,607,227 $ 1,556,017 $ 1,083,776 Changes From Operations: - Net investment income (loss) (382,636) 662,636 1,563 (6,381) - Net realized gain (loss) on investments 4,728,944 2,325,778 27,725 97,424 - Net change in unrealized appreciation or depreciation on investments (2,645,095) 10,463,964 225,911 149,162 ------------ ------------ ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 1,701,213 13,452,378 255,199 240,205 Changes From Unit Transactions: - Contract purchases 4,106,670 5,928,687 876,285 1,810,896 - Contract withdrawals (13,469,131) (15,142,047) (446,403) (739,148) ------------ ------------ ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (9,362,461) (9,213,360) 429,882 1,071,748 ------------ ------------ ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS (7,661,248) 4,239,018 685,081 1,311,953 ------------ ------------ ----------- ----------- NET ASSETS AT DECEMBER 31, 2006 61,996,523 103,846,245 2,241,098 2,395,729 Changes From Operations: - Net investment income (loss) (116,129) 729,465 10,425 (1,169) - Net realized gain (loss) on investments 5,265,749 4,129,936 68,745 230,291 - Net change in unrealized appreciation or depreciation on investments (11,267,819) (484,354) 18,130 (287,093) ------------ ------------ ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS (6,118,199) 4,375,047 97,300 (57,971) Changes From Unit Transactions: - Contract purchases 4,456,657 7,766,813 988,728 1,419,342 - Contract withdrawals (15,984,528) (19,580,259) (616,664) (1,196,481) ------------ ------------ ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (11,527,871) (11,813,446) 372,064 222,861 ------------ ------------ ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS (17,646,070) (7,438,399) 469,364 164,890 ------------ ------------ ----------- ----------- NET ASSETS AT DECEMBER 31, 2007 $ 44,350,453 $ 96,407,846 $ 2,710,462 $ 2,560,619 ============ ============ =========== ===========
L-8
FIDELITY FIDELITY VIP FIDELITY VIP ASSET CONTRAFUND FIDELITY VIP FIDELITY VIP VIP MONEY MANAGER SERVICE CLASS 2 EQUITY-INCOME GROWTH MARKET SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT - ----------------------------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2006 $ 63,249,886 $12,309,558 $ 76,068,846 $122,110,220 $ 54,179 Changes From Operations: - Net investment income (loss) 1,064,647 (2,383) 1,893,313 (696,759) 1,501 - Net realized gain (loss) on investments (373,906) 1,854,868 10,438,133 (1,089,837) -- - Net change in unrealized appreciation or depreciation on investments 3,002,056 (248,879) 1,766,940 8,367,391 -- ------------ ----------- ------------ ------------ --------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 3,692,797 1,603,606 14,098,386 6,580,795 1,501 Changes From Unit Transactions: - Contract purchases 3,183,247 10,034,888 8,446,040 6,758,836 255,954 - Contract withdrawals (9,869,085) (4,773,708) (10,337,548) (20,867,856) (266,884) ------------ ----------- ------------ ------------ --------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (6,685,838) 5,261,180 (1,891,508) (14,109,020) (10,930) ------------ ----------- ------------ ------------ --------- TOTAL INCREASE (DECREASE) IN NET ASSETS (2,993,041) 6,864,786 12,206,878 (7,528,225) (9,429) ------------ ----------- ------------ ------------ --------- NET ASSETS AT DECEMBER 31, 2006 60,256,845 19,174,344 88,275,724 114,581,995 44,750 Changes From Operations: - Net investment income (loss) 3,063,505 (52,437) 655,645 (179,945) 12,768 - Net realized gain (loss) on investments 1,782,418 6,286,416 8,662,393 978,727 -- - Net change in unrealized appreciation or depreciation on investments 3,221,791 (2,927,940) (8,566,930) 26,141,171 -- ------------ ----------- ------------ ------------ --------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 8,067,714 3,306,039 751,108 26,939,953 12,768 Changes From Unit Transactions: - Contract purchases 3,489,109 7,474,050 12,606,899 13,625,060 853,226 - Contract withdrawals (11,404,055) (6,384,639) (21,760,290) (25,783,389) (543,793) ------------ ----------- ------------ ------------ --------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (7,914,946) 1,089,411 (9,153,391) (12,158,329) 309,433 ------------ ----------- ------------ ------------ --------- TOTAL INCREASE (DECREASE) IN NET ASSETS 152,768 4,395,450 (8,402,283) 14,781,624 322,201 ------------ ----------- ------------ ------------ --------- NET ASSETS AT DECEMBER 31, 2007 $ 60,409,613 $23,569,794 $ 79,873,441 $129,363,619 $ 366,951 ============ =========== ============ ============ ========= JANUS LINCOLN VIPT LINCOLN VIPT ASPEN SERIES BARON GROWTH COHEN & STEERS LINCOLN VIPT WORLDWIDE OPPORTUNITIES GLOBAL REAL DELAWARE GROWTH SERVICE CLASS ESTATE BOUND SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT - ---------------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2006 $ 18,710,453 $ 25,076,997 $ -- $ 2,432,368 Changes From Operations: - Net investment income (loss) 135,548 (237,408) -- 121,059 - Net realized gain (loss) on investments (958,058) 1,987,915 -- (13,305) - Net change in unrealized appreciation or depreciation on investments 3,686,144 1,529,473 -- 14,893 ------------ ------------ -------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 2,863,634 3,279,980 -- 122,647 Changes From Unit Transactions: - Contract purchases 1,400,527 3,827,248 -- 2,114,937 - Contract withdrawals (4,125,819) (7,625,130) -- (1,012,496) ------------ ------------ -------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (2,725,292) (3,797,882) -- 1,102,441 ------------ ------------ -------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 138,342 (517,902) -- 1,225,088 ------------ ------------ -------- ----------- NET ASSETS AT DECEMBER 31, 2006 18,848,795 24,559,095 -- 3,657,456 Changes From Operations: - Net investment income (loss) (46,677) (248,424) 110 178,770 - Net realized gain (loss) on investments (227,639) 4,053,619 (154) (2,577) - Net change in unrealized appreciation or depreciation on investments 1,850,930 (3,133,202) (3,679) 3,840 ------------ ------------ -------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 1,576,614 671,993 (3,723) 180,033 Changes From Unit Transactions: - Contract purchases 2,809,671 4,761,777 46,072 2,323,996 - Contract withdrawals (4,320,748) (6,717,164) (4,721) (1,511,756) ------------ ------------ -------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (1,511,077) (1,955,387) 41,351 812,240 ------------ ------------ -------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 65,537 (1,283,394) 37,628 992,273 ------------ ------------ -------- ----------- NET ASSETS AT DECEMBER 31, 2007 $ 18,914,332 $ 23,275,701 $ 37,628 $ 4,649,729 ============ ============ ======== ===========
L-9
LINCOLN VIPT LINCOLN VIPT LINCOLN VIPT DELAWARE LINCOLN VIPT DELAWARE JANUS GROWTH AND DELAWARE SOCIAL CAPITAL INCOME MANAGED AWARENESS APPRECIATION SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT - ----------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2006 $ 6,069,588 $ 775,765 $19,802,809 $1,710,075 Changes From Operations: - Net investment income (loss) 17,645 13,800 (19,867) (14,361) - Net realized gain (loss) on investments 129,254 14,212 22,365 21,394 - Net change in unrealized appreciation or depreciation on investments 533,862 52,777 2,182,469 146,132 ----------- ---------- ----------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 680,761 80,789 2,184,967 153,165 Changes From Unit Transactions: - Contract purchases 1,278,386 487,173 2,247,054 444,455 - Contract withdrawals (1,285,587) (352,858) (2,660,370) (339,477) ----------- ---------- ----------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (7,201) 134,315 (413,316) 104,978 ----------- ---------- ----------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS 673,560 215,104 1,771,651 258,143 ----------- ---------- ----------- ---------- NET ASSETS AT DECEMBER 31, 2006 6,743,148 990,869 21,574,460 1,968,218 Changes From Operations: - Net investment income (loss) 12,206 19,697 (32,759) (15,316) - Net realized gain (loss) on investments 316,313 49,245 368,362 74,220 - Net change in unrealized appreciation or depreciation on investments 18,447 (41,069) 137,188 320,585 ----------- ---------- ----------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 346,966 27,873 472,791 379,489 Changes From Unit Transactions: - Contract purchases 1,724,155 920,567 2,356,539 527,496 - Contract withdrawals (1,922,185) (638,455) (3,953,286) (523,387) ----------- ---------- ----------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (198,030) 282,112 (1,596,747) 4,109 ----------- ---------- ----------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS 148,936 309,985 (1,123,956) 383,598 ----------- ---------- ----------- ---------- NET ASSETS AT DECEMBER 31, 2007 $ 6,892,084 $1,300,854 $20,450,504 $2,351,816 =========== ========== =========== ==========
See accompanying notes. L-10
LINCOLN VIPT LINCOLN VIPT T. ROWE PRICE MONDRIAN STRUCTURED LINCOLN VIPT LINCOLN VIPT LINCOLN VIPT INTERNATIONAL MID-CAP WILSHIRE 2010 WILSHIRE 2020 WILSHIRE 2030 VALUE GROWTH PROFILE PROFILE PROFILE SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT - --------------------------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2006 $ 1,620,318 $24,767,809 $ -- $ -- $ -- Changes From Operations: - Net investment income (loss) 111,084 (238,117) -- -- -- - Net realized gain (loss) on investments 32,438 (891,555) -- -- -- - Net change in unrealized appreciation or depreciation on investments 784,334 3,039,267 -- -- -- ----------- ----------- ------- -------- ------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 927,856 1,909,595 -- -- -- Changes From Unit Transactions: - Contract purchases 5,936,237 1,818,216 -- -- -- - Contract withdrawals (931,501) (4,919,375) -- -- -- ----------- ----------- ------- -------- ------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 5,004,736 (3,101,159) -- -- -- ----------- ----------- ------- -------- ------- TOTAL INCREASE (DECREASE) IN NET ASSETS 5,932,592 (1,191,564) -- -- -- ----------- ----------- ------- -------- ------- NET ASSETS AT DECEMBER 31, 2006 7,552,910 23,576,245 -- -- -- Changes From Operations: - Net investment income (loss) 132,138 (237,404) (12) 62 13 - Net realized gain (loss) on investments 641,732 (294,007) 18 41 70 - Net change in unrealized appreciation or depreciation on investments 265,680 3,366,180 319 751 1,313 ----------- ----------- ------- -------- ------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 1,039,550 2,834,769 325 854 1,396 Changes From Unit Transactions: - Contract purchases 9,246,024 2,132,845 54,826 105,804 95,291 - Contract withdrawals (5,538,549) (4,693,738) (4,588) (5,393) (4,577) ----------- ----------- ------- -------- ------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 3,707,475 (2,560,893) 50,238 100,411 90,714 ----------- ----------- ------- -------- ------- TOTAL INCREASE (DECREASE) IN NET ASSETS 4,747,025 273,876 50,563 101,265 92,110 ----------- ----------- ------- -------- ------- NET ASSETS AT DECEMBER 31, 2007 $12,299,935 $23,850,121 $50,563 $101,265 $92,110 =========== =========== ======= ======== ======= LINCOLN VIPT LINCOLN VIPT LINCOLN VIPT LINCOLN VIPT WILSHIRE WILSHIRE WILSHIRE WILSHIRE 2040 AGGRESSIVE CONSERVATIVE MODERATE PROFILE PROFILE PROFILE PROFILE SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT - --------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2006 $ -- $ 202,779 $ 122,340 $ 339,760 Changes From Operations: - Net investment income (loss) -- 343 2,414 7,254 - Net realized gain (loss) on investments -- 21,982 1,427 4,032 - Net change in unrealized appreciation or depreciation on investments -- 93,747 27,089 155,225 -------- ---------- ---------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS -- 116,072 30,930 166,511 Changes From Unit Transactions: - Contract purchases -- 1,117,864 2,031,714 2,263,168 - Contract withdrawals -- (359,548) (170,225) (247,370) -------- ---------- ---------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS -- 758,316 1,861,489 2,015,798 -------- ---------- ---------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS -- 874,388 1,892,419 2,182,309 -------- ---------- ---------- ---------- NET ASSETS AT DECEMBER 31, 2006 -- 1,077,167 2,014,759 2,522,069 Changes From Operations: - Net investment income (loss) 237 (44) 26,674 21,079 - Net realized gain (loss) on investments (337) 54,258 22,029 64,340 - Net change in unrealized appreciation or depreciation on investments (633) 88,739 110,921 167,425 -------- ---------- ---------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS (733) 142,953 159,624 252,844 Changes From Unit Transactions: - Contract purchases 62,001 1,471,419 1,137,410 2,454,227 - Contract withdrawals (12,498) (529,703) (285,432) (829,477) -------- ---------- ---------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 49,503 941,716 851,978 1,624,750 -------- ---------- ---------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS 48,770 1,084,669 1,011,602 1,877,594 -------- ---------- ---------- ---------- NET ASSETS AT DECEMBER 31, 2007 $ 48,770 $2,161,836 $3,026,361 $4,399,663 ======== ========== ========== ==========
L-11
LINCOLN VIPT WILSHIRE MODERATELY NB AMT T. ROWE PRICE AGGRESSIVE MID-CAP NB AMT INTERNATIONAL PROFILE GROWTH PARTNERS STOCK SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT - ----------------------------------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2006 $ 420,596 $ 3,423,300 $12,212,879 $21,428,493 Changes From Operations: - Net investment income (loss) 3,863 (44,024) (33,778) 39,806 - Net realized gain (loss) on investments 11,068 146,851 1,886,425 586,629 - Net change in unrealized appreciation or depreciation on investments 114,743 390,578 (633,211) 3,017,146 ---------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 129,674 493,405 1,219,436 3,643,581 Changes From Unit Transactions: - Contract purchases 1,273,591 2,271,352 2,240,885 2,204,556 - Contract withdrawals (259,029) (1,554,973) (3,780,117) (3,849,297) ---------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 1,014,562 716,379 (1,539,232) (1,644,741) ---------- ----------- ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 1,144,236 1,209,784 (319,796) 1,998,840 ---------- ----------- ----------- ----------- NET ASSETS AT DECEMBER 31, 2006 1,564,832 4,633,084 11,893,083 23,427,333 Changes From Operations: - Net investment income (loss) 28,916 (75,709) (41,864) 91,032 - Net realized gain (loss) on investments 50,687 270,274 1,702,865 3,660,225 - Net change in unrealized appreciation or depreciation on investments 120,726 980,167 (746,986) (1,111,172) ---------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 200,329 1,174,732 914,015 2,640,085 Changes From Unit Transactions: - Contract purchases 2,693,491 7,102,134 1,979,444 2,483,699 - Contract withdrawals (451,012) (2,524,382) (4,164,288) (5,067,691) ---------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 2,242,479 4,577,752 (2,184,844) (2,583,992) ---------- ----------- ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 2,442,808 5,752,484 (1,270,829) 56,093 ---------- ----------- ----------- ----------- NET ASSETS AT DECEMBER 31, 2007 $4,007,640 $10,385,568 $10,622,254 $23,483,426 ========== =========== =========== ===========
See accompanying notes. L-12 NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2007 1. ACCOUNTING POLICIES AND ACCOUNT INFORMATION THE VARIABLE ACCOUNT: Lincoln National Variable Annuity Account L (Variable Account) is a segregated investment account of The Lincoln National Life Insurance Company (the Company) and is registered with the Securities and Exchange Commission under the Investment Company Act of 1940, as amended, as a unit investment trust. The contracts are eligible for the lower, or "Breakpoint", mortality and expense risk charge if criteria has been satisfied that the Company realizes lower issue and administrative costs. The assets of the Variable Account are owned by the Company. The Variable Account's assets supporting the annuity contracts may not be used to satisfy liabilities arising from any other business of the Company. During 2007, Jefferson Pilot Life Insurance Company and Jefferson Pilot Financial Insurance Company merged into The Lincoln National Life Insurance Company. The merger did not affect the assets and liabilities of Lincoln National Variable Annuity Account L. BASIS OF PRESENTATION: The accompanying financial statements have been prepared in accordance with accounting principles generally accepted in the United States for unit investment trusts. In September 2006, the Financial Accounting Standards Board (FASB) issued FASB Statement No. 157 "Fair Value Measurements" (Statement 157). Statement 157 establishes a framework for measuring fair value in U.S. generally accepted accounting principles, clarifies the definition of fair value within that framework and expands disclosures about the use of fair value measurements. Statement 157 is intended to increase consistency and comparability among fair value estimates used in financial reporting. Statement 157 is effective for fiscal years beginning after November 15, 2007. Management does not expect the adoption of Statement 157 to have a material impact on the amounts reported in the financial statements. INVESTMENTS: The assets of the Variable Account are divided into variable subaccounts, each of which is invested in shares of forty-three mutual funds (the Funds) of eleven diversified open-end management investment companies, each Fund with its own investment objective. The Funds are: AllianceBernstein Variable Products Series Fund, Inc. (ABVPSF): ABVPSF Global Technology Class B Fund ABVPSF Growth Class B Fund ABVPSF Growth and Income Class B Fund American Century Variable Portfolios, Inc. (American Century VP): American Century VP Balanced Portfolio American Funds Insurance Series (American Funds): American Funds Global Growth Class 2 Fund American Funds Growth Class 2 Fund American Funds Growth-Income Class 2 Fund American Funds International Class 2 Fund Delaware VIP Trust (Delaware VIPT)*: Delaware VIPT Diversified Income Series Delaware VIPT High Yield Series Delaware VIPT REIT Service Class Series Delaware VIPT Small Cap Value Service Class Series Delaware VIPT Trend Service Class Series Dreyfus Variable Investment Fund (Dreyfus): Dreyfus Developing Leaders Portfolio Dreyfus Stock Index Fund DWS Scudder VIP Funds (DWS VIP): DWS VIP Equity 500 Index Fund DWS VIP Small Cap Index Fund Fidelity Variable Insurance Products Fund (Fidelity VIP): Fidelity VIP Asset Manager Portfolio Fidelity VIP Contrafund Service Class 2 Portfolio Fidelity VIP Equity-Income Portfolio Fidelity VIP Growth Portfolio Fidelity VIP Money Market Portfolio Janus Aspen Series: Janus Aspen Series Worldwide Growth Portfolio Lincoln Variable Insurance Products Trust (Lincoln VIPT)*: Lincoln VIPT Baron Growth Opportunities Service Class Lincoln VIPT Cohen & Steers Global Real Estate Lincoln VIPT Delaware Bond Lincoln VIPT Delaware Growth and Income Lincoln VIPT Delaware Managed Lincoln VIPT Delaware Social Awareness Lincoln VIPT Janus Capital Appreciation Lincoln VIPT Mondrian International Value Lincoln VIPT T. Rowe Price Structured Mid-Cap Growth Lincoln VIPT Wilshire 2010 Profile Lincoln VIPT Wilshire 2020 Profile Lincoln VIPT Wilshire 2030 Profile Lincoln VIPT Wilshire 2040 Profile Lincoln VIPT Wilshire Aggressive Profile Lincoln VIPT Wilshire Conservative Profile Lincoln VIPT Wilshire Moderate Profile Lincoln VIPT Wilshire Moderately Aggressive Profile Neuberger Berman Advisors Management Trust (NB AMT): NB AMT Mid-Cap Growth Fund NB AMT Partners Fund T. Rowe Price International Series, Inc. (T. Rowe Price): T. Rowe Price International Stock Portfolio * Denotes an affiliate of The Lincoln National Life Insurance Company. L-13 1. ACCOUNTING POLICIES AND ACCOUNT INFORMATION (CONTINUED) The Fidelity VIP Money Market Portfolio is used only for investments of initial contributions for which the Company has not received complete order instructions. Upon receipt of complete order instructions, the payments transferred to the Fidelity VIP Money Market Portfolio are allocated to purchase shares of one of the above Funds. Investments in the Funds are stated at the closing net asset value per share on December 31, 2007, which approximates fair value. The difference between cost and fair value is reflected as unrealized appreciation or depreciation of investments. Investment transactions are accounted for on a trade date basis. 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 with the exception of Fidelity VIP Money Market Portfolio, which is invested monthly. Dividend income is recorded on the ex-dividend 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. The Variable Account will not be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code, as amended. Under current federal income tax law, no federal income taxes are payable with respect to the Variable Account's net investment income and the net realized gain on investments. INVESTMENT FUND CHANGES: During 2006, the Scudder Investments VIT Funds (Scudder VIT) family of funds changed its name to DWS Scudder VIP Funds (DWS VIP). During 2007, the Lincoln VIPT Cohen & Steers Global Real Estate Fund, the Lincoln VIPT Wilshire 2010 Profile Fund, the Lincoln VIPT Wilshire 2020 Profile Fund, the Lincoln VIPT Wilshire 2030 Profile Fund and the Lincoln VIPT Wilshire 2040 Profile Fund became available as investment options for Account Contract owners. Accordingly, the 2007 statement of operations and statements of changes in net assets and total return and investment income ratios in note 3 for these subaccounts are for the period from the commencement of operations to December 31, 2007. Also during 2007 the following funds changed their names:
PREVIOUS FUND NAME NEW FUND NAME - ------------------------------------------------------------------------------------------------------------ Baron Capital Asset Fund Lincoln VIPT Baron Growth Opportunities Service Class Fund Lincoln VIPT Bond Fund Lincoln VIPT Delaware Bond Fund Lincoln VIPT Growth and Income Fund Lincoln VIPT Delaware Growth and Income Fund Lincoln VIPT Managed Fund Lincoln VIPT Delaware Managed Fund Lincoln VIPT Social Awareness Fund Lincoln VIPT Delaware Social Awareness Fund Lincoln VIPT Capital Appreciation Fund Lincoln VIPT Janus Capital Appreciation Fund Lincoln VIPT International Fund Lincoln VIPT Mondrian International Value Fund Lincoln VIPT Aggressive Growth Fund Lincoln VIPT T. Rowe Price Structured Mid-Cap Growth Fund Lincoln VIPT Aggressive Profile Fund Lincoln VIPT Wilshire Aggressive Profile Fund Lincoln VIPT Conservative Profile Fund Lincoln VIPT Wilshire Conservative Profile Fund Lincoln VIPT Moderate Profile Fund Lincoln VIPT Wilshire Moderate Profile Fund Lincoln VIPT Moderately Aggressive Profile Fund Lincoln VIPT Wilshire Moderately Aggressive Profile Fund
2. MORTALITY AND EXPENSE GUARANTEES AND OTHER TRANSACTIONS WITH AFFILIATES Amounts are paid to the Company for mortality and expense guarantees at a percentage of the current value of the Variable Account each day with the exception of Fidelity VIP Money Market Portfolio, which does not have a mortality and expense charge. The rates are as follows: - - Standard at a daily rate of .00273973 (1.00% on an annual basis) - - Breakpoint at a daily rate of .00205479 (.75% on an annual basis) Accordingly, the Company is responsible for all sales, general and administrative expenses applicable to the Variable Account. L-14 3. FINANCIAL HIGHLIGHTS A summary of the fee rates, unit values, units outstanding, net assets and total return and investment income ratios for variable annuity contracts as of and for each year or period in the five years ended December 31, 2007 follows.
MINIMUM MAXIMUM MINIMUM MAXIMUM MINIMUM MAXIMUM INVESTMENT COMMENCEMENT FEE FEE UNIT UNIT UNITS TOTAL TOTAL INCOME SUBACCOUNT YEAR DATE(1) RATE(2) RATE(2) VALUE(3) VALUE(3) OUTSTANDING NET ASSETS RETURN(4) RETURN(4) RATIO(5) - -------------------------------------------------------------------------------------------------------------------------------- ABVPSF GLOBAL TECHNOLOGY CLASS B 2007 0.75% 1.00% $ 5.84 $ 5.95 612,866 $ 3,582,758 18.70% 19.00% 0.00% 2006 0.75% 1.00% 4.92 5.00 518,348 2,550,964 7.30% 7.57% 0.00% 2005 0.75% 1.00% 4.58 4.64 543,901 2,494,243 2.61% 2.87% 0.00% 2004 0.75% 1.00% 4.47 4.52 645,002 2,882,430 4.04% 4.30% 0.00% 2003 0.75% 1.00% 4.29 4.33 634,977 2,726,924 42.36% 42.72% 0.00% ABVPSF GROWTH CLASS B 2007 0.75% 1.00% 8.56 8.71 187,221 1,603,632 11.54% 11.82% 0.00% 2006 0.75% 1.00% 7.67 7.79 184,496 1,415,809 -2.22% -1.98% 0.00% 2005 0.75% 1.00% 7.84 7.95 181,450 1,423,914 10.52% 10.80% 0.00% 2004 0.75% 1.00% 7.10 7.17 200,618 1,424,210 13.39% 13.67% 0.00% 2003 0.75% 1.00% 6.26 6.31 166,869 1,044,684 33.36% 33.70% 0.00% ABVPSF GROWTH AND INCOME CLASS B 2007 0.75% 1.00% 13.86 14.00 104,923 1,455,490 3.82% 4.14% 1.19% 2006 0.75% 1.00% 13.35 13.44 73,807 985,669 15.82% 16.11% 1.12% 2005 0.75% 1.00% 11.53 11.57 48,528 559,551 3.56% 3.82% 1.28% 2004 6/2/04 0.75% 1.00% 11.13 11.15 15,401 171,474 6.52% 8.62% 0.00% AMERICAN CENTURY VP BALANCED 2007 0.75% 1.00% 28.75 29.37 871,343 25,102,385 3.89% 4.15% 2.10% 2006 0.75% 1.00% 27.68 28.20 978,891 27,127,200 8.53% 8.80% 1.92% 2005 0.75% 1.00% 25.50 25.92 1,044,194 26,657,789 3.89% 4.15% 1.82% 2004 0.75% 1.00% 24.55 24.89 1,104,388 27,133,446 8.69% 8.96% 1.62% 2003 0.75% 1.00% 22.59 22.84 1,099,205 24,843,084 18.27% 18.57% 2.57% AMERICAN FUNDS GLOBAL GROWTH CLASS 2 2007 0.75% 1.00% 17.32 17.48 375,858 6,511,894 13.71% 13.99% 2.95% 2006 0.75% 1.00% 15.23 15.33 219,365 3,341,169 19.23% 19.53% 0.81% 2005 0.75% 1.00% 12.77 12.83 85,285 1,089,437 12.94% 13.23% 0.62% 2004 6/2/04 0.75% 1.00% 11.31 11.33 16,273 184,048 -0.18% 11.01% 0.00% AMERICAN FUNDS GROWTH CLASS 2 2007 0.75% 1.00% 11.48 11.69 2,965,556 34,102,836 11.23% 11.51% 0.79% 2006 0.75% 1.00% 10.32 10.48 2,940,200 30,355,492 9.12% 9.39% 0.83% 2005 0.75% 1.00% 9.46 9.58 2,598,102 24,577,604 15.04% 15.32% 0.75% 2004 0.75% 1.00% 8.22 8.31 2,028,674 16,680,604 11.38% 11.66% 0.19% 2003 0.75% 1.00% 7.38 7.44 1,490,461 11,001,230 35.45% 35.79% 0.14% AMERICAN FUNDS GROWTH-INCOME CLASS 2 2007 0.75% 1.00% 13.64 13.77 801,394 10,939,381 4.00% 4.26% 1.63% 2006 0.75% 1.00% 13.12 13.20 669,845 8,789,082 14.06% 14.34% 1.81% 2005 0.75% 1.00% 11.50 11.55 452,521 5,205,460 4.78% 5.04% 1.75% 2004 6/1/04 0.75% 1.00% 10.98 10.99 161,789 1,776,123 7.21% 8.00% 1.68% AMERICAN FUNDS INTERNATIONAL CLASS 2 2007 0.75% 1.00% 15.24 15.52 1,604,248 24,471,868 18.83% 19.13% 1.60% 2006 0.75% 1.00% 12.83 13.03 1,419,434 18,209,962 17.79% 18.09% 1.81% 2005 0.75% 1.00% 10.89 11.03 1,092,363 11,895,642 20.29% 20.60% 1.87% 2004 0.75% 1.00% 9.05 9.15 698,684 6,324,952 18.13% 18.43% 1.66% 2003 0.75% 1.00% 7.66 7.72 392,222 3,005,680 33.51% 33.85% 2.16% DELAWARE VIPT DIVERSIFIED INCOME 2007 0.75% 1.00% 12.27 12.38 331,528 4,070,254 6.56% 6.83% 2.35% 2006 0.75% 1.00% 11.52 11.59 158,190 1,822,062 6.85% 7.11% 1.48% 2005 0.75% 1.00% 10.78 10.82 117,970 1,271,497 -1.44% -1.20% 0.91% 2004 6/2/04 0.75% 1.00% 10.94 10.95 36,920 403,732 3.68% 8.87% 0.00% DELAWARE VIPT HIGH YIELD 2007 0.75% 1.00% 11.64 11.72 163,993 1,910,009 1.77% 2.03% 6.51% 2006 0.75% 1.00% 11.44 11.48 116,341 1,330,701 11.33% 11.61% 4.30% 2005 7/12/05 0.75% 1.00% 10.27 10.29 35,032 359,905 0.53% 0.90% 0.00%
L-15 3. FINANCIAL HIGHLIGHTS (CONTINUED)
MINIMUM MAXIMUM MINIMUM MAXIMUM MINIMUM MAXIMUM INVESTMENT COMMENCEMENT FEE FEE UNIT UNIT UNITS TOTAL TOTAL INCOME SUBACCOUNT YEAR DATE(1) RATE(2) RATE(2) VALUE(3) VALUE(3) OUTSTANDING NET ASSETS RETURN(4) RETURN(4) RATIO(5) - -------------------------------------------------------------------------------------------------------------------------------- DELAWARE VIPT REIT SERVICE CLASS 2007 0.75% 1.00% $23.78 $24.21 643,733 $15,321,152 -15.03% -14.82% 1.27% 2006 0.75% 1.00% 27.99 28.42 910,538 25,495,738 31.01% 31.33% 1.57% 2005 0.75% 1.00% 21.36 21.64 815,493 17,428,578 5.79% 6.06% 1.68% 2004 0.75% 1.00% 20.19 20.41 854,122 17,252,300 29.78% 30.11% 1.77% 2003 0.75% 1.00% 15.56 15.68 615,446 9,577,143 32.40% 32.73% 2.26% DELAWARE VIPT SMALL CAP VALUE SERVICE CLASS 2007 0.75% 1.00% 13.86 13.98 583,045 8,083,386 -7.77% -7.53% 0.27% 2006 0.75% 1.00% 15.02 15.12 637,375 9,575,927 14.73% 15.02% 0.02% 2005 0.75% 1.00% 13.09 13.15 407,175 5,331,621 8.06% 8.33% 0.12% 2004 6/1/04 0.75% 1.00% 12.12 12.14 131,091 1,588,398 17.56% 18.16% 0.00% DELAWARE VIPT TREND SERVICE CLASS 2007 0.75% 1.00% 9.30 9.46 328,935 3,065,845 9.36% 9.63% 0.00% 2006 0.75% 1.00% 8.50 8.63 356,472 3,031,363 6.27% 6.53% 0.00% 2005 0.75% 1.00% 8.00 8.10 348,466 2,788,133 4.56% 4.83% 0.00% 2004 0.75% 1.00% 7.65 7.73 331,456 2,535,815 11.20% 11.48% 0.00% 2003 0.75% 1.00% 6.88 6.93 222,850 1,533,130 33.45% 33.79% 0.00% DREYFUS DEVELOPING LEADERS 2007 0.75% 1.00% 23.37 23.87 1,894,725 44,350,453 -11.94% -11.72% 0.77% 2006 0.75% 1.00% 26.54 27.04 2,334,223 61,996,523 2.74% 2.99% 0.41% 2005 0.75% 1.00% 25.83 26.26 2,694,886 69,657,771 4.75% 5.01% 0.00% 2004 0.75% 1.00% 24.66 25.00 3,074,985 75,870,480 10.23% 10.51% 0.20% 2003 0.75% 1.00% 22.37 22.63 3,208,955 71,810,565 30.38% 30.71% 0.03% DREYFUS STOCK INDEX 2007 0.75% 1.00% 46.66 47.66 2,063,058 96,407,846 4.21% 4.47% 1.70% 2006 0.75% 1.00% 44.77 45.62 2,317,135 103,846,245 14.35% 14.63% 1.65% 2005 0.75% 1.00% 39.15 39.80 2,541,797 99,607,227 3.65% 3.91% 1.60% 2004 0.75% 1.00% 37.78 38.30 2,909,931 110,001,042 9.54% 9.81% 1.81% 2003 0.75% 1.00% 34.49 34.88 3,013,626 103,979,670 27.09% 27.41% 1.50% DWS VIP EQUITY 500 INDEX 2007 0.75% 1.00% 13.72 13.84 197,550 2,710,462 4.25% 4.51% 1.40% 2006 0.75% 1.00% 13.16 13.24 170,315 2,241,098 14.37% 14.66% 1.08% 2005 0.75% 1.00% 11.50 11.55 135,261 1,556,017 3.63% 3.89% 1.44% 2004 6/2/04 0.75% 1.00% 11.10 11.12 69,247 768,623 7.99% 10.41% 0.00% DWS VIP SMALL CAP INDEX 2007 0.75% 1.00% 13.75 13.87 186,113 2,560,619 -2.88% -2.63% 0.95% 2006 0.75% 1.00% 14.15 14.25 169,218 2,395,729 16.32% 16.61% 0.63% 2005 0.75% 1.00% 12.17 12.22 89,056 1,083,776 3.22% 3.48% 0.58% 2004 6/4/04 0.75% 1.00% 11.79 11.81 36,535 430,699 14.60% 15.88% 0.00% FIDELITY VIP ASSET MANAGER 2007 0.75% 1.00% 32.13 32.82 1,878,514 60,409,613 14.35% 14.64% 6.10% 2006 0.75% 1.00% 28.09 28.62 2,143,508 60,256,845 6.25% 6.52% 2.74% 2005 0.75% 1.00% 26.44 26.87 2,390,790 63,249,886 3.01% 3.27% 2.73% 2004 0.75% 1.00% 25.67 26.02 2,669,058 68,542,269 4.42% 4.68% 2.73% 2003 0.75% 1.00% 24.58 24.86 2,874,822 70,688,251 16.80% 17.09% 3.57% FIDELITY VIP CONTRAFUND SERVICE CLASS 2 2007 0.75% 1.00% 15.63 15.92 1,506,081 23,569,794 16.14% 16.43% 0.75% 2006 0.75% 1.00% 13.46 13.67 1,424,007 19,174,344 10.32% 10.60% 0.98% 2005 0.75% 1.00% 12.20 12.36 1,008,577 12,309,558 15.49% 15.78% 0.10% 2004 0.75% 1.00% 10.56 10.68 495,569 5,237,198 14.01% 14.30% 0.16% 2003 0.75% 1.00% 9.27 9.34 261,580 2,423,802 26.92% 27.24% 0.25% FIDELITY VIP EQUITY-INCOME 2007 0.75% 1.00% 34.50 35.24 2,311,317 79,873,441 0.52% 0.77% 1.74% 2006 0.75% 1.00% 34.32 34.97 2,570,626 88,275,724 19.00% 19.30% 3.37% 2005 0.75% 1.00% 28.84 29.31 2,636,306 76,068,846 4.81% 5.07% 1.64% 2004 0.75% 1.00% 27.51 27.90 2,823,725 77,728,119 10.42% 10.70% 1.52% 2003 0.75% 1.00% 24.92 25.20 2,831,538 70,574,288 29.03% 29.36% 1.78%
L-16 3. FINANCIAL HIGHLIGHTS (CONTINUED)
MINIMUM MAXIMUM MINIMUM MAXIMUM MINIMUM MAXIMUM INVESTMENT COMMENCEMENT FEE FEE UNIT UNIT UNITS TOTAL TOTAL INCOME SUBACCOUNT YEAR DATE(1) RATE(2) RATE(2) VALUE(3) VALUE(3) OUTSTANDING NET ASSETS RETURN(4) RETURN(4) RATIO(5) - -------------------------------------------------------------------------------------------------------------------------------- FIDELITY VIP GROWTH 2007 0.75% 1.00% $49.63 $50.70 2,603,144 $129,363,619 25.70% 26.02% 0.84% 2006 0.75% 1.00% 39.48 40.23 2,900,026 114,581,995 5.79% 6.05% 0.40% 2005 0.75% 1.00% 37.32 37.94 3,269,686 122,110,220 4.75% 5.01% 0.52% 2004 0.75% 1.00% 35.63 36.13 3,879,966 138,318,758 2.35% 2.61% 0.27% 2003 0.75% 1.00% 34.81 35.21 4,271,497 148,743,129 31.53% 31.86% 0.27% FIDELITY VIP MONEY MARKET 2007 0.00% 0.00% 17.27 17.29 21,250 366,951 5.21% 5.21% 5.08% 2006 0.00% 0.00% 16.41 16.44 2,727 44,749 4.87% 4.88% 4.70% 2005 0.00% 0.00% 15.65 15.67 3,462 54,179 3.01% 3.03% 2.86% 2004 0.00% 0.00% 15.19 15.21 2,594 39,405 1.21% 1.29% 1.13% 2003 0.00% 0.00% 15.01 15.02 2,512 37,695 1.00% 1.00% 1.04% JANUS ASPEN SERIES WORLDWIDE GROWTH 2007 0.75% 1.00% 16.34 16.69 1,155,228 18,914,332 8.54% 8.81% 0.74% 2006 0.75% 1.00% 15.06 15.34 1,250,294 18,848,795 17.03% 17.32% 1.74% 2005 0.75% 1.00% 12.87 13.08 1,452,801 18,710,453 4.81% 5.07% 1.34% 2004 0.75% 1.00% 12.28 12.45 1,782,575 21,898,470 3.74% 4.00% 1.00% 2003 0.75% 1.00% 11.83 11.97 1,997,597 23,648,472 22.76% 23.06% 1.11% LINCOLN VIPT BARON GROWTH OPPORTUNITIES SERVICE CLASS 2007 0.75% 1.00% 31.06 31.73 747,634 23,275,701 2.39% 2.65% 0.00% 2006 0.75% 1.00% 30.33 30.91 808,702 24,559,095 14.37% 14.66% 0.00% 2005 0.75% 1.00% 26.52 26.96 944,820 25,076,997 2.34% 2.59% 0.00% 2004 0.75% 1.00% 25.92 26.28 1,051,968 27,275,683 24.39% 24.70% 0.00% 2003 0.75% 1.00% 20.83 21.07 951,461 19,828,408 28.72% 29.04% 0.00% LINCOLN VIPT COHEN & STEERS GLOBAL REAL ESTATE 2007 6/4/07 0.75% 1.00% 8.26 8.28 4,553 37,628 -18.10% -7.47% 1.28% LINCOLN VIPT DELAWARE BOND 2007 0.75% 1.00% 11.60 11.71 400,480 4,649,729 4.40% 4.66% 5.23% 2006 0.75% 1.00% 11.12 11.19 328,992 3,657,456 3.67% 3.93% 4.98% 2005 0.75% 1.00% 10.72 10.76 226,840 2,432,368 1.62% 1.87% 5.82% 2004 5/28/04 0.75% 1.00% 10.55 10.57 62,916 663,873 0.24% 4.97% 5.39% LINCOLN VIPT DELAWARE GROWTH AND INCOME 2007 0.75% 1.00% 10.68 10.87 644,714 6,892,084 5.06% 5.33% 1.16% 2006 0.75% 1.00% 10.16 10.32 663,117 6,743,148 11.24% 11.52% 1.27% 2005 0.75% 1.00% 9.13 9.25 664,088 6,069,588 4.49% 4.75% 1.41% 2004 0.75% 1.00% 8.74 8.84 581,984 5,089,902 10.88% 11.15% 1.50% 2003 0.75% 1.00% 7.88 7.95 386,289 3,046,056 28.42% 28.75% 1.45% LINCOLN VIPT DELAWARE MANAGED 2007 0.75% 1.00% 12.92 13.04 100,474 1,300,854 3.54% 3.81% 2.72% 2006 0.75% 1.00% 12.48 12.56 79,421 990,869 9.47% 9.75% 2.68% 2005 0.75% 1.00% 11.40 11.44 68,069 775,765 3.49% 3.75% 3.10% 2004 6/7/04 0.75% 1.00% 11.01 11.03 29,588 325,853 -0.05% 7.64% 3.44% LINCOLN VIPT DELAWARE SOCIAL AWARENESS 2007 0.75% 1.00% 16.78 17.14 1,216,499 20,450,504 1.94% 2.20% 0.83% 2006 0.75% 1.00% 16.46 16.77 1,308,991 21,574,460 11.19% 11.47% 0.89% 2005 0.75% 1.00% 14.81 15.05 1,336,207 19,802,809 10.91% 11.19% 0.86% 2004 0.75% 1.00% 13.35 13.53 1,375,179 18,372,102 11.58% 11.86% 0.97% 2003 0.75% 1.00% 11.96 12.10 1,355,859 16,230,913 30.55% 30.88% 0.89% LINCOLN VIPT JANUS CAPITAL APPRECIATION 2007 0.75% 1.00% 7.98 8.13 293,950 2,351,816 19.22% 19.52% 0.27% 2006 0.75% 1.00% 6.70 6.80 293,578 1,968,218 8.58% 8.85% 0.19% 2005 0.75% 1.00% 6.17 6.25 276,982 1,710,075 3.17% 3.42% 0.26% 2004 0.75% 1.00% 5.98 6.04 295,673 1,768,942 4.23% 4.50% 0.00% 2003 0.75% 1.00% 5.74 5.78 256,029 1,469,023 31.14% 31.47% 0.00% LINCOLN VIPT MONDRIAN INTERNATIONAL VALUE 2007 0.75% 1.00% 19.40 19.58 633,457 12,299,935 10.38% 10.65% 2.12% 2006 0.75% 1.00% 17.58 17.69 429,665 7,552,910 28.71% 29.03% 4.22% 2005 0.75% 1.00% 13.65 13.71 118,640 1,620,318 11.42% 11.70% 2.67% 2004 5/24/04 0.75% 1.00% 12.25 12.27 21,536 263,924 18.67% 22.55% 1.63%
L-17 3. FINANCIAL HIGHLIGHTS (CONTINUED)
MINIMUM MAXIMUM MINIMUM MAXIMUM MINIMUM MAXIMUM INVESTMENT COMMENCEMENT FEE FEE UNIT UNIT UNITS TOTAL TOTAL INCOME SUBACCOUNT YEAR DATE(1) RATE(2) RATE(2) VALUE(3) VALUE(3) OUTSTANDING NET ASSETS RETURN(4) RETURN(4) RATIO(5) - -------------------------------------------------------------------------------------------------------------------------------- LINCOLN VIPT T. ROWE PRICE STRUCTURED MID-CAP GROWTH 2007 0.75% 1.00% $15.09 $15.41 1,577,936 $23,850,121 12.46% 12.74% 0.00% 2006 0.75% 1.00% 13.42 13.67 1,755,202 23,576,245 8.19% 8.46% 0.00% 2005 0.75% 1.00% 12.40 12.61 1,995,282 24,767,809 8.72% 8.99% 0.00% 2004 0.75% 1.00% 11.41 11.57 2,221,637 25,360,950 12.53% 12.82% 0.00% 2003 0.75% 1.00% 10.14 10.25 2,337,426 23,704,442 31.30% 31.63% 0.00% LINCOLN VIPT WILSHIRE 2010 PROFILE 2007 6/5/07 0.75% 1.00% 10.49 10.51 4,819 50,563 0.46% 4.95% 0.45% LINCOLN VIPT WILSHIRE 2020 PROFILE 2007 6/5/07 0.75% 1.00% 10.34 10.35 9,796 101,265 3.36% 4.32% 0.77% LINCOLN VIPT WILSHIRE 2030 PROFILE 2007 6/5/07 0.75% 1.00% 10.44 10.46 8,819 92,110 1.15% 3.97% 0.60% LINCOLN VIPT WILSHIRE 2040 PROFILE 2007 6/5/07 0.75% 1.00% 10.27 10.28 4,747 48,770 1.95% 3.74% 1.83% LINCOLN VIPT WILSHIRE AGGRESSIVE PROFILE 2007 0.75% 1.00% 13.87 13.96 155,798 2,161,836 9.91% 10.19% 0.99% 2006 0.75% 1.00% 12.62 12.67 85,336 1,077,167 15.39% 15.67% 1.05% 2005 6/7/05 0.75% 1.00% 10.94 10.95 18,537 202,779 8.10% 9.32% 0.00% LINCOLN VIPT WILSHIRE CONSERVATIVE PROFILE 2007 0.75% 1.00% 11.90 11.98 254,239 3,026,361 6.70% 6.97% 2.06% 2006 0.75% 1.00% 11.15 11.20 180,611 2,014,759 8.25% 8.52% 1.84% 2005 6/6/05 0.75% 1.00% 10.30 10.32 11,873 122,340 1.68% 3.04% 0.00% LINCOLN VIPT WILSHIRE MODERATE PROFILE 2007 0.75% 1.00% 12.63 12.71 348,198 4,399,663 8.18% 8.45% 1.58% 2006 0.75% 1.00% 11.67 11.72 216,008 2,522,069 10.92% 11.20% 1.57% 2005 6/24/05 0.75% 1.00% 10.52 10.54 32,283 339,760 1.20% 5.18% 0.00% LINCOLN VIPT WILSHIRE MODERATELY AGGRESSIVE PROFILE 2007 0.75% 1.00% 13.15 13.23 304,751 4,007,640 8.72% 8.99% 1.99% 2006 0.75% 1.00% 12.09 12.14 129,388 1,564,832 13.01% 13.29% 1.43% 2005 7/7/05 0.75% 1.00% 10.70 10.71 39,304 420,596 3.96% 6.49% 0.00% NB AMT MID-CAP GROWTH 2007 0.75% 1.00% 9.07 9.24 1,143,902 10,385,568 21.31% 21.61% 0.00% 2006 0.75% 1.00% 7.48 7.59 619,338 4,633,084 13.55% 13.84% 0.00% 2005 0.75% 1.00% 6.58 6.67 519,732 3,423,300 12.61% 12.89% 0.00% 2004 0.75% 1.00% 5.85 5.91 321,228 1,878,881 15.15% 15.44% 0.00% 2003 0.75% 1.00% 5.08 5.12 236,792 1,202,559 26.80% 27.12% 0.00% NB AMT PARTNERS 2007 0.75% 1.00% 20.12 20.55 526,935 10,622,254 8.25% 8.52% 0.61% 2006 0.75% 1.00% 18.58 18.94 639,280 11,893,083 11.12% 11.40% 0.71% 2005 0.75% 1.00% 16.72 17.00 729,534 12,212,879 16.87% 17.16% 1.00% 2004 0.75% 1.00% 14.31 14.51 624,552 8,945,159 17.79% 18.09% 0.01% 2003 0.75% 1.00% 12.15 12.29 545,036 6,626,293 33.75% 34.08% 0.00% T. ROWE PRICE INTERNATIONAL STOCK 2007 0.75% 1.00% 21.17 21.62 1,107,939 23,483,426 11.90% 12.18% 1.37% 2006 0.75% 1.00% 18.92 19.27 1,237,640 23,427,333 17.91% 18.20% 1.17% 2005 0.75% 1.00% 16.04 16.31 1,334,898 21,428,493 14.88% 15.17% 1.61% 2004 0.75% 1.00% 13.96 14.16 1,427,817 19,948,620 12.64% 12.92% 1.13% 2003 0.75% 1.00% 12.40 12.54 1,475,205 18,294,159 29.23% 29.55% 1.28%
(1) Reflects less than a full year of activity. Funds were first received in this option on the commencement date noted or the option was inactive at the date funds were received. (2) These amounts represent the annualized minimum and maximum contract expenses of the separate account, consisting primarily of mortality and expense charges, for each period indicated. The ratios include only those expenses that result in a direct reduction to unit values. Charges made directly to contract owner accounts through the redemption of units and expenses of the underlying funds have been excluded. (3) As the unit value is presented as a range of minimum to maximum values for only those subaccounts which existed for the entire year, some individual contract unit values may not be within the ranges presented as a result of partial year activity. L-18 3. FINANCIAL HIGHLIGHTS (CONTINUED) (4) These amounts represent the total return, including changes in value of mutual funds, and reflect deductions for all items included in the fee rate. The total return does not include contract charges deducted directly from policy account values. The total return is not annualized. As the total return is presented as a range of minimum to maximum values for only those subaccounts which existed for the entire year, some individual contract total returns may not be within the ranges presented as a result of partial year activity. (5) These amounts represent the dividends, excluding distributions of capital gains, received by the subaccount from the underlying mutual fund, net of management fees assessed by the fund manager, divided by the average net assets. These ratios exclude those expenses, such as mortality and expense guarantee charges, that result in direct reductions in the unit values. The recognition of investment income by the subaccount is affected by the timing of the declaration of dividends by the underlying fund in which the subaccounts invest. Investment income ratios are not annualized. Note: Fee rate, unit value and total return minimum and maximum are the same where there is only one active contract level charge for the subaccount. 4. PURCHASES AND SALES OF INVESTMENTS The aggregate cost of investments purchased and the aggregate proceeds from investments sold were as follows for 2007.
AGGREGATE AGGREGATE COST OF PROCEEDS SUBACCOUNT PURCHASES FROM SALES - ------------------------------------------------------------------------------- ABVPSF Global Technology Class B $ 1,312,047 $ 753,865 ABVPSF Growth Class B 360,424 349,023 ABVPSF Growth and Income Class B 822,522 326,510 American Century VP Balanced 3,716,936 5,132,454 American Funds Global Growth Class 2 3,635,980 776,744 American Funds Growth Class 2 8,855,254 6,296,899 American Funds Growth-Income Class 2 3,801,580 1,682,343 American Funds International Class 2 7,369,475 3,581,108 Delaware VIPT Diversified Income 2,661,804 566,722 Delaware VIPT High Yield 1,758,262 1,091,990 Delaware VIPT REIT Service Class 8,836,163 10,579,146 Delaware VIPT Small Cap Value Service Class 3,164,254 3,212,058 Delaware VIPT Trend Service Class 937,699 1,166,291 Dreyfus Developing Leaders 9,863,930 14,221,817 Dreyfus Stock Index 5,069,047 16,176,904 DWS VIP Equity 500 Index 841,107 482,060 DWS VIP Small Cap Index 1,493,300 1,059,109 Fidelity VIP Asset Manager 6,696,569 9,819,637 Fidelity VIP Contrafund Service Class 2 11,027,160 4,303,625 Fidelity VIP Equity-Income 14,586,361 16,483,002 Fidelity VIP Growth 8,093,650 20,393,323 Fidelity VIP Money Market 1,068,090 754,938 Janus Aspen Series Worldwide Growth 1,708,626 3,277,471 Lincoln VIPT Baron Growth Opportunities Service Class 5,519,247 4,971,255 Lincoln VIPT Cohen & Steers Global Real Estate 46,000 4,536 Lincoln VIPT Delaware Bond 2,087,820 1,114,576 Lincoln VIPT Delaware Growth and Income 1,402,626 1,587,173 Lincoln VIPT Delaware Managed 906,136 581,436 Lincoln VIPT Delaware Social Awareness 1,911,708 3,552,794 Lincoln VIPT Janus Capital Appreciation 414,593 425,928 Lincoln VIPT Mondrian International Value 7,887,168 3,686,947 Lincoln VIPT T. Rowe Price Structured Mid-Cap Growth 954,391 3,764,859 Lincoln VIPT Wilshire 2010 Profile 54,264 4,438 Lincoln VIPT Wilshire 2020 Profile 104,041 5,141 Lincoln VIPT Wilshire 2030 Profile 94,971 4,673 Lincoln VIPT Wilshire 2040 Profile 61,768 12,521 Lincoln VIPT Wilshire Aggressive Profile 1,334,136 365,996 Lincoln VIPT Wilshire Conservative Profile 1,130,880 243,218 Lincoln VIPT Wilshire Moderate Profile 2,294,049 626,990 Lincoln VIPT Wilshire Moderately Aggressive Profile 2,545,007 240,804 NB AMT Mid-Cap Growth 6,127,679 1,618,503 NB AMT Partners 2,276,040 3,397,924 T. Rowe Price International Stock 4,189,978 4,091,174
L-19 5. INVESTMENTS The following is a summary of investments owned at December 31, 2007.
NET SHARES ASSET FAIR VALUE SUBACCOUNT OWNED VALUE OF SHARES COST OF SHARES - ------------------------------------------------------------------------------------------------------ ABVPSF Global Technology Class B 176,210 $20.31 $ 3,578,825 $ 2,829,563 ABVPSF Growth Class B 71,474 22.42 1,602,455 1,270,304 ABVPSF Growth and Income Class B 54,741 26.55 1,453,383 1,408,800 American Century VP Balanced 3,424,783 7.33 25,103,656 24,389,358 American Funds Global Growth Class 2 259,165 25.00 6,479,115 5,790,221 American Funds Growth Class 2 511,532 66.72 34,129,386 27,027,328 American Funds Growth-Income Class 2 258,529 42.26 10,925,443 10,144,081 American Funds International Class 2 987,201 24.72 24,403,607 18,177,806 Delaware VIPT Diversified Income 397,947 10.22 4,067,023 3,859,162 Delaware VIPT High Yield 321,107 5.95 1,910,586 1,935,871 Delaware VIPT REIT Service Class 968,933 15.79 15,299,454 16,763,198 Delaware VIPT Small Cap Value Service Class 282,438 28.57 8,069,256 8,671,934 Delaware VIPT Trend Service Class 80,870 37.88 3,063,337 2,430,127 Dreyfus Developing Leaders 1,371,359 32.34 44,349,750 59,944,447 Dreyfus Stock Index 2,578,850 37.40 96,448,984 68,732,876 DWS VIP Equity 500 Index 173,710 15.53 2,697,717 2,364,020 DWS VIP Small Cap Index 173,992 14.71 2,559,422 2,641,184 Fidelity VIP Asset Manager 3,647,787 16.57 60,443,834 57,623,490 Fidelity VIP Contrafund Service Class 2 857,947 27.46 23,559,230 24,576,309 Fidelity VIP Equity-Income 3,343,111 23.91 79,933,777 77,204,894 Fidelity VIP Growth 2,867,122 45.12 129,364,558 106,396,501 Fidelity VIP Money Market 359,100 1.00 359,101 359,101 Janus Aspen Series Worldwide Growth 535,246 35.33 18,910,256 20,291,907 Lincoln VIPT Baron Growth Opportunities Service Class 777,456 29.94 23,280,138 16,982,521 Lincoln VIPT Cohen & Steers Global Real Estate 4,674 8.05 37,631 41,310 Lincoln VIPT Delaware Bond 366,227 12.68 4,643,024 4,691,920 Lincoln VIPT Delaware Growth and Income 186,832 36.86 6,886,056 5,508,098 Lincoln VIPT Delaware Managed 76,640 16.91 1,295,978 1,265,567 Lincoln VIPT Delaware Social Awareness 557,842 36.65 20,447,129 18,548,411 Lincoln VIPT Janus Capital Appreciation 97,180 24.17 2,348,838 1,761,972 Lincoln VIPT Mondrian International Value 508,768 24.16 12,293,358 11,126,494 Lincoln VIPT T. Rowe Price Structured Mid-Cap Growth 1,774,977 13.44 23,846,822 24,800,985 Lincoln VIPT Wilshire 2010 Profile 4,727 10.61 50,163 49,844 Lincoln VIPT Wilshire 2020 Profile 9,500 10.49 99,692 98,941 Lincoln VIPT Wilshire 2030 Profile 8,600 10.66 91,681 90,368 Lincoln VIPT Wilshire 2040 Profile 4,599 10.50 48,277 48,910 Lincoln VIPT Wilshire Aggressive Profile 151,193 14.28 2,159,193 1,966,481 Lincoln VIPT Wilshire Conservative Profile 251,818 12.01 3,023,331 2,883,813 Lincoln VIPT Wilshire Moderate Profile 339,960 12.93 4,394,324 4,062,110 Lincoln VIPT Wilshire Moderately Aggressive Profile 298,860 13.39 4,000,547 3,757,255 NB AMT Mid-Cap Growth 364,117 28.50 10,377,337 8,495,183 NB AMT Partners 511,860 20.77 10,631,333 9,152,523 T. Rowe Price International Stock 1,325,675 17.71 23,477,701 18,493,280
6. CHANGES IN UNITS OUTSTANDING The change in units outstanding for the year ended December 31, 2007 is as follows:
UNITS UNITS NET INCREASE SUBACCOUNT ISSUED REDEEMED (DECREASE) - --------------------------------------------------------------------- ABVPSF Global Technology Class B 290,814 (196,296) 94,518 ABVPSF Growth Class B 59,307 (56,582) 2,725 ABVPSF Growth and Income Class B 67,117 (36,001) 31,116 American Century VP Balanced 130,741 (238,289) (107,548) American Funds Global Growth Class 2 245,454 (88,961) 156,493 American Funds Growth Class 2 951,939 (926,583) 25,356 American Funds Growth-Income Class 2 339,209 (207,660) 131,549 American Funds International Class 2 676,007 (491,193) 184,814
L-20 6. CHANGES IN UNITS OUTSTANDING (CONTINUED)
UNITS UNITS NET INCREASE SUBACCOUNT ISSUED REDEEMED (DECREASE) - --------------------------------------------------------------------------------------- Delaware VIPT Diversified Income 243,223 (69,885) 173,338 Delaware VIPT High Yield 162,449 (114,797) 47,652 Delaware VIPT REIT Service Class 254,787 (521,592) (266,805) Delaware VIPT Small Cap Value Service Class 251,924 (306,254) (54,330) Delaware VIPT Trend Service Class 128,670 (156,207) (27,537) Dreyfus Developing Leaders 215,463 (654,961) (439,498) Dreyfus Stock Index 207,064 (461,141) (254,077) DWS VIP Equity 500 Index 80,196 (52,961) 27,235 DWS VIP Small Cap Index 108,692 (91,797) 16,895 Fidelity VIP Asset Manager 148,917 (413,911) (264,994) Fidelity VIP Contrafund Service Class2 560,729 (478,655) 82,074 Fidelity VIP Equity-Income 410,931 (670,240) (259,309) Fidelity VIP Growth 342,522 (639,404) (296,882) Fidelity VIP Money Market 73,003 (54,480) 18,523 Janus Aspen Series Worldwide Growth 195,468 (290,534) (95,066) Lincoln VIPT Baron Growth Opportunities Service Class 165,549 (226,617) (61,068) Lincoln VIPT Cohen& Steers Global Real Estate 5,119 (566) 4,553 Lincoln VIPT Delaware Bond 218,540 (147,052) 71,488 Lincoln VIPT Delaware Growth and Income 194,981 (213,384) (18,403) Lincoln VIPT Delaware Managed 72,614 (51,561) 21,053 Lincoln VIPT Delaware Social Awareness 179,644 (272,136) (92,492) Lincoln VIPT Janus Capital Appreciation 79,451 (79,079) 372 Lincoln VIPT Mondrian International Value 514,843 (311,051) 203,792 Lincoln VIPT T. Rowe Price Structured Mid-Cap Growth 166,120 (343,386) (177,266) Lincoln VIPT Wilshire 2010 Profile 5,387 (568) 4,819 Lincoln VIPT Wilshire 2020 Profile 10,372 (576) 9,796 Lincoln VIPT Wilshire 2030 Profile 9,687 (868) 8,819 Lincoln VIPT Wilshire 2040 Profile 6,304 (1,557) 4,747 Lincoln VIPT Wilshire Aggressive Profile 117,377 (46,915) 70,462 Lincoln VIPT Wilshire Conservative Profile 100,935 (27,307) 73,628 Lincoln VIPT Wilshire Moderate Profile 206,008 (73,818) 132,190 Lincoln VIPT Wilshire Moderately Aggressive Profile 222,366 (47,003) 175,363 NB AMT Mid-Cap Growth 844,089 (319,525) 524,564 NB AMT Partners 110,642 (222,987) (112,345) T.Rowe Price International Stock 141,812 (271,513) (129,701)
The change in units outstanding for the year ended December31, 2006 is as follows:
UNITS UNITS NET INCREASE SUBACCOUNT ISSUED REDEEMED (DECREASE) - -------------------------------------------------------------------------------------- ABVPSF Global Technology Class B 179,776 (205,329) (25,553) ABVPSF Growth Class B 64,807 (61,761) 3,046 ABVPSF Growth and Income Class B 55,942 (30,663) 25,279 American Century VP Balanced 106,236 (171,539) (65,303) American Funds Global Growth Class 2 172,553 (38,473) 134,080 American Funds Growth Class 2 960,248 (618,150) 342,098 American Funds Growth-Income Class 2 313,316 (95,992) 217,324 American Funds International Class 2 690,727 (363,656) 327,071 Lincoln VIPT Baron Growth Opportunities Service Class 149,366 (285,484) (136,118) Delaware VIPT Diversified Income 97,178 (56,958) 40,220 Delaware VIPT High Yield 112,091 (30,782) 81,309 Delaware VIPT REIT Service Class 312,335 (217,290) 95,045 Delaware VIPT Small Cap Value Service Class 340,354 (110,154) 230,200 Delaware VIPT Trend Service Class 137,429 (129,423) 8,006 Dreyfus Developing Leaders 166,707 (527,370) (360,663) Dreyfus Stock Index 160,227 (384,889) (224,662) DWS VIP Equity 500 Index 73,160 (38,106) 35,054 DWS VIP Small Cap Index 137,104 (56,942) 80,162 Fidelity VIP Asset Manager 130,860 (378,142) (247,282) Fidelity VIP Contrafund Service Class 2 823,152 (407,722) 415,430 Fidelity VIP Equity-Income 284,390 (350,070) (65,680) Fidelity VIP Growth 199,426 (569,086) (369,660)
L-21 6. CHANGES IN UNITS OUTSTANDING (CONTINUED)
UNITS UNITS NET INCREASE SUBACCOUNT ISSUED REDEEMED (DECREASE) - ------------------------------------------------------------------------------------- Fidelity VIP Money Market 18,787 (19,522) (735) Janus Aspen Series Worldwide Growth 112,717 (315,224) (202,507) Lincoln VIPT T. Rowe Price Structured Mid-Cap Growth 151,367 (391,447) (240,080) Lincoln VIPT Wilshire Aggressive Profile 97,142 (30,343) 66,799 Lincoln VIPT Delaware Bond 200,219 (98,067) 102,152 Lincoln VIPT Janus Capital Appreciation 73,133 (56,537) 16,596 Lincoln VIPT Wilshire Conservative Profile 185,332 (16,594) 168,738 Lincoln VIPT Delaware Growth and Income 141,028 (141,999) (971) Lincoln VIPT Mondrian International Value 375,309 (64,284) 311,025 Lincoln VIPT Delaware Managed 42,238 (30,886) 11,352 Lincoln VIPT Wilshire Moderate Profile 206,742 (23,017) 183,725 Lincoln VIPT Wilshire Moderately Aggressive Profile 113,306 (23,222) 90,084 Lincoln VIPT Delaware Social Awareness 154,893 (182,109) (27,216) NB AMT Mid-Cap Growth 339,154 (239,548) 99,606 NB AMT Partners 141,292 (231,546) (90,254) T.Rowe Price International Stock 133,896 (231,154) (97,258)
L-22 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM Board of Directors of The Lincoln National Life Insurance Company and Contract Owners of Lincoln National Variable Annuity Account L We have audited the accompanying statement of assets and liabilities of Lincoln National Variable Annuity Account L ("Variable Account"), comprised of the subaccounts described in Note 1, as of December 31, 2007, the related statement of operations for the year then ended, and the statements 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 Account's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Variable Account's internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Variable Account's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our procedures included confirmation of investments owned as of December 31, 2007, by correspondence with the custodian. 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 each of the respective subaccounts constituting Lincoln National Variable Annuity Account L at December 31, 2007, the results of their operations for the year then ended, and the changes in their net assets for each of the two years in the period then ended, in conformity with U.S. generally accepted accounting principles. /s/ Ernst & Young LLP Fort Wayne, Indiana March 7, 2008 L-23 -----END PRIVACY-ENHANCED MESSAGE-----