485BPOS 1 a2202226z485bpos.txt 485BPOS As filed with the Securities and Exchange Commission on April 6, 2011 1933 Act Registration No. 333-04999 1940 Act Registration No. 811-07645 -------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM N-4 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 / / POST-EFFECTIVE AMENDMENT NO. 21 /X/ and REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 / / AMENDMENT NO. 31 /X/ Lincoln National Variable Annuity Account L (Exact Name of Registrant) Group Variable Annuity I, II & III THE LINCOLN NATIONAL LIFE INSURANCE COMPANY (Name of Depositor) 1300 South Clinton Street Post Office Box 1110 Fort Wayne, Indiana 46801 (Address of Depositor's Principal Executive Offices) Depositor's Telephone Number, Including Area Code: (260) 455-2000 Nicole S. Jones, Esquire The Lincoln National Life Insurance Company 1300 South Clinton Street Post Office Box 1110 Fort Wayne, IN 46801 (Name and Address of Agent for Service) Copy to: Jeffrey V. Gery, Esquire The Lincoln National Life Insurance Company 1300 South Clinton Street Post Office Box 1110 Fort Wayne, IN 46801 Approximate Date of Proposed Public Offering: Continuous It is proposed that this filing will become effective: / / immediately upon filing pursuant to paragraph (b) of Rule 485 /x/ on May 1, 2011, pursuant to paragraph (b) of Rule 485 / / 60 days after filing pursuant to paragraph (a)(1) of Rule 485 / / on _______________________, pursuant to paragraph (a)(1) of Rule 485 Title of Securities being registered: Interests in a separate account under group flexible payment deferred variable annuity contracts. 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 46801-2340 1-800-341-0441 www.LincolnFinancial.com This prospectus describes a group annuity contract and an individual certificate that is issued by The Lincoln National Life Insurance Company (Lincoln Life). This prospectus is primarily for use with 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 a participant 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 VPS Global Thematic Growth Portfolio AllianceBernstein VPS Growth Portfolio** AllianceBernstein VPS Growth and Income Portfolio American Century Variable Portfolios (Class I): Balanced Fund** Inflation Protection 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 BlackRock Variable Series Funds, Inc. (Class I): BlackRock Global Allocation V.I. Fund Delaware VIP (Reg. TM) Trust (Service Class): Delaware VIP (Reg. TM) REIT Series Delaware VIP (Reg. TM) Small Cap Value Series Delaware VIP (Reg. TM) Smid Cap Growth Series (formerly Delaware VIP (Reg. TM) Trend Series) Delaware VIP (Reg. TM) Trust (Standard Class): Delaware VIP (Reg. TM) Diversified Income Series Delaware VIP (Reg. TM) High Yield Series Dreyfus Variable Investment Fund (Initial Class): Dreyfus Opportunistic Small Cap Portfolio** Dreyfus Stock Index Fund, Inc.** DWS Investments VIT Funds (Class A): DWS Equity 500 Index VIP DWS Small Cap Index VIP** DWS Variable Series II (Class A): DWS Alternative Asset Allocation Plus VIP Portfolio 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 Portfolio** 1 Lincoln Variable Insurance Products Trust (Service Class): LVIP Baron Growth Opportunities Fund LVIP Delaware Diversified Floating Rate Fund* Lincoln Variable Insurance Products Trust (Standard Class): LVIP Cohen & Steers Global Real Estate Fund LVIP Delaware Bond Fund LVIP Delaware Foundation Aggressive Allocation Fund LVIP Delaware Foundation Conservative Allocation Fund LVIP Delaware Foundation Moderate Allocation Fund LVIP Delaware Growth and Income Fund LVIP Delaware Social Awareness Fund LVIP Global Income Fund LVIP Janus Capital Appreciation Fund LVIP Mondrian International Value Fund LVIP SSgA Bond Index Fund LVIP SSgA Emerging Markets 100 Fund LVIP SSgA Global Tactical Allocation Fund (formerly LVIP Wilshire Aggressive Profile Fund) LVIP SSgA International Index Fund LVIP T. Rowe Price Structured Mid-Cap Growth Fund LVIP 2010 Profile Fund (formerly LVIP Wilshire 2010 Profile Fund) LVIP 2020 Profile Fund (formerly LVIP Wilshire 2020 Profile Fund) LVIP 2030 Profile Fund (formerly LVIP Wilshrie 2030 Profile Fund) LVIP 2040 Profile Fund (formerly LVIP Wilshire 2040 Profile Fund) LVIP 2050 Profile Fund* LVIP Conservative Profile Fund (formerly LVIP Wilshire Conservative Profile Fund) LVIP Moderate Profile Fund (formerly LVIP Wilshire Moderate Profile Fund) LVIP Moderately Aggressive Profile Fund (formerly LVIP Wilshire Moderately 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** * Not all funds are available in all contracts. Refer to Description of Funds for specific information regarding the availability of funds. ** It is currently anticipated that during the third quarter of 2011, 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. May 1, 2011 2 Table of Contents
Item Page Special Terms 4 Expense Tables 5 Summary of Common Questions 6 The Lincoln National Life Insurance Company 8 Fixed Side of the Contract 8 Variable Annuity Account (VAA) 9 Investments of the VAA 9 Charges and Other Deductions 14 The Contracts 17 Purchase of the Contracts 17 Transfers On or Before the Annuity Commencement Date 18 Death Benefit Before the Annuity Commencement Date 20 Withdrawals 22 Annuity Payouts 24 Distribution of the Contracts 25 Federal Tax Matters 26 Additional Information 29 Voting Rights 29 Return Privilege 30 Other Information 30 Legal Proceedings 30 Contents of the Statement of Additional Information (SAI) for Lincoln National Variable Annuity Account L 32 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. Good Order - The actual receipt at our Home Office of the requested transaction in writing or by other means we accept, along with all information and supporting legal documentation necessary to effect the transaction. The forms we provide will identify the necessary documentation. We may, in our sole discretion, determine whether any particular transaction request is in good order, and we reserve the right to change or waive any good order requirements at any time. 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. 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, 2010. 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): 2.94% 0.29% Net Total Annual Fund Operating Expenses (after contractual waivers/reimbursements): 1.44% 0.29%
5 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* $ 904 $1,725 $2,563 $4,291 GVA II Standard* 1,004 1,826 2,664 4,505 GVA III Standard* 400 1,212 2,041 4,189
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* $ 399 $1,209 $2,037 $4,181 GVA II Standard* 398 1,207 2,032 4,172 GVA III Standard* 400 1,212 2,041 4,189
* 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. Certain underlying funds have reserved the right to impose fees when fund shares are redeemed within a specified period of time of purchase ("redemption fees"). As of the date of this prospectus, none have done so. See The Contracts - Market Timing for a discussion of redemption fees. For information concerning compensation paid for the sale of the contracts, see Distribution of the Contracts. 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 Payouts. 6 What charges do I pay under the contract? If participants in GVA I or GVA II withdraw account values, 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. We charge an annual 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 or a time as required by law. 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 his or her fixed account holdings to the VAA each year, unless the participant intends to liquidate his or her 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 participants 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. 7 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 amounts promised to policy owners under the policies. Depending on when you purchased your contract, you may be permitted to make allocations to the fixed account, which is part of our general account. See The Fixed Side of the Contract. In addition, any guarantees under the contract that exceed your contract value, such as those associated with death benefit options and Living Benefit riders are paid from our general account (not the VAA). Therefore, any amounts that we may pay under the contract in excess of contract value are subject to our financial strength and claims-paying ability and our long-term ability to make such payments. With respect to the issuance of the contracts, Lincoln Life does not file periodic financial reports with the SEC pursuant to the exemption for life insurance companies provided under Rule 12h-7 of the Securities Exchange Act of 1934. We issue other types of insurance policies and financial products as well, and we also pay our obligations under these products from our assets in the general account. Moreover, unlike assets held in the VAA, the assets of the general account are subject to the general liabilities of the Company and, therefore, to the Company's general creditors. In the event of an insolvency or receivership, payments we make from our general account to satisfy claims under the contract would generally receive the same priority as our other contractowner obligations. Our Financial Condition. Among the laws and regulations applicable to us as an insurance company are those which regulate the investments we can make with assets held in our general account. In general, those laws and regulations determine the amount and type of investments which we can make with general account assets. In addition, state insurance regulations require that insurance companies calculate and establish on their financial statements, a specified amount of reserves in order to meet the contractual obligations to pay the claims of our policyholders. In order to meet our claims-paying obligations, we regularly monitor our reserves to ensure we hold sufficient amounts to cover actual or expected contract and claims payments. However, it is important to note that there is no guarantee that we will always be able to meet our claims paying obligations, and that there are risks to purchasing any insurance product. State insurance regulators also require insurance companies to maintain a minimum amount of capital in excess of liabilities, which acts as a cushion in the event that the insurer suffers a financial impairment, based on the inherent risks in the insurer's operations. These risks include those associated with losses that we may incur as the result of defaults on the payment of interest or principal on assets held in our general account, which include bonds, mortgages, general real estate investments, and stocks, as well as the loss in value of these investments resulting from a loss in their market value. How to Obtain More Information. We encourage both existing and prospective policyholders to read and understand our financial statements. We prepare our financial statements on both a statutory basis and according to Generally Accepted Accounting Principles (GAAP). Our audited GAAP financial statements, as well as the financial statements of the VAA, are located in the SAI. If you would like a free copy of the SAI, please write to us at: PO Box 2340, Fort Wayne, IN 46801-2340 , or call 1-800-341-0441. In addition, the Statement of Additional Information is available on the SEC's website at http://www.sec.gov. You may obtain our audited statutory financial statements and any unaudited statutory financial statements that may be available by visiting our website at www.LincolnFinancial.com. You also will find on our website information on ratings assigned to us by one or more independent rating organizations. These ratings are opinions of an operating insurance company's financial capacity to meet the obligations of its insurance and annuity contracts based on its financial strength and/or claims-paying ability. Additional information about rating agencies is included in the Statement of Additional Information. Lincoln Financial Group is the marketing name for Lincoln National Corporation (NYSE:LNC) and its affiliates. Through its affiliates, Lincoln Financial Group offers annuities, life, group life and disability insurance, 401(k) and 403(b) plans, 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. 8 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 December 31, 2010 financial statements of the VAA and the December 31, 2010 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 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. 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 0.25%, 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. 9 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, Fidelity, and Lincoln Funds offered as part of this contract make payments to us under their distribution plans (12b-1 plans). The payment rates range up to 0.30% 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 2011: oAllianceBernstein VPS Growth Portfolio (Class B) with AllianceBernstein VPS Growth and Income Portfolio (Class B); oAmerican Century VP Balanced Fund (Class 1) with LVIP SSgA Bond Index Fund (Standard Class); oDreyfus VIF Opportunistic Small-Cap Portfolio (Initial Class) with LVIP SSgA Small Cap Index (Standard Class); oDreyfus Stock Index Fund, Inc. (Initial Class) with LVIP SSgA S&P 500 Index Fund (Standard Class); oDWS Small-Cap Index VIP (Class A) with LVIP SSgA Small-Cap Index Fund (Standard Class); oFidelity VIP Asset Manager Portfolio (Initial Class) with LVIP SSgA Bond Index Fund (Standard Class); oJanus Aspen Series Worldwide Portfolio (Institutional Class) with LVIP SSgA S&P 500 Index Fund (Standard Class); oNeuberger Berman AMT Partners Portfolio (I Class) with LVIP SSgA S&P 500 Index Fund (Class B); oNeuberger Berman Mid-Cap Growth Portfolio (I Class) with LVIP SSgA Small-Cap Index Fund (Standard Class); oT. Rowe Price International Stock Portfolio with LVIP Mondrian International Value 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. Certain funds invest substantially all of their assets in other funds. As a result, you will pay fees and expenses at both fund levels. This will reduce your investment return. These arrangements are referred to as funds of funds. Funds of funds structures may have higher expenses than funds that invest directly in debt or equity securities. Following are brief summaries of the fund descriptions. More detailed information may be obtained from the current prospectus for each fund. You should read each fund prospectus carefully before investing. Prospectuses for each fund are available by contacting us. In addition, if you receive a summary prospectus for a fund, you may obtain a full statutory prospectus by referring to the contact information for the fund company on the cover page of the summary prospectus. 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 VPS Global Thematic Growth Portfolio: Long-term growth of capital. o AllianceBernstein VPS Growth Portfolio: Long-term growth of capital. It is currently anticipated that during the third quarter of 2011, we will close and replace this investment option. o AllianceBernstein VPS Growth and Income Portfolio: Long-term growth of capital. American Century Variable Products, advised by American Century Investment Management, Inc. o Balanced Fund: Long-term capital growth & current income. It is currently anticipated that during the third quarter of 2011, we will close and replace this investment option. 10 o Inflation Protection Fund: Long-term total return. American Funds Insurance SeriesSM, advised by Capital Research and Management Company o Global Growth Fund: Long-term growth. o Growth Fund: Long-term growth. o Growth-Income Fund: Long-term growth and income. o International Fund: Long-term growth. BlackRock Variable Series Funds, Inc., advised by BlackRock Advisors, LLC and subadvised by BlackRock Investment Management, LLC. o BlackRock Global Allocation V.I. Fund: High total investment return. Delaware VIP (Reg. TM) Trust, advised by Delaware Management Company* o Diversified Income Series: Long-term total return. o High Yield Series: Total return and secondarily high current income. o REIT Series: Total return. o Small Cap Value Series: Capital appreciation. o Smid Cap Growth Series: Long-term capital appreciation. (formerly Trend Series) Dreyfus Variable Investment Fund, advised by The Dreyfus Corporation o Opportunistic Small Cap Portfolio: Capital growth. It is currently anticipated that during the third quarter of 2011, we will close and replace this investment option. o Stock Index Fund, Inc.: 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 2011, we will close and replace this investment option. DWS Investments VIT Funds, advised by Deutsche Asset Management, Inc. and subadvised by Northern Trust Investments, Inc. o DWS Equity 500 Index VIP: Replicate S&P 500 (Reg. TM) Index before deduction of expenses. (Sub-advised by Northern Trust Investments, Inc.) o DWS Small Cap Index VIP: Replicate Russell 2000 (Reg. TM) Index before deduction of expenses. (Sub-advised by Northern Trust Investments, Inc.) It is currently anticipated that during the third quarter of 2011, we will close and replace this investment option. DWS Variable Series II, advised by Deutsche Asset management, Inc. and subadvised by RREEF America, L.L.C. o DWS Alternative Asset Allocation Plus VIP Portfolio: Capital appreciation; a fund of funds. Fidelity (Reg. TM) Variable Insurance Products, advised by Fidelity Management and Research Company and subadvised by FMR Co., Inc. o Asset Manager Portfolio: High total return. It is currently anticipated that during the third quarter of 2011, we will close and replace this investment option. o Contrafund (Reg. TM) Portfolio: Long-term capital appreciation. o Equity-Income Portfolio: Reasonable income. o Growth Portfolio: Capital appreciation. Janus Aspen Series, advised by Janus Capital Management LLC o Worldwide Portfolio: Long-term growth. It is currently anticipated that during the third quarter of 2011, we will close and replace this investment option. Lincoln Variable Insurance Products Trust, advised by Lincoln Investment Advisors o LVIP Baron Growth Opportunities Fund: Capital appreciation. (Sub-advised by BAMCO, Inc.) o LVIP Cohen & Steers Global Real Estate Fund: Total return. (Sub-advised by Cohen & Steers Capital Management) 11 o LVIP Delaware Bond Fund: Current income. (Sub-advised by Delaware Management Company)* o LVIP Delaware Diversified Floating Rate Fund: Total return This fund will be available on or about May 16, 2011. Consult your financial advisor. o LVIP Delaware Foundation Aggressive Allocation Fund: Long-term capital growth (Sub-advised by Delaware Management Company)* o LVIP Delaware Foundation Conservative Allocation Fund: Current income and preservation of capital with capital appreciation. (Sub-advised by Delaware Management Company)* o LVIP Delaware Foundation Moderate Allocation Fund: Capital appreciation with current income. (Sub-advised by Delaware Management Company)* o LVIP Delaware Growth and Income Fund: Capital appreciation. (Sub-advised by Delaware Management Company)* o LVIP Delaware Social Awareness Fund: Capital appreciation. (Sub-advised by Delaware Management Company)* o LVIP Global Income Fund: Current income consistent with preservation of capital. (Sub-advised by Mondrian Investment Partners Limited and Franklin Advisors, Inc.) o LVIP Janus Capital Appreciation Fund: Long-term growth. (Sub-advised by Janus Capital Management LLC) o LVIP Mondrian International Value Fund: Long-term capital appreciation. (Sub-advised by Mondrian Investment Partners Limited) o LVIP SSgA Bond Index Fund: Replicate Barclays Aggregate Bond Index. (Sub-advised by SSgA Funds Management, Inc.) o LVIP SSgA Emerging Markets 100 Fund: Long-term capital appreciation. (Sub-advised by SSgA Funds Management, Inc.) o LVIP SSgA Global Tactical Allocation Fund: Long-term growth of capital; a fund of funds. (formerly LVIP Willshire Aggressive Profile Fund) (Sub-advised by SSgA Funds Management, Inc.) o LVIP SSgA International Index Fund: Replicate broad foreign index. (Sub-advised by SSgA Funds Management, Inc.) o LVIP T. Rowe Price Structured Mid-Cap Growth Fund: Maximum capital appreciation. (Sub-advised by T. Rowe Price Associates, Inc.) o LVIP 2010 Profile Fund: Total return; a fund of funds. (formerly LVIP Wilshire 2010 Profile Fund) o LVIP 2020 Profile Fund: Total return; a fund of funds. (formerly LVIP Wilshire 2020 Profile Fund) o LVIP 2030 Profile Fund: Total return; a fund of funds. (formerly LVIP Wilshire 2030 Profile Fund) o LVIP 2040 Profile Fund: Total return; a fund of funds. (formerly LVIP Wilshire 2040 Profile Fund) o LVIP 2050 Profile Fund: Total return; a fund of funds. This fund will be available on or about May 16, 2011. Consult your financial advisor. o LVIP Conservative Profile Fund: Current income; a fund of funds. (formerly LVIP Wilshire Conservative Profile Fund) o LVIP Moderate Profile Fund: Total return; a fund of funds. (formerly LVIP Wilshire Moderate Profile Fund) o LVIP Moderately Aggressive Profile Fund: Growth and income; a fund of funds. (formerly LVIP Wilshire Moderately Aggressive Profile Fund) Neuberger Berman Advisers Management Trust, advised by Neuberger Berman Management Inc. and subadvised by Neuberger Berman LLC. o Mid-Cap Growth Portfolio: Capital appreciation. It is currently anticipated that during the third quarter of 2011, we will close and replace this investment option. 12 o Partners Portfolio: Capital appreciation. It is currently anticipated that during the third quarter of 2011, 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 2011, we will close and replace this investment option. *Investments in Delaware Investments VIP Series, Delaware Funds, LVIP Delaware Funds or Lincoln Life accounts managed by Delaware Investment Advisors, a series of Delaware Management Business Trust, are not and will not be deposits with or liabilities of Macquarie Bank Limited ABN 46008 583 542 and its holding companies, including their subsidiaries or related companies, and are subject to investment risk, including possible delays in prepayment and loss of income and capital invested. No Macquarie Group company guarantees or will guarantee the performance of the Series or Funds or accounts, the repayment of capital from the Series or Funds or account, or any particular rate of return. 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. 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 and, if required, after approval from the SEC. 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. 13 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). 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. 14 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 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. 15 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 contracts 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 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, unless the governmental entity dictates otherwise, 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 tax rates generally depend upon the law of your state of residence. The tax rates range from zero to 3.5%. Other Charges and Deductions The mortality and expense risk charge of 1.00% of the contract value will be assessed on all variable annuity payouts, including options that may be offered that do not have a life contingency and therefore no mortality risk. This charge covers the expense risk and administrative services listed previously in this prospectus. The expense risk is the risk that our costs in providing the serices will exceed our revenues from contract charges. 16 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. 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 17 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 Home 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. 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. 18 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 received in good order 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 received in good order 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 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. 19 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, first-class 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. 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 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 certain subaccounts, or the fixed side of the contract, 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. Beginning May 1, 2010, this service will no longer be available unless the contractowner has enrolled in this service prior to this date. 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 20 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. 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 death benefit is over $10,000, the proceeds will be placed into a SecureLine (Reg. TM) account in the recipient's name as the owner of the account. SecureLine (Reg. TM) is a service we offer to help the recipient manage the death benefit proceeds. With SecureLine (Reg. TM), an interest bearing account is established from the proceeds payable on a policy or contract administered by us. The recipient is the owner of the account, and is the only one authorized to transfer proceeds from the account. Instead of mailing the recipient a check, we will send a checkbook so that the recipient will have access to the account by writing a check. The recipient may choose to leave the proceeds in this account, or may begin writing checks right away. If the recipient decides he or she wants the entire proceeds immediately, the recipient may write one check for the entire account balance. The recipient can write as many checks as he or she wishes. We may at our discretion set minimum withdrawal amounts per check. The total of all checks written cannot exceed the account balance. The SecureLine (Reg. TM) account is part of our general account. It is not a bank account and it is not insured by the FDIC or any other government agency. As part of our general account, it is subject to the claims of our creditors. We receive a benefit from all amounts left in the SecureLine (Reg. TM) account. The recipient may request that surrender proceeds be paid directly to him or her instead of applied to a SecureLine (Reg. TM) account. Interest credited in the SecureLine (Reg. TM) account is taxable as ordinary income in the year such interest is credited, and is not tax deferred. We recommend that the recipient consult a tax advisor to determine the tax consequences associated with the payment of interest on amounts in the SecureLine (Reg. TM) account. The balance in the recipient's SecureLine (Reg. TM) account starts earning interest the day the account is opened and will continue to earn interest until all funds are withdrawn. Interest is compounded daily and credited to the recipient's account on the last day of each month. The interest rate will be updated monthly and we may increase or decrease the rate at our discretion. The interest rate credited to the recipient's SecureLine (Reg. TM) account may be more or less than the rate earned on funds held in our general account. There are no monthly fees. The recipient will be charged a fee for a stop payment or if a check is returned for insufficient funds. 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. 21 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 22 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. If you request a lump sum surrender and your surrender value is over $10,000, your money will be placed into a SecureLine (Reg. TM) account in your name. SecureLine (Reg. TM) is a service we offer to help you manage your surrender proceeds. With SecureLine (Reg. TM), an interest bearing draft account is established from the proceeds payable on a policy or contract administered by us. You are the owner of the account, and are the only one authorized to transfer proceeds from the account. Instead of mailing you a check, we will send a checkbook so that you will have access to the account by writing a check. You may choose to leave the proceeds in this account, or you may begin writing checks right away. If you decide you want the entire proceeds immediately, you may write one check for the entire account balance. The SecureLine (Reg. TM) account is part of our general account. It is not a bank account and it is not insured by the FDIC or any other government agency. As part of our general account, it is subject to the claims of our creditors. We receive a benefit from all amounts left in the SecureLine (Reg. TM) account. You may request that surrender proceeds be paid directly to you instead of applied to a SecureLine (Reg. TM) account. Interest credited in the SecureLine (Reg. TM) account is taxable as ordinary income in the year such interest is credited, and is not tax deferred. We recommend that you consult your tax advisor to determine the tax consequences associated with the payment of interest on amounts in the SecureLine (Reg. TM) account. The balance in your SecureLine (Reg. TM) account starts earning interest the day your account is opened and will continue to earn interest until all funds are withdrawn. Interest is compounded daily and credited to your account on the last day of each month. The interest rate will be updated monthly and we may increase or decrease the rate at our discretion. The interest rate credited to your SecureLine (Reg. TM) account may be more or less than the rate earned on funds held in our general account. There are no monthly fees. You may be charged a fee if you stop a payment or if you present a check for payment without sufficient funds. 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. 23 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). 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. Contractowner Questions The obligations to purchasers under the contracts are those of Lincoln Life. This prospectus provides a general description of the material features 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. 24 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. 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. Distribution of the Contracts Lincoln Financial Distributors, Inc. ("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 and/or Lincoln Financial Securities Corporation (collectively, "LFN"), also affiliates of ours. The Principal Underwriter has also entered into selling agreements with broker-dealers that are unaffiliated with us ("Selling Firms"). 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. You may ask your registered representative how he/she will personally be compensated, in whole or in part, for the sale of the contract to you or for any alternative proposal that may have been presented to you. You may wish to take such compensation payments into account when considering and evaluating any recommendation made to you in connection with the purchase of a contract. The following paragraphs describe how payments are made by us and the Principal Underwriter to various parties. Compensation Paid to LFN. The maximum commission the Principal Underwriter pays to LFN is 3.50% of purchase payments. LFN 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 LFN 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 LFN, including the following sales expenses: sales representative training allowances; compensation and bonuses for LFN's management team; advertising expenses; and all other expenses of distributing the contracts. LFN pays its sales representatives a portion of the commissions received for their sales of contracts. LFN 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 LFN. Non-cash compensation items may include conferences, seminars, trips, entertainment, merchandise and other similar items. In addition, LFN 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 LFN sales representatives and/or their managers qualify for such benefits. LFN 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 LFN, 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 25 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 2010 is contained in the SAI. 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. 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) 26 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. 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. If your contract was issued pursuant to a 403(b) plan, we now are generally required to confirm, with your 403(b) plan sponsor or otherwise, that contributions (purchase payments), as well as surrenders, loans or transfers you request, comply with applicable tax requirements and to decline purchase payments or requests that are not in compliance. We will defer crediting purchase payments we receive or processing payments you request until all information required under the tax law has been received. By directing purchase payments to the contract or requesting a surrender, loan or transfer, you consent to the sharing of confidential information about you, the contract, and transactions under the contract and any other 403(b) contracts or accounts you have under the 403(b) plan among us, your employer or plan sponsor, any plan administrator or recordkeeper, and other product providers. Also, for 403(b) contracts issued on or after January 1, 2009, amounts attributable to employer contributions are subject to restrictions on withdrawals specified in your employer's 403(b) plan, in order to comply with new tax regulations (previously, only amounts attributable to your salary-reduction contributions were subject to withdrawal restrictions). Amounts transferred to a 403(b) contract from other 403(b) contracts or accounts must generally be subject to the same restrictions on withdrawals applicable under the prior contract or account. 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 issued little 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 Minimum annual distributions are required under most qualified plans once you reach a certain age, typically age 701/2, as described below. 27 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 (RMDs) 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 regulations applicable to required minimum distributions include a rule that 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. 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. Unearned Income Medicare Contribution Congress enacted the "Unearned Income Medicare Contribution" as a part of the Health Care and Education Reconciliation Act of 2010. This new tax, which affects individuals whose modified adjusted gross income exceeds certain thresholds, is a 3.8% tax on the lesser of (i) the individual's "unearned income," or (ii) the dollar amount by which the individual's modified adjusted gross income exceeds the applicable threshold. Distributions that you take from your contract are not included in the calculation of unearned income because your contract is a qualified plan contract. However, the amount of any such distribution is included in determining whether you exceed the modified adjusted gross income threshold. The tax is effective for tax years after December 31, 2012. Please consult your tax advisor to determine whether your annuity distributions are subject to this tax. 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 28 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. The PPA permits direct conversions from certain qualified, 403(b) or 457(b) plans to Roth IRAs (effective for distribution after 2007). 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. 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 an IRA or a qualified retirement plan receiving special tax treatment under the tax code. 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. 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 VAA 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 29 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 The Bank of New York Mellon, 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 Home 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. 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 financial position of the VAA, or the principal underwriter. 30 (This page intentionally left blank) 31 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 Capital Markets Advertising & Ratings 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 46801-2340 32 (This page intentionally left blank) 33 (This page intentionally left blank) 34 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. The methodology of determining accumulation unit values may be found in the prospectus (see The Contracts - Valuation of Accumulation Units).
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 Thematic Growth 2000 . 10.000 7.094 58 10.000 7.098 1(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 2008 . 5.839 3.037 535 5.946 3.100 27 2009 . 3.037 4.604 533 3.100 4.712 28 2010 . 4.604 5.405 493 4.712 5.546 22 --------- ------ ----- --- ------ ----- ---- AllianceBernstein VPS Growth 2000 . 10.000 8.743 8 10.000 8.748 1(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 2008 . 8.555 4.862 171 8.711 4.963 10 2009 . 4.862 6.396 164 4.963 6.545 12 2010 . 6.396 7.269 152 6.545 7.457 10 --------- ------ ----- --- ------ ----- ---- AllianceBernstein VPS Growth and Income 2004 . 10.249 11.133 15 10.467 11.149 1(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 2008 . 13.862 8.144 91 13.996 8.238 4 2009 . 8.144 9.704 99 8.238 9.841 6 2010 . 9.704 10.837 78 9.841 11.017 5 --------- ------ ------ --- ------ ------ ---- American Century VP Balanced Fund 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 2008 . 28.754 22.680 700 29.371 23.224 61 2009 . 22.680 25.931 622 23.224 26.620 54 2010 . 25.931 28.660 566 26.620 29.495 41 --------- ------ ------ ----- ------ ------ ---- American Century VP Inflation Protection 2009 . 10.063 10.611 42 10.487 10.626 1(1) 2010 . 10.611 11.069 71 10.626 11.113 1(1) --------- ------ ------ ----- ------ ------ ----
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 Global Growth Fund 2004 . 10.188 11.310 16 11.347 11.327 1(1) 2005 . 11.310 12.774 85 11.327 12.826 1(1) 2006 . 12.774 15.230 217 12.826 15.331 3 2007 . 15.230 17.317 357 15.331 17.475 19 2008 . 17.317 10.563 348 17.475 10.686 28 2009 . 10.563 14.882 327 10.686 15.093 29 2010 . 14.882 16.465 312 15.093 16.740 26 --------- ------ ------ --- ------ ------ ---- American Funds Growth Fund 2000 . 10.000 8.991 88 10.000 8.997 1(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 2008 . 11.477 6.367 2,498 11.688 6.500 280 2009 . 6.367 8.788 2,400 6.500 8.994 319 2010 . 8.788 10.325 2,209 8.994 10.594 182 --------- ------ ------ ----- ------ ------ ----- 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 2008 . 13.644 8.395 705 13.767 8.493 44 2009 . 8.395 10.908 675 8.493 11.062 46 2010 . 10.908 12.034 642 11.062 12.234 36 --------- ------ ------ ----- ------ ------ ----- American Funds International Fund 2000 . 10.000 8.582 17 10.000 8.587 1(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 2008 . 15.240 8.733 1,478 15.519 8.915 63 2009 . 8.733 12.370 1,415 8.915 12.659 67 2010 . 12.370 13.132 1,245 12.659 13.473 39 --------- ------ ------ ----- ------ ------ ----- Blackrock Global Allocation VI 2009 . 10.224 11.400 33 11.340 11.415 1(1) 2010 . 11.400 12.421 71 11.415 12.471 1(1) --------- ------ ------ ----- ------ ------ ----- Delaware VIP (Reg. TM) Diversified Income Series 2004 . 10.044 10.935 36 10.563 10.951 1(1) 2005 . 10.935 10.778 118 10.951 10.820 1(1) 2006 . 10.778 11.516 153 10.820 11.590 5 2007 . 11.516 12.271 314 11.590 12.381 18 2008 . 12.271 11.597 468 12.381 11.730 33 2009 . 11.597 14.577 467 11.730 14.781 38 2010 . 14.577 15.595 452 14.781 15.853 20 --------- ------ ------ ----- ------ ------ ----- Delaware VIP (Reg. TM) High Yield Series 2005 . 10.182 10.273 34 10.234 10.289 1(1) 2006 . 10.273 11.437 115 10.289 11.483 2 2007 . 11.437 11.640 149 11.483 11.716 15 2008 . 11.640 8.738 133 11.716 8.817 16 2009 . 8.738 12.888 185 8.817 13.037 21 2010 . 12.888 14.715 198 13.037 14.922 10 --------- ------ ------ ----- ------ ------ -----
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) Delaware VIP (Reg. TM) REIT Series 2000 . 10.000 10.569 56 10.000 10.575 1(1) 2001 . 10.569 11.371 179 10.575 11.406 1(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 2008 . 23.779 15.235 536 24.212 15.552 28 2009 . 15.235 18.589 458 15.552 19.023 25 2010 . 18.589 23.301 445 19.023 23.904 20 --------- ------ ------ --- ------ ------ ---- Delaware VIP (Reg. TM) 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 2008 . 13.856 9.593 534 13.982 9.704 36 2009 . 9.593 12.495 515 9.704 12.672 40 2010 . 12.495 16.319 510 12.672 16.592 30 --------- ------ ------ --- ------ ------ ---- Delaware VIP (Reg. TM) Smid Cap Growth(4) 2000 . 10.000 7.781 45 10.000 7.786 1(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 2008 . 9.295 4.890 236 9.464 4.992 37 2009 . 4.890 7.474 234 4.992 7.648 49 2010 . 8.929 10.115 241 9.155 10.376 26 --------- ------ ------ --- ------ ------ ---- Dreyfus Opportunistic Small Cap 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 2008 . 23.370 14.439 1,548 23.871 14.786 111 2009 . 14.439 18.018 1,363 14.786 18.497 100 2010 . 18.018 23.395 1,217 18.497 24.077 84 --------- ------ ------ ----- ------ ------ ----- Dreyfus Stock Index Fund 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 2008 . 46.657 29.036 1,620 47.659 29.734 135 2009 . 29.036 36.317 1,433 29.734 37.283 120 2010 . 36.317 41.291 1,280 37.283 42.496 98 --------- ------ ------ ----- ------ ------ ----- DWS VIP Alternative Asset Allocation Plus 2009 . 11.349 11.247 1(1) N/A N/A N/A 2010 . 11.247 12.524 7 N/A N/A N/A --------- ------ ------ ------ ------ ------ -----
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) DWS VIP Equity 500 Index 2004 . 10.278 11.100 69 10.068 11.116 1(1) 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 2008 . 13.715 8.534 226 13.838 8.632 5 2009 . 8.534 10.673 226 8.632 10.823 7 2010 . 10.673 12.121 195 10.823 12.321 5 --------- ------ ------ ---- ------ ------ --- DWS VIP Small Cap Index 2004 . 10.286 11.788 36 10.188 11.806 1(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 2008 . 13.748 8.966 161 13.872 9.070 13 2009 . 8.966 11.236 147 9.070 11.394 15 2010 . 11.236 14.060 135 11.394 14.294 13 --------- ------ ------ ---- ------ ------ ---- Fidelity (Reg. TM) VIP Money Market Portfolio (Pending Allocation Account) 2000 . 13.192 14.024 7 13.195 14.054 1(1) 2001 . 14.024 14.610 7 14.054 14.633 1(1) 2002 . 14.610 14.859 5 14.633 14.871 1(1) 2003 . 14.859 15.007 3 14.871 15.020 0 2004 . 15.007 15.189 3 15.021 15.214 1(1) 2005 . 15.189 15.649 3 15.214 15.673 1(1) 2006 . 15.649 16.412 3 15.673 16.438 1(1) 2007 . 16.412 17.267 20 16.438 17.295 1(1) 2008 . 17.267 17.788 3 17.295 17.818 1(1) 2009 . 17.788 17.916 1(1) N/A N/A N/A 2010 . 17.916 17.960 1(1) 17.946 17.991 1(1) --------- ------ ------ ----- ------ ------ ----- Fidelity (Reg. TM) VIP Asset Manager Portfolio 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 2008 . 32.126 22.672 1,616 32.815 23.216 79 2009 . 22.672 28.981 1,451 23.216 29.751 73 2010 . 28.981 32.785 1,282 29.751 33.741 62 --------- ------ ------ ------ ------ ------ ----- Fidelity (Reg. TM) VIP Contrafund (Reg. TM) Portfolio 2000 . 10.000 9.412 2 10.000 9.419 1(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 2008 . 15.630 8.868 1,394 15.918 9.054 93 2009 . 8.868 11.894 1,397 9.054 12.174 89 2010 . 11.894 13.769 1,335 12.174 14.128 68 --------- ------ ------ ------ ------ ------ -----
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) Fidelity (Reg. TM) VIP Equity-Income Portfolio 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 2008 . 34.496 19.585 1,759 35.237 20.056 158 2009 . 19.585 25.248 1,543 20.056 25.919 157 2010 . 25.248 28.783 1,383 25.919 29.623 121 --------- ------ ------ ----- ------ ------ --- Fidelity (Reg. TM) VIP Growth Portfolio 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 2008 . 49.632 25.960 2,130 50.698 26.585 129 2009 . 25.960 32.972 1,891 26.585 33.850 121 2010 . 32.972 40.536 1,679 33.850 41.719 96 --------- ------ ------ ----- ------ ------ --- Janus Aspen Series Worldwide 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 2008 . 16.342 8.953 914 16.694 9.169 90 2009 . 8.953 12.206 836 9.169 12.531 83 2010 . 12.206 13.998 759 12.531 14.407 60 --------- ------ ------ ----- ------ ------ --- LVIP Baron Growth Opportunities(2) 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 2008 . 31.059 18.716 572 31.730 19.168 60 2009 . 18.716 25.631 524 19.168 26.316 58 2010 . 25.631 32.071 468 26.316 33.010 42 --------- ------ ------ ----- ------ ------ --- LVIP Cohen & Steers Global Real Estate 2007 . 10.091 8.265 5 8.946 8.278 1(1) 2008 . 8.265 4.743 18 8.278 4.762 1(1) 2009 . 4.743 6.472 54 4.762 6.515 2 2010 . 6.472 7.560 80 6.515 7.628 4 --------- ------ ------ ----- ------ ------ ----- LVIP 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 2008 . 11.604 11.153 489 11.709 11.281 37 2009 . 11.153 13.129 534 11.281 13.313 33 2010 . 13.129 14.101 542 13.313 14.336 28 --------- ------ ------ ----- ------ ------ -----
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) LVIP Delaware Foundation Aggressive Allocation 2009 . 9.861 11.988 1(1) 10.539 12.004 1(1) 2010 . 11.988 13.350 5 12.004 13.401 1(1) --------- ------ ------ --- ------ ------ --- LVIP Delaware Foundation Conservative Allocation(3) 2004 . 10.231 11.013 29 11.035 11.029 1(1) 2005 . 11.013 11.397 68 11.029 11.444 1(1) 2006 . 11.397 12.476 79 11.444 12.559 1(1) 2007 . 12.476 12.918 76 12.559 13.038 25 2008 . 12.918 9.342 68 13.038 9.452 18 2009 . 9.342 11.362 70 9.452 11.524 15 2010 . 11.362 12.422 66 11.524 12.631 16 --------- ------ ------ ---- ------ ------ ---- LVIP Delaware Foundation Moderate Allocation 2009 . 10.910 11.800 1(1) N/A N/A N/A 2010 . 11.800 12.970 12 N/A N/A N/A --------- ------ ------ ---- ------ ------ ----- LVIP Delaware Growth and Income 2000 . 10.000 9.051 9 10.000 9.057 1(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 2008 . 10.675 6.789 553 10.871 6.930 37 2009 . 6.789 8.380 486 6.930 8.576 34 2010 . 8.380 9.370 424 8.576 9.613 29 --------- ------ ------ ----- ------ ------ ----- LVIP Delaware Social Awareness 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 2008 . 16.782 10.897 1,017 17.143 11.160 85 2009 . 10.897 14.026 920 11.160 14.399 77 2010 . 14.026 15.493 841 14.399 15.945 64 --------- ------ ------ ------ ------ ------ ----- LVIP Global Income 2009 . 10.256 10.805 6 N/A N/A N/A 2010 . 10.805 11.733 13 10.819 11.778 1(1) --------- ------ ------ ------ ------ ------ ----- LVIP 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 2008 . 7.984 4.678 257 8.131 4.776 23 2009 . 4.678 6.416 226 4.776 6.566 21 2010 . 6.416 7.073 209 6.566 7.257 16 --------- ------ ------ ------ ------ ------ ----- LVIP Mondrian International Value 2004 . 10.000 12.255 21 10.343 12.274 1(1) 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 2008 . 19.400 12.166 450 19.576 12.307 54 2009 . 12.166 14.603 370 12.307 14.809 56 2010 . 14.603 14.814 308 14.809 15.061 34 --------- ------ ------ ------ ------ ------ -----
A-6
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) LVIP SSgA Bond Index 2009 . 10.121 10.385 7 10.454 10.399 3 2010 . 10.385 10.895 39 10.399 10.937 5 --------- ------ ------ -- ------ ------ -- LVIP SSgA Emerging Markets 100 2009 . 10.051 13.640 41 11.245 13.659 1(1) 2010 . 13.640 17.255 77 13.659 17.322 1(1) --------- ------ ------ -- ------ ------ --- LVIP SSgA Global Tactical Allocation(5) 2005 . 10.006 10.939 18 10.134 10.955 1(1) 2006 . 10.939 12.622 84 10.955 12.672 1(1) 2007 . 12.622 13.873 151 12.672 13.962 5 2008 . 13.873 8.178 195 13.962 8.251 6 2009 . 8.178 10.590 157 8.251 10.712 8 2010 . 10.590 11.400 162 10.712 11.560 8 --------- ------ ------ --- ------ ------ --- LVIP SSgA International Index 2009 . 10.140 12.116 5 N/A N/A N/A 2010 . 12.116 12.841 9 N/A N/A N/A --------- ------ ------ --- ------ ------ ----- LVIP T. Rowe Price Structured Mid-Cap Growth 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 2008 . 15.089 8.548 1,309 15.413 8.754 115 2009 . 8.548 12.385 1,203 8.754 12.715 106 2010 . 12.385 15.741 1,087 12.715 16.200 81 --------- ------ ------ ----- ------ ------ ----- LVIP Wilshire 2010 Profile 2007 . 9.998 10.493 5 10.460 10.509 1(1) 2008 . 10.493 7.904 47 10.509 7.936 8 2009 . 7.904 9.735 65 7.936 9.799 9 2010 . 9.735 10.744 68 9.799 10.841 9 --------- ------ ------ ----- ------ ------ ----- LVIP Wilshire 2020 Profile 2007 . 10.001 10.337 10 9.924 10.353 1(1) 2008 . 10.337 7.482 122 10.353 7.512 1(1) 2009 . 7.482 9.309 141 7.512 9.369 4 2010 . 9.309 10.325 212 9.369 10.418 4 --------- ------ ------ ----- ------ ------ ----- LVIP Wilshire 2030 Profile 2007 . 10.045 10.444 8 10.342 10.461 1(1) 2008 . 10.444 7.157 70 10.461 7.187 1(1) 2009 . 7.157 9.067 176 7.187 9.127 2 2010 . 9.067 10.103 224 9.127 10.195 2 --------- ------ ------ ----- ------ ------ ----- LVIP Wilshire 2040 Profile 2007 . 10.072 10.269 3 9.914 10.285 2 2008 . 10.269 6.553 36 10.285 6.579 2 2009 . 6.553 8.496 59 6.579 8.551 2 2010 . 8.496 9.560 81 8.551 9.647 2 --------- ------ ------ ----- ------ ------ ----- LVIP Wilshire Conservative Profile 2005 . 10.000 10.304 12 10.148 10.319 1(1) 2006 . 10.304 11.155 178 10.319 11.198 2 2007 . 11.155 11.902 250 11.198 11.979 5 2008 . 11.902 9.611 260 11.979 9.697 5 2009 . 9.611 11.880 262 9.697 12.016 6 2010 . 11.880 12.997 283 12.016 13.179 3 --------- ------ ------ ----- ------ ------ -----
A-7
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) LVIP Wilshire Moderate Profile 2005 . 10.006 10.524 32 10.415 10.540 1(1) 2006 . 10.524 11.674 206 10.540 11.721 10 2007 . 11.674 12.629 319 11.721 12.711 29 2008 . 12.629 9.175 412 12.711 9.258 25 2009 . 9.175 11.631 353 9.258 11.765 23 2010 . 11.631 12.892 356 11.765 13.074 22 --------- ------ ------ --- ------ ------ ---- LVIP Wilshire Moderately Aggressive Profile 2005 . 10.049 10.701 39 10.306 10.715 1(1) 2006 . 10.701 12.093 126 10.715 12.139 4 2007 . 12.093 13.147 292 12.139 13.230 13 2008 . 13.147 8.666 357 13.230 8.743 16 2009 . 8.666 11.071 394 8.743 11.196 16 2010 . 11.071 12.355 408 11.196 12.526 13 --------- ------ ------ --- ------ ------ ---- Neuberger Berman AMT Mid-Cap Growth Portfolio 2000 . 10.000 7.673 59 10.000 7.678 1(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 2008 . 9.070 5.085 974 9.236 5.192 53 2009 . 5.085 6.626 905 5.192 6.781 70 2010 . 6.626 8.469 833 6.781 8.689 40 --------- ------ ------ ----- ------ ------ ---- Neuberger Berman AMT Partners Portfolio 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 2008 . 20.116 9.481 409 20.549 9.709 40 2009 . 9.481 14.651 369 9.709 15.041 39 2010 . 14.651 16.777 336 15.041 17.267 24 --------- ------ ------ ----- ------ ------ ---- T. Rowe Price International Stock Portfolio 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 2008 . 21.167 10.750 914 21.622 11.008 59 2009 . 10.750 16.219 844 11.008 16.650 57 2010 . 16.219 18.379 747 16.650 18.915 41 --------- ------ ------ ----- ------ ------ ----
(1) All numbers less than 500 were rounded up to one. (2) 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. (3) Effective June 15, 2009, the LVIP Delaware Managed Fund was reorganized into the LVIP Delaware Foundation Conservative Allocation Fund. The values in the table for periods prior to the date of the reorganization reflect investments in the LVIP Delaware Managed Fund. (4) Effective October 9, 2010, the Delaware VIP Trend Series was reorganized into the Delaware VIP Smid Cap Growth Series. The values in the table for periods prior to the date of the reorganization reflect investments in the Delaware VIP Trend Series. (5) Effective July 30, 2010, the LVIP Wilshire Aggressive Profile Fund was restructured into the LVIP SSgA Global Tactical Allocation Fund. The values in the table for periods prior to the date of the restructuring reflect investments in the LVIP Wilshire Aggressive Profile Fund. A-8 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 May 1, 2011. 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 46801-2340, by calling Lincoln Life at 1-800-341-0441, or by visiting www.LincolnFinancial.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 Capital Markets B-3 Advertising & Ratings B-4 More About the S&P 500 Index B-4 Additional Services B-4 Other Information B-5 Financial Statements B-5
This SAI is not a prospectus. The date of this SAI is May 1, 2011. Special Terms The special terms used in this SAI are the ones defined in the Prospectus. Services Independent Registered Public Accounting Firm Ernst & Young LLP, independent registered public accounting firm, Two Commerce Square, 2001 Market Street, Suite 4000, Philadelphia, Pennsylvania, 19103, has audited a) our financial statements of the VAA as of December 31, 2010; and b) our consolidated financial statements of The Lincoln National Life Insurance Company as of December 31, 2010, which are included in this SAI and Registration Statement. The aforementioned financial statements are included herein in reliance on Ernst & Young LLP's 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 Bank of New York Mellon, 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 and/or Lincoln Financial Securities Corporation (collectively, "LFN"), our affiliates. 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. LFD, acting as Principal Underwriter, paid $2,907,217, $2,345,317 and $2,228,859 to LFN and Selling Firms in 2008, 2009 and 2010, respectively, as sales compensation with respect to the contracts. The Principal Underwriter retained no underwriting commissions for the 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 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; B-2 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. Capital Markets In any particular year, our capital may increase or decrease depending on a variety of factors - the amount of our statutory income or losses (which is sensitive to equity market and credit market conditions), the amount of additional capital we must hold to support business growth, changes in reserving requirements, our inability to secure capital market solutions to provide reserve relief, such as issuing letters of credit to support captive reinsurance structures, changes in equity market levels, the value of certain fixed-income and equity securities in our investment portfolio and changes in interest rates. B-3 Advertising & Ratings 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. Nationally recognized rating agencies rate the financial strength of our Company. The ratings do not imply approval of the product and do not refer to the performance of the product, or to the VAA, including underlying investment options. Ratings are not recommendations to buy our products. Each of the rating agencies reviews its ratings periodically. Accordingly, all ratings are subject to revision or withdrawal at any time by the rating agencies, and therefore, no assurance can be given that these ratings will be maintained. All ratings are on outlook stable. Our financial strength ratings, which are intended to measure our ability to meet contract holder obligations, are an important factor affecting public confidence in most of our products and, as a result, our competitiveness. A downgrade of our financial strength rating could affect our competitive position in the insurance industry by making it more difficult for us to market our products as potential customers may select companies with higher financial strength ratings and by leading to increased withdrawals by current customers seeking companies with higher financial strength ratings. More About the S&P 500 Index Investors look to indexes as a standard of market performance. Indexes are 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 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. 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 B-4 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 canceled 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 The December 31, 2010 financial statements of the VAA and the December 31, 2010 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, 2010 AND 2009 S-2 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholder of The Lincoln National Life Insurance Company We have audited the accompanying consolidated balance sheets of The Lincoln National Life Insurance Company (the Company) as of December 31, 2010 and 2009, and the related consolidated statements of income (loss), stockholder's equity, and cash flows for each of the three years in the period ended December 31, 2010. 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 subsidiaries at December 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles. As discussed in Note 2 to the consolidated financial statements, in 2010 the Company changed its method of accounting for the consolidation of variable interest entities. Also, as discussed in Note 2 to the consolidated financial statements, in 2009 the Company changed its method of accounting for the recognition and presentation of other-than-temporary impairments. /s/ Ernst & Young LLP Philadelphia, Pennsylvania April 1, 2011 S-3 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY CONSOLIDATED BALANCE SHEETS (IN MILLIONS, EXCEPT SHARE DATA)
AS OF DECEMBER 31, --------------------- 2010 2009 -------- ------------ ASSETS Investments: Available-for-sale securities, at fair value: Fixed maturity securities (amortized cost: 2010 -- $63,512; 2009 -- $58,816) $ 66,289 $ 58,889 Variable interest entities' fixed maturity securities (amortized cost: 2010 -- $570) 584 -- Equity securities (cost: 2010 -- $119; 2009 -- $141) 140 155 Trading securities 2,459 2,366 Mortgage loans on real estate 6,431 6,835 Real estate 168 128 Policy loans 2,832 2,864 Derivative investments 1,021 841 Other investments 978 975 -------- ------------ Total investments 80,902 73,053 Cash and invested cash 1,904 2,553 Deferred acquisition costs and value of business acquired 8,854 9,396 Premiums and fees receivable 334 302 Accrued investment income 904 860 Reinsurance recoverables 7,626 7,880 Reinsurance related embedded derivatives 112 277 Goodwill 3,017 3,011 Other assets 3,729 3,375 Separate account assets 84,630 73,500 -------- ------------ Total assets $192,012 $174,207 ======== ============ LIABILITIES AND STOCKHOLDER'S EQUITY LIABILITIES Future contract benefits $ 14,872 $ 14,507 Other contract holder funds 66,721 63,177 Short-term debt 10 21 Long-term debt 2,429 1,925 Funds withheld reinsurance liabilities 3,385 3,137 Deferred gain on business sold through reinsurance 405 516 Payables for collateral on investments 1,712 1,924 Variable interest entities' liabilities 132 -- Other liabilities 3,118 2,099 Separate account liabilities 84,630 73,500 -------- ------------ Total liabilities 177,414 160,806 -------- ------------ CONTINGENCIES AND COMMITMENTS (SEE NOTE 14) STOCKHOLDER'S EQUITY Common stock -- 10,000,000 shares authorized, issued and outstanding 10,585 10,588 Retained earnings 3,137 2,915 Accumulated other comprehensive income (loss) 876 (102) -------- ------------ Total stockholder's equity 14,598 13,401 -------- ------------ Total liabilities and stockholder's equity $192,012 $174,207 ======== ============ See accompanying Notes to Consolidated Financial Statements
S-4 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF INCOME (LOSS) (IN MILLIONS)
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 2010 2009 2008 --------- --------- --------- REVENUES Insurance premiums $1,929 $1,878 $1,835 Insurance fees 3,070 2,841 2,990 Net investment income 4,362 4,006 3,975 Realized gain (loss): Total other-than-temporary impairment losses on securities (231) (643) (682) Portion of loss recognized in other comprehensive income 83 262 -- --------- --------- --------- Net other-than-temporary impairment losses on securities recognized in earnings (148) (381) (682) Realized gain (loss), excluding other-than-temporary impairment losses on securities (100) (208) (142) --------- --------- --------- Total realized gain (loss) (248) (589) (824) --------- --------- --------- Amortization of deferred gain on business sold through reinsurance 52 73 76 Other revenues and fees 360 299 271 --------- --------- --------- Total revenues 9,525 8,508 8,323 --------- --------- --------- BENEFITS AND EXPENSES Interest credited 2,435 2,406 2,438 Benefits 2,570 2,450 2,654 Underwriting, acquisition, insurance and other expenses 2,999 2,579 2,960 Interest and debt expense 99 93 85 Impairment of intangibles -- 729 -- --------- --------- --------- Total benefits and expenses 8,103 8,257 8,137 --------- --------- --------- Income (loss) before taxes 1,422 251 186 Federal income tax expense (benefit) 347 163 (68) --------- --------- --------- Net income (loss) $1,075 $ 88 $ 254 ========= ========= =========
See accompanying Notes to Consolidated Financial Statements S-5 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY (IN MILLIONS)
FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 2010 2009 2008 ---------- ---------- ---------- COMMON STOCK Balance as of beginning-of-year $10,588 $ 9,132 $ 9,105 Capital contribution from Lincoln National Corporation -- 1,451 -- Stock compensation/issued for benefit plans (3) 5 27 ---------- ---------- ---------- Balance as of end-of-year 10,585 10,588 9,132 ---------- ---------- ---------- RETAINED EARNINGS Balance as of beginning-of-year 2,915 3,135 3,283 Cumulative effect from adoption of new accounting standards (169) 97 -- Comprehensive income (loss) 1,872 2,692 (2,408) Less other comprehensive income (loss), net of tax 797 2,604 (2,662) ---------- ---------- ---------- Net income (loss) 1,075 88 254 Dividends declared (684) (405) (402) ---------- ---------- ---------- Balance as of end-of-year 3,137 2,915 3,135 ---------- ---------- ---------- ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS) Balance as of beginning-of-year (102) (2,609) 53 Cumulative effect from adoption of new accounting standards 181 (97) -- Other comprehensive income (loss), net of tax 797 2,604 (2,662) ---------- ---------- ---------- Balance as of end-of-year 876 (102) (2,609) ---------- ---------- ---------- Total stockholder's equity as of end-of-year $14,598 $13,401 $ 9,658 ========== ========== ==========
See accompanying Notes to Consolidated Financial Statements S-6 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY CONSOLIDATED STATEMENTS OF CASH FLOWS (IN MILLIONS)
FOR THE YEARS ENDED DECEMBER 31, ------------------------------- 2010 2009 2008 ---------- ---------- --------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ 1,075 $ 88 $ 254 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Deferred acquisition costs, value of business acquired, deferred sales inducements and deferred front-end loads deferrals and interest, net of amortization (304) (371) (237) Trading securities purchases, sales and maturities, net 39 (20) 177 Change in premiums and fees receivable (32) 143 (61) Change in accrued investment income (44) (87) 19 Change in future contract benefits and other contract holder funds (202) (2,857) 4,098 Change in reinsurance related assets and liabilities 888 2,790 (3,618) Change in federal income tax accruals 692 178 (45) Realized (gain) loss 248 589 824 Amortization of deferred gain on business sold through reinsurance (52) (73) (76) Impairment of intangibles -- 729 -- Other 63 1 (12) ---------- ---------- ---------- Net cash provided by (used in) operating activities 2,371 1,110 1,323 ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES Purchases of available-for-sale securities (12,816) (13,075) (5,776) Sales of available-for-sale securities 2,642 3,614 1,506 Maturities of available-for-sale securities 4,429 3,209 3,732 Purchases of other investments (2,775) (779) (1,163) Sales or maturities of other investments 3,099 1,102 907 Increase (decrease) in payables for collateral on investments (212) 1,044 (255) Proceeds from sale of subsidiaries/businesses, net of cash disposed -- 6 -- Proceeds from reinsurance recapture 25 -- -- Other (74) (51) (117) ---------- ---------- ---------- Net cash provided by (used in) investing activities (5,682) (4,930) (1,166) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES Issuance of long-term debt, net of issuance costs 504 -- 250 Increase (decrease) in short-term debt (11) 3 (14) Deposits of fixed account values, including the fixed portion of variable 11,051 11,346 9,806 Withdrawals of fixed account values, including the fixed portion of variable (5,225) (5,440) (5,910) Transfers to and from separate accounts, net (2,958) (2,248) (2,204) Payment of funding agreements -- -- (550) Common stock issued for benefit plans and excess tax benefits (15) -- 8 Capital contribution from parent company -- 1,001 -- Dividends paid to stockholders (684) (405) (402) ---------- ---------- ---------- Net cash provided by (used in) financing activities 2,662 4,257 984 ---------- ---------- ---------- Net increase (decrease) in cash and invested cash, including discontinued operations (649) 437 1,141 Cash and invested cash, including discontinued operations, as of beginning-of-year 2,553 2,116 975 ---------- ---------- ---------- Cash and invested cash, including discontinued operations, as of end-of-year $ 1,904 $ 2,553 $ 2,116 ========== ========== ==========
See accompanying Notes to Consolidated Financial Statements S-7 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 of America and several U.S. territories. See Note 23 for additional information. BASIS OF PRESENTATION The accompanying consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). Certain GAAP policies, which significantly affect the determination of financial position, results of operations and cash flows, are summarized below. On May 7, 2009, LNC made a capital contribution to LNL that transferred ownership of Lincoln Financial Media ("LFM") to LNL. LFM's results subsequent to May 7, 2009, are included in 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 21 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. These reclassifications had 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 and any variable interest entities ("VIEs") in which we are the primary beneficiary. See Note 4 below for additional details. Entities in which we do not have a controlling financial interest and do not exercise significant management influence over the operating and financing decisions are reported using the equity method. The carrying value of our investments that we account for using the equity method on our Consolidated Balance Sheets and equity in earnings on our Consolidated Statements of Income (Loss) is not material. All material inter-company accounts and transactions have been eliminated in consolidation. Our involvement with VIEs is primarily to obtain financing to either invest in assets that allow us to gain exposure to a broadly diversified pool of corporate issuers or to support our universal life ("UL") business with secondary guarantees. The factors used to determine whether or not we are the primary beneficiary and must consolidate a VIE in which we hold a variable interest changed effective January 1, 2010, upon the adoption of new accounting guidance. See "Consolidations Topic" in Note 2 for details. Beginning January 1, 2010, we continuously analyze the primary beneficiary of our VIEs, to determine whether we are the primary beneficiary, by applying a qualitative approach to identify the variable interest that has the power to direct activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or the right to receive returns that could potentially be significant to the VIE. 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 acquisition costs ("DAC"), value of business acquired ("VOBA"), deferred sales inducements ("DSI"), goodwill, future contract benefits, other contract holder funds which includes deferred front-end loads ("DFEL"), pension plans, income taxes and the potential effects of resolving litigated matters. BUSINESS COMBINATIONS For all business combination transactions occurring after January 1, 2009, we use the acquisition method of accounting, and accordingly generally, recognize the fair values of assets acquired, liabilities assumed and any noncontrolling interests. For all business combination transactions initiated after June 30, 2001, but before January 1, 2009, the purchase method of accounting has been used, and accordingly, the assets and liabilities of the acquired company have been recorded at their estimated fair values as of the merger date. The allocation of fair values may be subject to adjustment after the initial allocation for up to a one-year period as more information relative to the fair values as of the acquisition date becomes available. The consolidated financial statements include the results of operations of any acquired company since the acquisition date. FAIR VALUE MEASUREMENT Our measurement of fair value is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset or non-performance risk, which would include our own credit risk. Our estimate of an 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 S-8 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 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"). Pursuant to the Fair Value Measurements and Disclosures Topic of the Financial Accounting Standards Board ("FASB") ACCOUNTING STANDARDS CODIFICATION(TM) ("ASC"), we categorize our financial instruments carried at fair value into a three-level fair value hierarchy, based on the priority of inputs to the respective valuation technique. The three-level hierarchy for fair value measurement is defined as follows: - Level 1 - inputs to the valuation methodology are quoted prices available in active markets for identical investments as of the reporting date, except for large holdings subject to "blockage discounts" that are excluded; - Level 2 - inputs to the valuation methodology are other than quoted prices in active markets, that are either directly or indirectly observable as of the reporting date, and fair value can be determined through the use of models or other valuation methodologies; and - Level 3 - inputs to the valuation methodology are unobservable inputs in situations where there is little or no mar- ket activity for the asset or liability, and we make estimates and assumptions related to the pricing of the asset or liability, including assumptions regarding risk. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment's level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the investment. When a determination is made to classify an asset or liability within Level 3 of the fair value hierarchy, the determination is based upon the significance of the unobservable inputs to the overall fair value measurement. Because certain securities trade in less liquid or illiquid markets with limited or no pricing information, the determination of fair value for these securities is inherently more difficult. However, Level 3 fair value investments may include, in addition to the unobservable or Level 3 inputs, observable components, which are components that are actively quoted or can be validated to market-based sources. AVAILABLE-FOR-SALE SECURITIES -- FAIR VALUATION METHODOLOGIES AND ASSOCIATED INPUTS Securities classified as available-for-sale ("AFS") consist of fixed maturity and equity securities and are stated at fair value with unrealized gains and losses included within accumulated other comprehensive income (loss) ("OCI"), net of associated DAC, VOBA, DSI, other contract holder funds and deferred income taxes. See Notes 5 and 15 for additional details. We measure the fair value of our securities classified as AFS based on assumptions used by market participants in pricing the security. The most appropriate valuation methodology is selected based on the specific characteristics of the fixed maturity or equity security, and we consistently apply the valuation methodology to measure the security's fair value. Our fair value measurement is based on a market approach, which utilizes prices and other relevant information generated by market transactions involving identical or comparable securities. Sources of inputs to the market approach include third-party pricing services, independent broker quotations or pricing matrices. We do not adjust prices received from third parties; however, we do analyze the third-party pricing services' valuation methodologies and related inputs and perform additional evaluation to determine the appropriate level within the fair value hierarchy. We use observable and unobservable inputs in our valuation methodologies. Observable inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators, industry and economic events are monitored and further market data is acquired if certain triggers are met. For certain security types, additional inputs may be used, or some of the inputs described above may not be applicable. For broker-quoted only securities, quotes from market makers or broker-dealers are obtained from sources recognized to be market participants. In order to validate the pricing information and broker-dealer quotes, we employ, where possible, procedures that include comparisons with similar observable positions, comparisons with subsequent sales, discussions with senior business leaders and brokers and observations of general market movements for those security classes. For those securities trading in less liquid or illiquid markets with limited or no pricing information, we use unobservable inputs in order to measure the fair value of these securities. In cases where this information is not available, such as for privately placed securities, fair value is estimated using an internal pricing matrix. This matrix relies on management's judgment concerning the discount rate used in calculating expected future cash flows, credit quality, industry sector performance and expected maturity. The observable and unobservable inputs to our valuation methodologies are based on a set of standard inputs that we generally use to evaluate all of our AFS securities. Depending on the type of security or the daily market activity, standard inputs may be prioritized differently or may not be available for all AFS securities on any given day. The following summarizes our fair valuation methodologies and associated inputs, which are particular to the specified security type and are in addition to the defined standard inputs to our valuation methodologies for all of our AFS securities discussed above: - Corporate bonds and U.S. Government bonds - We also use Trade Reporting and Compliance Engine(TM) reported tables for our corporate bonds and vendor trading platform data for our U. S. Government bonds. - Mortgage- and asset-backed securities - We also utilize additional inputs which include new issues data, monthly payment information and monthly collateral performance, including prepayments, severity, delinquencies, step-down S-9 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) features and over collateralization features for each of our mortgage-backed securities ("MBS"), which include collateralized mortgage obligations ("CMOs"), mortgage pass through securities backed by residential mortgages ("MPTS") and MBS backed by commercial mortgages ("CMBS"), and for our asset-backed securities ("ABS") collateralized debt obligations ("CDOs"). - State and municipal bonds - We also use additional inputs which include information from the Municipal Securities Rule Making Board, as well as material event notices, new issue data, issuer financial statements and Municipal Market Data benchmark yields for our state and municipal bonds. - Hybrid and redeemable preferred and equity securities - We also utilize additional inputs of exchange prices (underlying and common stock of the same issuer) for our hybrid and redeemable preferred and equity securities, including banking, insurance, other financial services and other securities. AFS SECURITIES -- EVALUATION FOR RECOVERY OF AMORTIZED COST We regularly review our AFS securities for declines in fair value that we determine to be other-than-temporary. For an equity security, if we do not have the ability and intent to hold the security for a sufficient period of time to allow for a recovery in value, we conclude that an other-than-temporary impairment ("OTTI") has occurred and the amortized cost of the equity security is written down to the current fair value, with a corresponding charge to realized gain (loss) on our Consolidated Statements of Income (Loss). When assessing our ability and intent to hold the equity security to recovery, we consider, among other things, the severity and duration of the decline in fair value of the equity security as well as the cause of the decline, a fundamental analysis of the liquidity, and business prospects and overall financial condition of the issuer. For our fixed maturity AFS securities, we generally consider the following to determine that our unrealized losses are not OTTI: - The estimated range and average period until recovery; - The estimated range and average holding period to maturity; - Remaining payment terms of the security; - Current delinquencies and nonperforming assets of underlying collateral; - Expected future default rates; - Collateral value by vintage, geographic region, industry concentration or property type; - Subordination levels or other credit enhancements as of the balance sheet date as compared to origination; and - Contractual and regulatory cash obligations. For a debt security, if we intend to sell a security or it is more likely than not we will be required to sell a debt security before recovery of its amortized cost basis and the fair value of the debt security is below amortized cost, we conclude that an OTTI has occurred and the amortized cost is written down to current fair value, with a corresponding charge to realized gain (loss) on our Consolidated Statements of Income (Loss). If we do not intend to sell a debt security or it is not more likely than not we will be required to sell a debt security before recovery of its amortized cost basis but the present value of the cash flows expected to be collected is less than the amortized cost of the debt security (referred to as the credit loss), we conclude that an OTTI has occurred and the amortized cost is written down to the estimated recovery value with a corresponding charge to realized gain (loss) on our Consolidated Statements of Income (Loss), as this amount is deemed the credit portion of the OTTI. The remainder of the decline to fair value is recorded in OCI to unrealized OTTI on AFS securities on our Consolidated Statements of Stockholder's Equity, as this amount is considered a noncredit (i.e., recoverable) impairment. When assessing our intent to sell a debt security or if it is more likely than not we will be required to sell a debt security before recovery of its cost basis, we evaluate facts and circumstances such as, but not limited to, decisions to reposition our security portfolio, sale of securities to meet cash flow needs and sales of securities to capitalize on favorable pricing. In order to determine the amount of the credit loss for a debt security, we calculate the recovery value by performing a discounted cash flow analysis based on the current cash flows and future cash flows we expect to recover. The discount rate is the effective interest rate implicit in the underlying debt security. The effective interest rate is the original yield or the coupon if the debt security was previously impaired. See the discussion below for additional information on the methodology and significant inputs, by security type, which we use to determine the amount of a credit loss. Our conclusion that it is not more likely than not that we will be required to sell the fixed maturity AFS securities before recovery of their amortized cost basis, the estimated future cash flows are equal to or greater than the amortized cost basis of the debt securities, or we have the ability to hold the equity AFS securities for a period of time sufficient for recovery is based upon our asset-liability management process. Management considers the following as part of the evaluation: - The current economic environment and market conditions; - Our business strategy and current business plans; - The nature and type of security, including expected maturities and exposure to general credit, liquidity, market and interest rate risk; - Our analysis of data from financial models and other internal and industry sources to evaluate the current effectiveness of our hedging and overall risk management strategies; - The current and expected timing of contractual maturities of our assets and liabilities, expectations of prepayments on investments and expectations for surrenders and withdrawals of life insurance policies and annuity contracts; - The capital risk limits approved by management; and - Our current financial condition and liquidity demands. To determine the recovery period of a debt security, we consider the facts and circumstances surrounding the underlying issuer including, but not limited to, the following: - Historic and implied volatility of the security; - Length of time and extent to which the fair value has been less than amortized cost; S-10 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) - Adverse conditions specifically related to the security or to specific conditions in an industry or geographic area; - Failure, if any, of the issuer of the security to make scheduled payments; and - Recoveries or additional declines in fair value subsequent to the balance sheet date. In periods subsequent to the recognition of an OTTI, the AFS security is accounted for as if it had been purchased on the measurement date of the OTTI. Therefore, for the fixed maturity AFS security, the original discount or reduced premium is reflected in net investment income over the contractual term of the investment in a manner that produces a constant effective yield. To determine recovery value of a corporate bond or ABS CDOs, we perform additional analysis related to the underlying issuer including, but not limited to, the following: - Fundamentals of the issuer to determine what we would recover if they were to file bankruptcy versus the price at which the market is trading; - Fundamentals of the industry in which the issuer operates; - Earnings multiples for the given industry or sector of an industry that the underlying issuer operates within, divided by the outstanding debt to determine an expected recovery value of the security in the case of a liquidation; - Expected cash flows of the issuer (e.g., whether the issuer has cash flows in excess of what is required to fund its operations); - Expectations regarding defaults and recovery rates; - Changes to the rating of the security by a rating agency; and - Additional market information (e.g., if there has been a replacement of the corporate debt security). Each quarter we review the cash flows for the MBS to determine whether or not they are sufficient to provide for the recovery of our amortized cost. We revise our cash flow projections only for those securities that are at most risk for impairment based on current credit enhancement and trends in the underlying collateral performance. To determine recovery value of a MBS, we perform additional analysis related to the underlying issuer including, but not limited to, the following: - Discounted cash flow analysis based on the current cash flows and future cash flows we expect to recover; - Level of creditworthiness of the home equity loans that back a CMO, residential mortgages that back a MPTS or commercial mortgages that back a CMBS; - Susceptibility to fair value fluctuations for changes in the interest rate environment; - Susceptibility to reinvestment risks, in cases where market yields are lower than the securities' book yield earned; - Susceptibility to reinvestment risks, in cases where market yields are higher than the book yields earned on a security; - Expectations of sale of such a security where market yields are higher than the book yields earned on a security; and - Susceptibility to variability of prepayments. When evaluating MBS and mortgage-related ABS, we consider a number of pool-specific factors as well as market level factors when determining whether or not the impairment on the security is temporary or other-than-temporary. The most important factor is the performance of the underlying collateral in the security and the trends of that performance in the prior periods. We use this information about the collateral to forecast the timing and rate of mortgage loan defaults, including making projections for loans that are already delinquent and for those loans that are currently performing but may become delinquent in the future. Other factors used in this analysis include type of underlying collateral (e.g., prime, Alt-A or sub-prime), geographic distribution of underlying loans and timing of liquidations by state. Once default rates and timing assumptions are determined, we then make assumptions regarding the severity of a default if it were to occur. Factors that impact the severity assumption include expectations for future home price appreciation or depreciation, loan size, first lien versus second lien, existence of loan level private mortgage insurance, type of occupancy and geographic distribution of loans. Once default and severity assumptions are determined for the security in question, cash flows for the underlying collateral are projected including expected defaults and prepayments. These cash flows on the collateral are then translated to cash flows on our tranche based on the cash flow waterfall of the entire capital security structure. If this analysis indicates the entire principal on a particular security will not be returned, the security is reviewed for OTTI by comparing the expected cash flows to amortized cost. To the extent that the security has already been impaired or was purchased at a discount, such that the amortized cost of the security is less than or equal to the present value of cash flows expected to be collected, no impairment is required. Otherwise, if the amortized cost of the security is greater than the present value of the cash flows expected to be collected, and the security was not purchased at a discount greater than the expected principal loss, then impairment is recognized. We further monitor the cash flows of all of our AFS securities backed by pools on an ongoing basis. We also perform detailed analysis on all of our subprime, Alt-A, non-agency residential MBS and on a significant percentage of our AFS securities backed by pools of commercial mortgages. The detailed analysis includes revising projected cash flows by updating the cash flows for actual cash received and applying assumptions with respect to expected defaults, foreclosures and recoveries in the future. These revised projected cash flows are then compared to the amount of credit enhancement (subordination) in the structure to determine whether the amortized cost of the security is recoverable. If it is not recoverable, we record an impairment of the security. TRADING SECURITIES Trading securities consist of fixed maturity and equity securities in designated portfolios, some of which support modified coinsurance ("Modco") and coinsurance with funds withheld ("CFW") reinsurance arrangements. Investment results for the portfolios that support Modco and CFW reinsurance S-11 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) arrangements, 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 and changes in the fair value of embedded derivative liabilities associated with the underlying reinsurance arrangements, are recorded in realized gain (loss) on our Consolidated Statements of Income (Loss) as they occur. ALTERNATIVE INVESTMENTS Alternative investments, which consist primarily of investments in Limited Partnerships ("LPs"), are included in other investments on our Consolidated Balance Sheets. We account for our investments in LPs using the equity method to determine the carrying value. Recognition of alternative investment income is delayed due to the availability of the related financial statements, which are generally obtained from the partnerships' general partners. As a result, our venture capital, real estate and oil and gas portfolios are generally on a three-month delay and our hedge funds are on a one-month delay. In addition, the impact of audit adjustments related to completion of calendar-year financial statement audits of the in-vestees are typically received during the second quarter of each calendar year. Accordingly, our investment income from alternative investments for any calendar-year period may not include the complete impact of the change in the underlying net assets for the partnership for that calendar-year period. PAYABLES FOR COLLATERAL ON INVESTMENTS When we enter into collateralized financing transactions on our investments, a liability is recorded equal to the cash collateral received. This liability is included within payables for collateral on investments on our Consolidated Balance Sheets. 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 (Loss). Changes in payables for collateral on investments are reflected within cash flows from investing activities on our Consolidated Statements of Cash Flows. MORTGAGE LOANS ON REAL ESTATE Mortgage loans on real estate are carried at unpaid principal balances adjusted for amortization of premiums and accretion of discounts and are net of valuation allowances. Interest income is accrued on the principal balance of the loan based on the loan's contractual interest rate. Premiums and discounts are amortized using the effective yield method over the life of the loan. Interest income and amortization of premiums and discounts are reported in net investment income on our Consolidated Statements of Income (Loss) along with mortgage loan fees, which are recorded as they are incurred. Our commercial loan portfolio is comprised of long-term loans secured by existing commercial real estate. As such, it does not exhibit risk characteristics unique to mezzanine, construction, residential, agricultural, land or other types of real estate loans. We believe all of the loans in our portfolio share three primary risks: borrower creditworthiness; sustainability of the cash flow of the property; and market risk; therefore, our methods for monitoring and assessing credit risk are consistent for our entire portfolio. Loans are considered impaired when it is probable that, based upon current information and events, we will be unable to collect all amounts due under the contractual terms of the loan agreement. When we determine that a loan is impaired, a valuation allowance is established for the excess carrying value of the loan over its estimated value. The loan's estimated value is based on: the present value of expected future cash flows discounted at the loan's effective interest rate; the loan's observable market price; or the fair value of the loan's collateral. Valuation allowances are maintained at a level we believe is adequate to absorb estimated probable credit losses of each specific loan. 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. Trends in market vacancy and rental rates are incorporated into the analysis that we perform for monitored loans and may contribute to the establishment of (or an increase or decrease in) an allowance for credit losses. In addition, we review each loan individually in our commercial mortgage loan portfolio on an annual basis to identify emerging risks. We focus on properties that experienced a reduction in debt-service coverage or that have significant exposure to tenants with deteriorating credit profiles. Where warranted, we establish or increase loss reserves for a specific loan based upon this analysis. Our process for determining past due or delinquency status begins when a payment date is missed, at which time the borrower is contacted. After the grace period expiration that may last up to 10 days, we send a default notice. The default notice generally provides a short time period to cure the default. Our policy is to report loans that are 60 or more days past due, which equates to two or more payments missed, as delinquent. We do not accrue interest on loans 90 days past due, and any interest received on these loans is either applied to the principal or recorded in net investment income on our Consolidated Statements of Income (Loss) when received, depending on the assessment of the collectibility of the loan. We resume accruing interest once a loan complies with all of its original terms or restructured terms. Mortgage loans deemed uncollectible are charged against the allowance for losses, and subsequent recoveries, if any, are credited to the allowance for losses. All mortgage loans that are impaired have an established allowance for credit losses. Changes in valuation allowances are reported in realized gain (loss) on our Consolidated Statements of Income (Loss). We measure and assess the credit quality of our mortgage loans by using loan-to-value and debt-service coverage ratios. The loan-to-value ratio compares the principal amount of the loan to the fair value at origination of the underlying property collateralizing the loan and is commonly expressed as a percentage. Loan-to-value ratios greater than 100% indicate that the principal amount is greater than the collateral value. Therefore, all else being equal, a lower loan-to-value ratio S-12 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) generally indicates a higher quality loan. The debt-service coverage ratio compares a property's net operating income to its debt-service payments. Debt-service coverage ratios of less than 1.0 indicate that property operations do not generate enough income to cover its current debt payments. Therefore, all else being equal, a higher debt-service coverage ratio generally indicates a higher quality loan. POLICY LOANS Policy loans represent loans we issue to contract holders that use the cash surrender value of their life insurance policy as collateral. Policy loans are carried at unpaid principal balances. REAL ESTATE Real estate includes both real estate held for the production of income and real estate held-for-sale. Real estate held for the production of income is carried at cost less accumulated depreciation. Depreciation is calculated on a straight-line basis over the estimated useful life of the asset. We periodically review properties held for the production of income for impairment. Properties whose carrying values are greater than their projected undiscounted cash flows are written down to estimated fair value, with impairment losses reported in realized gain (loss) on our Consolidated Statements of Income (Loss). The estimated fair value of real estate is generally computed using the present value of expected future cash flows from the real estate discounted at a rate commensurate with the underlying risks. Real estate classified as held-for-sale is stated at the lower of depreciated cost or fair value less expected disposition costs at the time classified as held-for-sale. Real estate is not depreciated while it is classified as held-for-sale. Also, valuation allowances for losses are established, as appropriate, for real estate held-for-sale and any changes to the valuation allowances are reported in realized gain (loss) on our Consolidated Statements of Income (Loss). Real estate acquired through foreclosure proceedings is recorded at fair value at the settlement date. DERIVATIVE INSTRUMENTS We hedge certain portions of our exposure to interest rate risk, foreign currency exchange risk, equity market risk and credit risk by entering into derivative transactions. All of our derivative instruments are recognized as either assets or liabilities on our Consolidated Balance Sheets at estimated fair value. We categorized derivatives into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique as discussed above in "Fair Value Measurement." The accounting for changes in the estimated fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship, and further, on the type of hedging relationship. For those derivative instruments that are designated and qualify as hedging instruments, we must designate the hedging instrument based upon the exposure being hedged: as a cash flow hedge, a fair value hedge or a hedge of a net investment in a foreign subsidiary. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of accumulated OCI and reclassified into net income in the same period or periods during which the hedged transaction affects net income. The remaining gain or loss on the derivative instrument in excess of the cumulative change in the present value of designated future cash flows of the hedged item (hedge ineffectiveness), if any, is recognized in net income during the period of change. For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative instrument, as well as the offsetting gain or loss on the hedged item attributable to the hedged risk are recognized in net income during the period of change in estimated fair values. For derivative instruments not designated as hedging instruments but that are economic hedges, the gain or loss is recognized in net income. See Note 6 for details of where the gain or loss recognized in net income is reported on our Consolidated Statements of Income (Loss). We purchase and issue financial instruments and products that contain embedded derivative instruments. When it is determined that the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated from the host for measurement purposes. The embedded derivative, which is reported with the host instrument in the Consolidated Balance Sheets, is carried at fair value with changes in fair value recognized in net income during the period of change. See Note 6 for additional discussion of our derivative instruments, including details of where the gain or loss recognized in net income is reported on our Consolidated Statements of Income (Loss). We employ several different methods for determining the fair value of our derivative instruments. The fair value of our derivative contracts are measured based on current settlement values, which are based on quoted market prices, industry standard models that are commercially available and broker quotes. These techniques project cash flows of the derivatives using current and implied future market conditions. We calculate the present value of the cash flows to measure the current fair market value of the derivative. CASH AND CASH EQUIVALENTS Cash and invested cash is carried at cost and includes all highly liquid debt instruments purchased with a maturity of three months or less. DAC, VOBA, DSI AND DFEL Commissions and other costs of acquiring UL insurance, variable universal life ("VUL") insurance, traditional life insurance, annuities and other investment contracts, which vary with and are related primarily to the production of new business, have been deferred (i.e., DAC) to the extent recoverable. VOBA is an intangible asset that reflects the estimated fair value of in-force contracts in a life insurance company acquisition and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the business in force at the acquisition date. Bonus S-13 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) credits and excess interest for dollar cost averaging contracts are considered DSI, and the unamortized balance is reported in other assets on our Consolidated Balance Sheets. Contract sales charges that are collected in the early years of an insurance contract are deferred (referred to as "DFEL"), and the un-amortized balance is reported in other contract holder funds on our Consolidated Balance Sheets. Both DAC and VOBA amortization is reported within underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income (Loss). DSI amortization is reported in interest credited on our Consolidated Statements of Income (Loss). The amortization of DFEL is reported within insurance fees on our Consolidated Statements of Income (Loss). The methodology for determining the amortization of DAC, VOBA, DSI and DFEL varies by product type. For all insurance contracts, amortization is based on assumptions consistent with those used in the development of the underlying contract adjusted for emerging experience and expected trends. Acquisition costs for UL and VUL 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 (loss) on investments. Contract lives for UL and VUL policies are estimated to be 40 years and 30 years, respectively, based on the expected lives of the contracts. Contract lives for fixed and variable deferred annuities are generally between 12 and 30 years, while some of our fixed multi-year guarantee products have amortization periods equal to the guarantee period. 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. Acquisition costs for all traditional contracts, including traditional life insurance, which include individual whole life, group business and term life insurance contracts, are amortized over periods of 7 to 30 years on either a straight-line basis or as a level percent of premium of the related policies depending on the block of business. There is currently no DAC, VOBA, DSI or DFEL balance or related amortization for fixed and variable payout annuities. The carrying amounts of DAC, VOBA, DSI and DFEL are adjusted for the effects of realized and unrealized gains and losses on securities classified as AFS and certain derivatives and embedded derivatives. Amortization expense of DAC, VOBA, DSI and DFEL reflects an assumption for an expected level of credit-related investment losses. When actual credit-related investment losses are realized, we recognize a true-up to our DAC, VOBA, DSI and DFEL amortization within realized gain (loss) on our Consolidated Statements of Income (Loss) reflecting the incremental effect of actual versus expected credit-related investment losses. These actual to expected amortization adjustments can create volatility from period to period in realized gain (loss). On a quarterly basis, we may record an adjustment to the amounts included within our Consolidated Balance Sheets for DAC, VOBA, DSI and DFEL with an offsetting benefit or charge to revenue or expense for the effect of the difference between future EGPs used in the prior quarter and the emergence of actual and updated future EGPs in the current quarter ("retrospective unlocking"). In addition, in the third quarter of each year, we conduct our annual comprehensive review of the assumptions and the projection models used for our estimates of future gross profits underlying the amortization of DAC, VOBA, DSI and DFEL and the calculations of the embedded derivatives and reserves for life insurance and annuity products with living benefit and death benefit guarantees. These assumptions include investment margins, mortality, retention, rider utilization and maintenance expenses (costs associated with maintaining records relating to insurance and individual and group annuity contracts and with the processing of premium collections, deposits, withdrawals and commissions). Based on our review, the cumulative balances of DAC, VOBA, DSI and DFEL, included on our Consolidated Balance Sheets, are adjusted with an offsetting benefit or charge to revenue or amortization expense to reflect such change ("prospective unlocking - assumption changes"). We may have prospective unlocking in other quarters as we become aware of information that warrants updating prospective assumptions outside of our annual comprehensive review. We may also identify and implement actuarial modeling refinements ("prospective unlocking -- model refinements") that result in increases or decreases to the carrying values of DAC, VOBA, DSI, DFEL, embedded derivatives and reserves for life insurance and annuity products with living benefit and death benefit guarantees. The primary distinction between retrospective and prospective unlocking is that retrospective unlocking is driven by the difference between actual gross profits compared to EGPs each period, while prospective unlocking is driven by changes in assumptions or projection models related to our expectations of future EGPs. DAC, VOBA, DSI and DFEL are reviewed periodically to ensure that the unamortized portion does not exceed the expected recoverable amounts. REINSURANCE Our insurance companies enter into reinsurance agreements with other companies in the normal course of business. Assets and liabilities and premiums and benefits from certain reinsurance contracts that grant statutory surplus relief to other insurance companies are netted on our Consolidated Balance Sheets and Consolidated Statements of Income (Loss), 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. Reinsurance premiums and benefits paid or provided are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance S-14 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) contracts. Premiums, benefits and DAC are reported net of insurance ceded. GOODWILL We recognize the excess of the purchase price, plus the fair value of any noncontrolling interest in the acquiree, over the fair value of identifiable 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. We are required to perform a two-step test in our evaluation of the carrying value of goodwill for impairment. In Step 1 of the evaluation, the fair value of each reporting unit is determined and compared to the carrying value of the reporting unit. If the fair value is greater than the carrying value, then the carrying value is deemed to be sufficient and Step 2 is not required. If the fair value estimate is less than the carrying value, it is an indicator that impairment may exist and Step 2 is required to be performed. In Step 2, the implied fair value of the reporting unit's goodwill is determined by assigning the reporting unit's fair value as determined in Step 1 to all of its net assets (recognized and unrecognized) as if the reporting unit had been acquired in a business combination at the date of the impairment test. If the implied fair value of the reporting unit's goodwill is lower than its carrying amount, goodwill is impaired and written down to its fair value, and a charge is reported in impairment of intangibles on our Consolidated Statements of Income (Loss). SPECIFICALLY IDENTIFIABLE INTANGIBLE ASSETS Specifically identifiable intangible assets, net of accumulated amortization, are reported in other assets on our Consolidated Balance Sheets. The carrying values of specifically identifiable intangible assets are reviewed at least annually for indicators of impairment in value that are other-than-temporary, including unexpected or adverse changes in the following: the economic or competitive environments in which the Company operates; profitability analyses; cash flow analyses; and the fair value of the relevant business operation. If there was an indication of impairment, then the cash flow method would be used to measure the impairment, and the carrying value would be adjusted as necessary and reported in impairment of intangibles on our Consolidated Statements of Income (Loss). Sales force intangibles are attributable to the value of the new business distribution system for certain life insurance products within the Insurance Solutions - Life Insurance segment acquired through business combinations. These assets are amortized on a straight-line basis over their useful life of 25 years. Specifically identifiable intangible assets also include Federal Communications Commission ("FCC") licenses and other agreements reported within Other Operations. The FCC licenses are not amortized. OTHER LONG-LIVED ASSETS Property and equipment owned for company use is included in other assets on our Consolidated Balance Sheets and is carried at cost less allowances for depreciation. Provisions for depreciation of investment real estate and property and equipment owned for company use are computed principally on the straight-line method over the estimated useful lives of the assets, which include buildings, computer hardware and software and other property and equipment. We periodically review the carrying value of our long-lived assets, including property and equipment, for impairment whenever events or circumstances indicate that the carrying amount of such assets may not be fully recoverable. For long-lived assets to be held and used, impairments are recognized when the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. The carrying amount of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. An impairment loss is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. Long-lived assets to be disposed of by abandonment or in an exchange for a similar productive long-lived asset are classified as held-for-use until they are disposed. Long-lived assets to be sold are classified as held-for-sale and are no longer depreciated. Certain criteria have to be met in order for the long-lived asset to be classified as held-for-sale, including that a sale is probable and expected to occur within one year. Long-lived assets classified as held-for-sale are recorded at the lower of their carrying amount or fair value less cost to sell. SEPARATE ACCOUNT ASSETS AND LIABILITIES We maintain separate account assets, which are reported at fair value. The related liabilities are reported at an amount equivalent to the separate account assets. Investment risks associated with market value changes are borne by the contract holders, except to the extent of minimum guarantees made by the Company with respect to certain accounts. See Note 11 for additional information regarding arrangements with contractual guarantees. We issue variable annuity contracts through our separate accounts for which investment income and investment gains and losses accrue directly to, and investment risk is borne by, the contract holder (traditional variable annuities). We also issue variable annuity and life contracts through separate accounts that include various types of guaranteed death benefit ("GDB"), guaranteed withdrawal benefit ("GWB") and guaranteed income benefit ("GIB") features. The GDB features include those where we contractually guarantee to the contract holder either: return of no less than total deposits made to the contract less any partial withdrawals ("return of net deposits"); total deposits made to the contract less any partial withdrawals plus a minimum return ("minimum return"); or the highest contract value on any contract anniversary date through age S-15 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) 80 minus any payments or withdrawals following the contract anniversary ("anniversary contract value"). As discussed in Note 6, certain features of these guarantees are accounted for as embedded derivative reserves, whereas other guarantees are accounted for as benefit reserves. Other guarantees contain characteristics of both and are accounted for under an approach that calculates the value of the embedded derivative reserve and the benefit reserve based on the specific characteristics of each guaranteed living benefit ("GLB") feature. We use derivative instruments to hedge our exposure to the risks and earnings volatility that result from the embedded derivatives for living benefits in certain of our variable annuity products. The change in fair value of these instruments tends to move in the opposite direction of the change in the value of the associated reserves. The net impact of these changes is reported as a component of realized gain (loss) on our Consolidated Statements of Income (Loss) in a category referred to as GLBs. The "market consistent scenarios" used in the determination of the fair value of the GWB liability are similar to those used by an investment bank to value derivatives for which the pricing is not transparent and the aftermarket is nonexistent or illiquid. In our calculation, risk-neutral Monte-Carlo simulations resulting in over 10 million scenarios are utilized to value the entire block of guarantees. The market consistent scenario assumptions, as of each valuation date, are those we view to be appropriate for a hypothetical market participant. The market consistent inputs include assumptions for the capital markets (e.g., implied volatilities, correlation among indices, risk-free swap curve, etc.), policyholder behavior (e.g., policy lapse, benefit utilization, mortality, etc.), risk margins, administrative expenses and a margin for profit. We believe these assumptions are consistent with those that would be used by a market participant; however, as the related markets develop we will continue to reassess our assumptions. It is possible that different valuation techniques and assumptions could produce a materially different estimate of fair value. FUTURE CONTRACT BENEFITS AND OTHER CONTRACT HOLDER FUNDS Future contract benefits represent liability reserves that we have established and carry based on estimates of how much we will need to pay for future benefits and claims. Other contract holder funds represent liabilities for account values, dividends payable, premium deposit funds, undistributed earnings on participating business and other contract holder funds as well the carrying value of DFEL discussed above. The liabilities for future contract benefits and claim reserves for UL and VUL insurance policies consist of contract account balances that accrue to the benefit of the contract holders, excluding surrender charges. The liabilities for future insurance contract benefits and claim reserves for traditional life policies are computed using assumptions for investment yields, mortality and withdrawals based principally on generally accepted actuarial methods and assumptions at the time of contract issue. Investment yield assumptions for traditional direct individual life reserves for all contracts range from 2.25% to 7.75% depending on the time of contract issue. The investment yield assumptions for immediate and deferred paid-up annuities range from 1.00% to 13.50% . These investment yield assumptions are intended to represent an estimation of the interest rate experience for the period that these contract benefits are payable. The liabilities for future claim reserves for variable annuity products containing GDB features are calculated by estimating the present value of total expected benefit payments over the life of the contract divided by the present value of total expected assessments over the life of the contract ("benefit ratio") multiplied by the cumulative assessments recorded from the contract inception through the balance sheet date less the cumulative GDB payments plus interest on the reserves. The change in the reserve for a period is the benefit ratio multiplied by the assessments recorded for the period less GDB claims paid in the period plus interest. If experience or assumption changes result in a new benefit ratio, the reserves are adjusted to reflect the changes in a manner similar to the unlocking of DAC, VOBA, DFEL and DSI. With respect to our future contract benefits and other contract holder funds, we continually review: overall reserve position, reserving techniques and reinsurance arrangements. As experience develops and new information becomes known, liabilities are adjusted as deemed necessary. The effects of changes in estimates are included in the operating results for the period in which such changes occur. The business written or assumed by us includes participating life insurance contracts, under which the contract holder is entitled to share in the earnings of such contracts via receipt of dividends. The dividend scale for participating policies is reviewed annually and may be adjusted to reflect recent experience and future expectations. UL and VUL products with secondary guarantees represented approximately 40% of permanent life insurance in force as of December 31, 2010, and approximately 52% of sales for these products in 2010. Liabilities for the secondary guarantees on UL-type products are calculated by multiplying the benefit ratio by the cumulative assessments recorded from contract inception through the balance sheet date less the cumulative secondary guarantee benefit payments plus interest. If experience or assumption changes result in a new benefit ratio, the reserves are adjusted to reflect the changes in a manner similar to the unlocking of DAC, VOBA, DFEL and DSI. The accounting for secondary guarantee benefits impacts, and is impacted by, EGPs used to calculate amortization of DAC, VOBA, DFEL and DSI. Future contract benefits on our Consolidated Balance Sheets include GLB features and remaining guaranteed interest and similar contracts that are carried at fair value, which represents approximate surrender value including an estimate for our nonperformance risk. Our LINCOLN SMARTSECURITY(R) Advantage GWB feature, GIB and 4LATER(R) features have elements of both insurance benefits and embedded derivatives. We weight these features and their associated reserves accordingly based on their hybrid nature. We classify these items in S-16 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Level 3 within the hierarchy levels described above in "Fair Value Measurement." The fair value of our indexed annuity contracts is based on their approximate surrender values. 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. DEFERRED GAIN ON BUSINESS SOLD THROUGH REINSURANCE Our reinsurance operations were acquired by Swiss Re Life & Health America, Inc. ("Swiss Re") in December 2001 through a series of indemnity reinsurance transactions. We are recognizing the gain related to these transactions at the rate that earnings on the reinsured business are expected to emerge, over a period of 15 years from the date of sale. COMMITMENTS AND CONTINGENCIES Contingencies arising from environmental remediation costs, regulatory judgments, claims, assessments, guarantees, litigation, recourse reserves, fines, penalties and other sources are recorded when deemed probable and reasonably estimable. INSURANCE FEES Insurance fees for investment and interest-sensitive life insurance contracts consist of asset-based fees, cost of insurance charges, percent of premium charges, contract administration charges and surrender charges that are assessed against contract holder account balances. Investment products consist primarily of individual and group variable and fixed deferred annuities. Interest-sensitive life insurance products include UL insurance, VUL insurance and other interest-sensitive life insurance policies. These products include life insurance sold to individuals, corporate-owned life insurance and bank-owned life insurance. In bifurcating the embedded derivative of our GLB features on our variable annuity products, we attribute to the embedded derivative the portion of total fees collected from the contract holder that relate to the GLB riders (the "attributed fees"), which are not reported within insurance fees on our Consolidated Statements of Income (Loss). These attributed fees represent the present value of future claims expected to be paid for the GLB at the inception of the contract plus a margin that a theoretical market participant would include for risk/profit and are reported within realized gain (loss) on our Consolidated Statements of Income (Loss). The timing of revenue recognition as it relates to fees assessed on investment contracts is determined based on the nature of such fees. Asset-based fees, cost of insurance and contract administration charges are assessed on a daily or monthly basis and recognized as revenue when assessed and earned. Percent of premium charges are assessed at the time of premium payment and recognized as revenue when assessed and earned. Certain amounts assessed that represent compensation for services to be provided in future periods are reported as unearned revenue and recognized in income over the periods benefited. Surrender charges are recognized upon surrender of a contract by the contract holder in accordance with contractual terms. For investment and interest-sensitive life insurance contracts, the amounts collected from contract holders are considered deposits and are not included in revenue. INSURANCE PREMIUMS Our insurance premiums for traditional life insurance and group insurance products are recognized as revenue when due from the contract holder. Our traditional life insurance products include those products with fixed and guaranteed premiums and benefits and consist primarily of whole life insurance, limited-payment life insurance, term life insurance and certain annuities with life contingencies. Our group non-medical insurance products consist primarily of term life, disability and dental. NET INVESTMENT INCOME 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. For ABS and MBS, included in the trading and AFS 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 retrospective effective yield is recalculated to reflect actual payments to date and a catch up adjustment is recorded in the current period. In addition, the new effective yield, which reflects anticipated future payments, is used prospectively. Any adjustments resulting from changes in effective yield are reflected in net investment income on our Consolidated Statements of Income (Loss). REALIZED GAIN (LOSS) Realized gain (loss) on our Consolidated Statements of Income (Loss) includes realized gains and losses from the sale of investments, write-downs for other-than-temporary impairments of investments, certain derivative and embedded derivative gains and losses, gains and losses on the sale of subsidiaries and businesses and net gains and losses on reinsurance embedded derivative and trading securities. Realized gains and losses on the sale of investments are determined using the specific identification method. Realized gain (loss) is recognized in net income, net of associated amortization of DAC, VOBA, DSI and DFEL. Realized gain (loss) is also net of allocations of investment gains and losses to certain contract holders and certain funds withheld on reinsurance arrangements for which we have a contractual obligation. OTHER REVENUES AND FEES Other revenues and fees consists primarily of fees attributable to broker-dealer services recorded as earned at the time of sale, S-17 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 1. NATURE OF OPERATIONS, BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) changes in the market value of our seed capital investments and communications sales recognized as earned, net of agency and representative commissions. INTEREST CREDITED Interest credited includes interest credited to contract holder account balances. Interest crediting rates associated with funds invested in our general account during 2008 through 2010 ranged from 3.00% to 9.00%. BENEFITS Benefits for UL and other interest-sensitive life insurance products include benefit claims incurred during the period in excess of contract account balances. Benefits also include the change in reserves for life insurance products with secondary guarantee benefits and annuity products with guaranteed death benefits. For traditional life, group health and disability income products, benefits are recognized when incurred in a manner consistent with the related premium recognition policies. PENSION AND OTHER POSTRETIREMENT BENEFIT PLANS Pursuant to the accounting rules for our obligations to employees and agents under our various pension and other postretirement benefit plans, we are required to make a number of assumptions to estimate related liabilities and expenses. We use assumptions for the weighted-average discount rate and expected return on plan assets to estimate pension expense. The discount rate assumptions are determined using an analysis of current market information and the projected benefit flows associated with these plans. The expected long-term rate of return on plan assets is based on historical and projected future rates of return on the funds invested in the plan. The calculation of our accumulated postretirement benefit obligation also uses an assumption of weighted-average annual rate of increase in the per capita cost of covered benefits, which reflects a health care cost trend rate. See Note 18 for additional information. STOCK-BASED COMPENSATION In general, we expense the fair value of stock awards included in our incentive compensation plans. As of the date LNC's Board of Directors approves stock awards, the fair value of stock options is determined using a Black-Scholes options valuation methodology, and the fair value of other stock awards is based upon the market value of the stock. The fair value of the awards is expensed over the performance or service period, which generally corresponds to the vesting period, and is recognized as an increase to common stock in stockholder's equity. We classify certain stock awards as liabilities. For these awards, the settlement value is classified as a liability on our consolidated balance sheet and the liability is marked-to-market through net income at the end of each reporting period. Stock-based compensation expense is reflected in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income (Loss). See Note 20 for additional information. INTEREST AND DEBT EXPENSES Interest expense on our short-term and long-term debt is recognized as due and any associated premiums, discounts, and costs are amortized (accreted) over the term of the related borrowing utilizing the effective interest method. In addition, gains or losses related to certain derivative instruments associated with debt are recognized in interest expense during the period of the change. INCOME TAXES We have elected to file consolidated federal income tax returns with LNC and its 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 7 for additional information. 2. NEW ACCOUNTING STANDARDS ADOPTION OF NEW ACCOUNTING STANDARDS CONSOLIDATIONS TOPIC In June 2009, the FASB issued Accounting Standards Update ("ASU") No. 2009-17, "Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities" ("ASU 2009-17"), which amended the consolidation guidance for VIEs. Primarily, the quantitative analysis previously required under the Consolidations Topic of the FASB ASC was eliminated and replaced with a qualitative approach for identifying the variable interest that has the power to direct the activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or the right to receive returns that could potentially be significant to the VIE. In addition, variable interest holders are required to perform an ongoing reassessment of the primary beneficiary of the VIE. Upon adoption of ASU 2009-17, an entity was required to reconsider prior consolidation assessments for VIEs in which the entity continues to hold a variable interest. In February 2010, the FASB issued ASU No. 2010-10, "Amendments for Certain Investment Funds" ("ASU 2010-10"), which deferred application of the guidance in ASU 2009-17 for reporting entities with interests in an entity that applies the specialized accounting guidance for investment companies. Effective January 1, 2010, we adopted the amendments in ASU 2009-17 and ASU 2010-10, and accordingly reconsidered our involvement with all our VIEs and the primary beneficiary of the VIEs. In accordance with ASU 2009-17, we are the primary beneficiary of the VIEs associated with our investments S-18 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. NEW ACCOUNTING STANDARDS (CONTINUED) in Credit-Linked Notes ("CLN"), and as such, we consolidated all of the assets and liabilities of these VIEs and recorded a cumulative effect adjustment of $169 million, after-tax, to the beginning balance of retained earnings as of January 1, 2010. The following summarizes the increases or (decreases) recorded effective January 1, 2010, to the categories (in millions) on our Consolidated Balance Sheets for this cumulative effect adjustment:
ASSETS AFS securities, at fair value: Fixed maturity securities -- ABS CLNs $(322) VIEs' fixed maturity securities 565 -------- Total assets $ 243 ======== LIABILITIES VIEs' liabilities: Derivative instruments $ 225 Federal income tax (91) -------- Total VIEs' liabilities 134 Other liabilities -- deferred income taxes 97 -------- Total liabilities $ 231 ======== STOCKHOLDER'S EQUITY Retained earnings $(169) Accumulated OCI -- unrealized gain (loss) on AFS securities 181 -------- Total stockholder's equity 12 -------- Total liabilities and stockholder's equity $ 243 ========
In addition, we considered our investments in LPs and other alternative investments, and concluded these investments are within the scope of the deferral in ASU 2010-10, and as such they are not subject to the amended consolidation guidance in ASU 2009-17. As a result, we will continue to account for our alternative investments consistent with the accounting policy in Note 1. See Note 4 for more detail regarding the consolidation of our VIEs. DERIVATIVES AND HEDGING TOPIC In March 2010, the FASB issued ASU No. 2010-11, "Scope Exception Related to Embedded Credit Derivatives" ("ASU 2010-11"), to clarify the scope exception when evaluating an embedded credit derivative, which may potentially require separate accounting. Specifically, ASU 2010-11 states that only an embedded credit derivative feature related to the transfer of credit risk that is solely in the form of subordination of one financial instrument to another is not subject to further analysis as a potential embedded derivative under the Derivatives and Hedging Topic of the FASB ASC. Embedded credit derivatives, which no longer qualify for the scope exception, are subject to a bifurcation analysis. The fair value option may be elected for investments within the scope of ASU 2010-11 on an instrument-by-instrument basis. If the fair value option is not elected, preexisting contracts acquired, issued or subject to a remeasurement event on or after January 1, 2007 are within the scope of ASU 2010-11. We adopted ASU 2010-11 at the beginning of the interim reporting period ended September 30, 2010. The adoption did not have a material impact on our consolidated financial condition and results of operations. FAIR VALUE MEASUREMENTS AND DISCLOSURES TOPIC In January 2010, the FASB issued ASU No. 2010-06, "Improving Disclosures about Fair Value Measurements" ("ASU 2010-06"), which requires additional disclosure related to the three-level fair value hierarchy. Entities are required to disclose significant transfers in and out of Levels 1 and 2 of the fair value hierarchy, and separately present information related to purchases, sales, issuances and settlements in the reconciliation of fair value measurements classified as Level 3. In addition, ASU 2010-06 amended the fair value disclosure requirement for pension and postretirement benefit plan assets to require this disclosure at the investment class level. We adopted the amendments in ASU 2010-06 effective January 1, 2010, and have prospectively included the required disclosures in Note 18 related to benefit plans and Note 22 related to Levels 1 and 2 of the fair value hierarchy. The disclosures related to purchases, sales, issuances and settlements for Level 3 fair value measurements are effective for reporting periods beginning after December 15, 2010, and as such, these disclosures will be included in the Notes to Consolidated Financial Statements effective January 1, 2011. INVESTMENTS -- DEBT AND EQUITY SECURITIES TOPIC In April 2009, the FASB replaced the guidance in the Investments - Debt and Equity Securities Topic of the FASB ASC related to OTTI. Under this new accounting guidance, management's assertion that it has the intent and ability to hold an impaired debt security until recovery was replaced by the requirement for management to assert if it either has the intent to sell the debt security or if it is more likely than not the entity will be required to sell the debt security before recovery of its amortized cost basis. Our accounting policy for OTTI, included in Note 1, reflects these changes to the accounting guidance adopted by FASB. As permitted by the transition guidance, we early adopted these amendments to the Investments - Debt and Equity Securities Topic effective January 1, 2009, by recording an increase of $97 million to the opening balance of retained earnings with a corresponding decrease to accumulated OCI on our Consolidated Statements of Stockholder's Equity to reclassify the noncredit portion of previously other-than-temporarily impaired debt securities held as of January 1, 2009. The following summarizes the components (in millions) for this cumulative effect adjustment:
NET UNREALIZED UNREALIZED OTTI LOSS ON AFS ON AFS SECURITIES SECURITIES TOTAL ------------- ------------- -------- Increase in amortized cost of fixed maturity AFS securities $33 $152 $185 Change in DAC, VOBA, DSI, and DFEL (6) (30) (36) Income tax (9) (43) (52) ------------- ------------- -------- Net cumulative effect adjustment $18 $ 79 $ 97 ============= ============= ========
S-19 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. NEW ACCOUNTING STANDARDS (CONTINUED) The cumulative effect adjustment was calculated for all debt securities held as of January 1, 2009, for which an OTTI was previously recognized, and for which we did not intend to sell the security and it was not more likely than not that we would be required to sell the security before recovery of its amortized cost, by comparing the present value of cash flows expected to be received as of January 1, 2009, to the amortized cost basis of the debt securities. The discount rate used to calculate the present value of the cash flows expected to be collected was the rate for each respective debt security in effect before recognizing any OTTI. In addition, because the carrying amounts of DAC, VOBA, DSI and DFEL are adjusted for the effects of realized and unrealized gains and losses on fixed maturity AFS securities, we recognized a true-up to our DAC, VOBA, DSI and DFEL balances for this cumulative effect adjustment. The following summarizes the increase to the amortized cost of our fixed maturity AFS securities (in millions) as of January 1, 2009, resulting from the recognition of the cumulative effect adjustment: Corporate bonds $121 CMOs 62 CDOs 2 ---- Total fixed maturity AFS securities $185 ====
In addition, we include on the face of our Consolidated Statements of Income (Loss) the total OTTI recognized in realized gain (loss), with an offset for the amount of noncredit impairments recognized in accumulated OCI. We disclose the amount of OTTI recognized in accumulated OCI in Note 15, and the enhanced disclosures related to OTTI are included in Note 5. RECEIVABLES TOPIC In July 2010, the FASB issued ASU No. 2010-20, "Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses" ("ASU 2010-20"), in order to enhance and expand the financial statement disclosures. These amendments are intended to provide more information regarding the nature of the risk associated with financing receivables and how the assessment of the risk is used to estimate the allowance for credit losses. In addition, expanded disclosures provide more information regarding changes recognized during the reporting period to the allowance for credit losses. Comparative disclosures are not required for earlier reporting periods ending prior to the initial adoption date, and the amendments in ASU 2010-20 are effective in phases over two reporting periods. We adopted the amendments related to information required as of the end of the reporting period for the reporting period ending December 31, 2010, and have included the required disclosures in Notes 1 and 5. Disclosures that provide information about the activity during a reporting period, primarily the allowance for credit losses and modifications of financing receivables, are effective for interim and annual reporting periods beginning on or after December 15, 2010, and will be included in the Notes to Consolidated Financial Statements beginning with the reporting period ending March 31, 2011. TRANSFERS AND SERVICING TOPIC In June 2009, the FASB issued ASU No. 2009-16, "Accounting for Transfers of Financial Assets" ("ASU 2009-16"), which, among other things, eliminated the concept of a qualifying special-purpose entity ("SPE") and removed the scope exception for a qualifying SPE from the Consolidations Topic of the FASB ASC. As a result, previously unconsolidated qualifying SPEs were required to be re-evaluated for consolidation by the sponsor or transferor. We adopted ASU 2009-16 effective January 1, 2010. The adoption did not have a material impact on our consolidated financial condition and results of operations. See "Consolidations Topic" above for additional information and Note 4 for further discussion of the accounting treatment of our VIEs. FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS FINANCIAL SERVICES -- INSURANCE INDUSTRY TOPIC In April 2010, the FASB issued ASU No. 2010-15, "How Investments Held through Separate Accounts Affect an Insurer's Consolidation Analysis of Those Investments" ("ASU 2010-15"), to clarify a consolidation issue for insurance entities that hold a controlling interest in an investment fund either partially or completely through separate accounts. ASU 2010-15 concludes that an insurance entity would not be required to consider interests held in separate accounts when determining whether or not to consolidate an investment fund, unless the separate account interest is held for the benefit of a related party. If an investment fund is consolidated, the portion of the assets representing interests held in separate accounts would be recorded as a separate account asset with a corresponding separate account liability. The remaining investment fund assets would be consolidated in the insurance entity's general accounts. ASU 2010-15 will be applied retrospectively for fiscal years and interim periods within those fiscal years beginning after December 15, 2010, with early application permitted. We will adopt ASU 2010-15 as of the beginning of the reporting period ending March 31, 2011, and do not expect the adoption will have a material impact on our consolidated financial condition and results of operations. In October 2010, the FASB issued ASU No. 2010-26, "Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts" ("ASU 2010-26"), which clarifies the types of costs incurred by an insurance entity that can be capitalized in the acquisition of insurance contracts. Only those costs incurred which result directly from and are essential to the successful acquisition of new or renewal insurance contracts may be capitalized. Incremental costs related to unsuccessful attempts to acquire insurance contracts must be expensed as incurred. Under ASU 2010-26, the capitalization criteria in the direct-response advertising guidance of the Other Assets and Deferred Costs Topic of the FASB ASC must be met in order to capitalize advertising costs. The amendments are effective for fiscal years and interim periods beginning after December 15, 2011. Early adoption is permitted, and an entity may elect to apply the guidance prospectively or retrospectively. We will adopt the provisions of ASU 2010-26 effective January 1, 2012, and are currently evaluating the impact of the adoption on our consolidated financial condition and results of operations. S-20 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. NEW ACCOUNTING STANDARDS (CONTINUED) INTANGIBLES -- GOODWILL AND OTHER TOPIC In December 2010, the FASB issued ASU No. 2010-28, "When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts" ("ASU 2010-28"). Generally, reporting units with zero or negative carrying amounts will pass Step 1 of the goodwill impairment test as the fair value will exceed carrying value; therefore, goodwill impairment is not assessed under Step 2. ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts, and requires these reporting units to perform Step 2 of the impairment test to determine if it is more likely than not that goodwill impairment exists. The amendments are effective for fiscal years and interim periods beginning after December 15, 2010, and early adoption is not permitted. Upon adoption of this ASU, all reporting units within scope must be evaluated under the new accounting guidance, and any resulting impairment will be recognized as a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Impairments identified after the period of adoption must be recognized in earnings. We will adopt the amendments in ASU 2010-28 effective as of the beginning of the reporting period ending March 31, 2011, and do not expect the adoption will have a material impact on our consolidated financial condition and result of operations. 3. REINSURANCE CEDED, REINSURANCE RECAPTURED, FUNDS WITHHELD AGREEMENT, REINSURANCE ASSUMED AND CAPITAL CONTRIBUTION REINSURANCE CEDED TO LINCOLN NATIONAL REINSURANCE COMPANY (BARBADOS) LIMITED ("LNBAR") We completed a reinsurance transaction during the fourth quarter of 2010 whereby we ceded a block of business to LNBAR, a wholly-owned subsidiary of LNC, which resulted in the release of approximately $151 million of capital previously supporting a portion of statutory reserves related to our term insurance products. The following summarizes the impact of this transaction (in millions) on our Consolidated Balance Sheets:
ASSETS Deferred acquisition costs $(148) Other assets (40) -------- Total assets $(188) ======== LIABILITIES Future contract benefits $ (72) Deferred gain (loss) on business sold through reinsurance (76) Other liabilities (40) -------- Total liabilities $(188) ========
REINSURANCE RECAPTURED FROM LNBAR During the third quarter of 2010, we completed a reinsurance transaction whereby we recaptured a portion of business previously ceded to LNBAR. The following summarizes the impact of this transaction (in millions) on our Consolidated Balance Sheets:
ASSETS Cash $ 25 Deferred acquisition costs 110 -------- Total assets $ 135 ======== LIABILITIES Future contract benefits $ 387 Other contract holder funds 22 Funds withheld reinsurance liabilities (346) Deferred gain (loss) on business sold through reinsurance 42 Other liabilities 10 -------- Total liabilities $ 115 ======== REVENUES AND EXPENSES Amortization of deferred gain on business sold through reinsurance: Write-off of unamortized deferred loss $ (42) Gain on recapture 17 Benefits 55 Federal income tax expense (10) -------- Net income $ 20 ========
FUNDS WITHHELD AGREEMENT WITH LNBAR We completed a funds withheld transaction with LNBAR during the fourth quarter of 2009 whereby we acquired the hedging program for certain GLB variable annuity products with GWB and GIB features. This transaction resulted in the receipt of cash of $162 million, an increase to derivative investments of $790 million and an increase in funds withheld reinsurance liabilities of $952 million. For further information on our hedging program regarding this matter, see "Guaranteed Living Benefit Embedded Derivative Reserves" in Note 6. REINSURANCE ASSUMED FROM FIRST PENN-PACIFIC LIFE INSURANCE COMPANY ("FPP") We completed a reinsurance transaction during the fourth quarter of 2009 whereby we assumed a block of business from FPP, a wholly-owned subsidiary of LNC. The following S-21 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. REINSURANCE CEDED, REINSURANCE RECAPTURED, FUNDS WITHHELD AGREEMENT, REINSURANCE ASSUMED AND CAPITAL CONTRIBUTION (CONTINUED) summarizes the impact of this transaction (in millions) on our Consolidated Balance Sheets:
ASSETS Deferred acquisition costs $48 Other assets 15 --- Total assets $63 === LIABILITIES Future contract benefits $15 Deferred gain (loss) on business sold through reinsurance 47 Other liabilities 1 --- Total liabilities $63 ===
CAPITAL CONTRIBUTION OF LFM On May 7, 2009, LNC made a capital contribution to LNL that transferred ownership of LFM to LNL. The following summarizes the impact of this capital contribution (in millions):
CAPITAL CONTRIBUTION VALUE --------------- Cash and invested cash $ 1 Goodwill 174 Specifically identifiable intangible assets 168 Other assets 21 Short-term debt (14) Other liabilities (70) --------------- Total capital contribution of LFM(1) $280 ===============
(1) Reported in capital contribution from LNC on our Consolidated Statements of Stockholder's Equity. 4. VARIABLE INTEREST ENTITIES CONSOLIDATED VIES In 2006 and 2007, we issued two funding agreements and used the proceeds to invest in the Class 1 Notes of two CLN structures, which represent special purpose trusts combining asset-backed securities with credit default swaps to produce multi-class structured securities. The CLN structures also include subordinated Class 2 Notes, which are held by third parties, and, together with the Class 1 Notes, represent 100% of the outstanding notes of the CLN structures. The entities that issued the CLNs are financed by the note holders, and, as such, the note holders participate in the expected losses and residual returns of the entities. Because the note holders do not have voting rights or similar rights, we determined the entities issuing the CLNs are VIEs, and as a note holder, our interest represented a variable interest. As of December 31, 2009, these VIEs were not consolidated because under the authoritative accounting guidance at that time, we were not the primary beneficiary of the VIEs because the Class 2 Notes absorbed the majority of the expected losses of the CLN structures. The carrying value of the CLNs as of December 31, 2009, was recognized as a fixed maturity security within AFS on our Consolidated Balance Sheets, and the funding agreements we issued were reported in other contract holder funds on our Consolidated Balance Sheets as of December 31, 2010 and 2009. Effective January 1, 2010, we adopted the new accounting guidance noted above and evaluated the primary beneficiary of the CLN structures using qualitative factors. Based on our evaluation, we concluded that the ability to actively manage the reference portfolio underlying the credit default swaps is the most significant activity impacting the performance of the CLN structures, because the subordination and participation in credit losses may change. We concluded that we have the power to direct this activity. In addition, we receive returns from the CLN structures and may absorb losses that could potentially be significant to the CLN structures. As such, we concluded that we are the primary beneficiary of the VIEs associated with the CLNs. We consolidated all of the assets and liabilities of the CLN structures through a cumulative effect adjustment to the beginning balance of retained earnings as of January 1, 2010, and recognized the results of operations of these VIEs on our consolidated financial statements beginning in the first quarter of 2010. See "Consolidations Topic" in Note 2 for more detail regarding the effect of the adoption. Asset and liability information (dollars in millions) for these S-22 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. VARIABLE INTEREST ENTITIES (CONTINUED) consolidated VIEs included on our Consolidated Balance Sheets as of December 31, 2010, was as follows:
NUMBER OF NOTIONAL CARRYING INSTRUMENTS AMOUNTS VALUE ----------- -------- ----------- ASSETS Fixed maturity corporate asset-backed credit card loan securities(1) N/A $ -- $584 =========== ======== =========== LIABILITIES Derivative instruments not designated and not qualifying as hedging instruments: Credit default swaps(2) 2 $600 $215 Contingent forwards(2) 2 -- (6) ----------- -------- ----------- Total derivative instruments not designated and not qualifying as hedging instruments 4 600 209 Federal income tax(2) N/A -- (77) ----------- -------- ----------- Total liabilities 4 $600 $132 =========== ======== ===========
(1) Reported in VIEs' fixed maturity securities on our Consolidated Balance Sheets. (2) Reported in VIEs' liabilities on our Consolidated Balance Sheets. For details related to the fixed maturity AFS securities for these VIEs, see Note 5. The credit default swaps create variability in the CLN structures and expose the note holders to the credit risk of the referenced portfolio. The contingent forwards transfer a portion of the loss in the underlying fixed maturity corporate asset-backed credit card loan securities back to the counterparty after credit losses reach our attachment point. The gains (losses) for these consolidated VIEs (in millions) recorded on our Consolidated Statements of Income (Loss) were as follows:
FOR THE YEAR ENDED DECEMBER 31, 2010 --------------- DERIVATIVE INSTRUMENTS NOT DESIGNATED AND NOT QUALIFYING AS HEDGING INSTRUMENTS Credit default swaps(1) $25 Contingent forwards(1) (9) --------------- Total derivative instruments not designated and not qualifying as hedging instruments $16 ===============
(1) Reported in realized gain (loss) on our Consolidated Statements of Income (Loss). The following summarizes information regarding the CLN structures (dollars in millions) as of December 31, 2010:
AMOUNT AND DATE OF ISSUANCE -------------------------- $400 $200 DECEMBER APRIL 2006 2007 ------------- ------------ Original attachment point (subordination) 5.50% 2.05% Current attachment point (subordination) 4.17% 1.48% Maturity 12/20/2016 3/20/2017 Current rating of tranche B- Ba2 Current rating of underlying collateral pool Aa1-B3 Aaa-B1 Number of defaults in underlying collateral pool 2 2 Number of entities 123 99 Number of countries 19 22
There has been no event of default on the CLNs themselves. Based upon our analysis, the remaining subordination as represented by the attachment point should be sufficient to absorb future credit losses, subject to changing market conditions. Similar to other debt market instruments, our maximum principal loss is limited to our original investment as of December 31, 2010. As described more fully in Note 1, we regularly review our investment holdings for OTTIs. Based upon this review, we believe that the fixed maturity corporate asset-backed credit card loan securities were not other-than-temporarily impaired as of December 31, 2010. S-23 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 4. VARIABLE INTEREST ENTITIES (CONTINUED) The following summarizes the exposure of the CLN structures' underlying collateral by industry and rating as of December 31, 2010:
AAA AA A BBB BB B CCC TOTAL ------- ------- ------- ------- ------- ------- ------- -------- INDUSTRY Telecommunications --% --% 6.4% 3.7% 1.1% --% --% 11.2% Financial intermediaries 0.4% 4.0% 6.2% 0.5% --% --% --% 11.1% Oil and gas --% 1.0% 1.2% 4.1% --% --% --% 6.3% Utilities --% --% 3.1% 1.4% --% --% --% 4.5% Chemicals and plastics --% --% 2.4% 1.2% 0.3% --% --% 3.9% Drugs 0.3% 2.2% 1.2% --% --% --% --% 3.7% Retailers (except food and drug) --% --% 0.6% 1.8% 1.1% --% --% 3.5% Industrial equipment --% --% 3.0% 0.3% --% --% --% 3.3% Sovereign --% 0.6% 1.6% 1.0% --% --% --% 3.2% Food products --% 0.3% 1.8% 1.1% --% --% --% 3.2% Conglomerates --% 2.7% 0.5% --% --% --% --% 3.2% Forest products --% --% --% 1.6% 1.4% --% --% 3.0% Other industry < 3% (28 industries) --% 2.0% 15.4% 17.3% 3.5% 1.4% 0.3% 39.9% ------- ------- ------- ------- ------- ------- ------- -------- Total by industry 0.7% 12.8% 43.4% 34.0% 7.4% 1.4% 0.3% 100.0% ======= ======= ======= ======= ======= ======= ======= ========
UNCONSOLIDATED VIES Effective December 31, 2010, we issued a $500 million long-term senior note in exchange for a corporate bond AFS security of like principal and duration from a non-affiliated VIE whose primary activities are to acquire, hold and issue notes and loans, as well as pay and collect interest on the notes and loans. We have concluded that we are not the primary beneficiary of this VIE because we do not have power over the activities that most significantly affect its economic performance. In addition, the terms of the senior note provide us with a set-off right to the corporate bond AFS security we purchased from the VIE; therefore, neither appears on our Consolidated Balance Sheets. We assigned the corporate bond AFS security to one of our subsidiaries and issued a guarantee to our subsidiary for the timely payment of the corporate bond's principle. Through our investment activities, we make passive investments in structured securities issued by VIEs for which we are not the manager. These structured securities include our MBS, which include CMOs, MPTS and CMBS and our ABS CDOs. We have not provided financial or other support with respect to these VIEs other than our original investment. We have determined that we are not the primary beneficiary of these VIEs due to the relative size of our investment in comparison to the principal amount of the structured securities issued by the VIEs and the level of credit subordination which reduces our obligation to absorb losses or right to receive benefits. Our maximum exposure to loss on these structured securities is limited to the amortized cost for these investments. We recognize our variable interest in these VIEs at fair value on our consolidated financial statements. For information about these structured securities, see Note 5. 5. INVESTMENTS AFS SECURITIES Pursuant to the Fair Value Measurements and Disclosures Topic of the FASB ASC, we have categorized AFS securities into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3), as described in Note 1, which also includes additional disclosures regarding our fair value measurements. S-24 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. INVESTMENTS (CONTINUED) The amortized cost, gross unrealized gains, losses and OTTI and fair value of AFS securities (in millions) were as follows:
AS OF DECEMBER 31, 2010 ----------------------------------------- GROSS UNREALIZED AMORTIZED ----------------------- FAIR COST GAINS LOSSES OTTI VALUE --------- ------ ------ --------- ------- FIXED MATURITY SECURITIES Corporate bonds $47,920 $3,470 $ 597 $ 78 $50,715 U.S. Government bonds 106 16 -- -- 122 Foreign government bonds 459 37 2 -- 494 MBS: CMOs 5,423 309 107 140 5,485 MPTS 2,801 100 5 -- 2,896 CMBS 2,047 89 165 6 1,965 ABS CDOs 173 21 13 8 173 State and municipal bonds 3,150 26 91 -- 3,085 Hybrid and redeemable preferred securities 1,433 55 134 -- 1,354 VIEs' fixed maturity securities 570 14 -- -- 584 --------- ------ ------ --------- ------- Total fixed maturity securities 64,082 4,137 1,114 232 66,873 --------- ------ ------ --------- ------- EQUITY SECURITIES Banking securities 2 -- -- -- 2 Insurance securities 32 4 -- -- 36 Other financial services securities 18 14 -- -- 32 Other securities 67 7 4 -- 70 --------- ------ ------ --------- ------- Total equity securities 119 25 4 -- 140 --------- ------ ------ --------- ------- Total AFS securities $64,201 $4,162 $1,118 $232 $67,013 ========= ====== ====== ========= =======
AS OF DECEMBER 31, 2009 ----------------------------------------- GROSS UNREALIZED AMORTIZED ----------------------- FAIR COST GAINS LOSSES OTTI VALUE --------- ------ ------ --------- ------- FIXED MATURITY SECURITIES Corporate bonds $43,028 $2,195 $1,084 $ 63 $44,076 U.S. Government bonds 136 12 -- -- 148 Foreign government bonds 473 25 9 -- 489 MBS: CMOs 5,819 246 289 149 5,627 MPTS 2,874 61 26 -- 2,909 CMBS 2,332 46 330 -- 2,048 ABS: CDOs 189 10 33 9 157 CLNs 600 -- 278 -- 322 State and municipal bonds 1,983 14 54 -- 1,943 Hybrid and redeemable preferred securities 1,382 33 245 -- 1,170 --------- ------ ------ --------- ------- Total fixed maturity securities 58,816 2,642 2,348 221 58,889 --------- ------ ------ --------- ------- EQUITY SECURITIES Banking securities 25 -- 1 -- 24 Insurance securities 44 2 -- -- 46 Other financial services securities 22 12 6 -- 28 Other securities 50 7 -- -- 57 --------- ------ ------ --------- ------- Total equity securities 141 21 7 -- 155 --------- ------ ------ --------- ------- Total AFS securities $58,957 $2,663 $2,355 $221 $59,044 ========= ====== ====== ========= =======
S-25 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. INVESTMENTS (CONTINUED) The amortized cost and fair value of fixed maturity AFS securities by contractual maturities (in millions) were as follows:
AS OF DECEMBER 31, 2010 ----------------------- AMORTIZED FAIR COST VALUE --------- ------------- Due in one year or less $ 2,236 $ 2,281 Due after one year through five years 11,815 12,631 Due after five years through ten years 19,298 20,601 Due after ten years 20,289 20,841 --------- ------------- Subtotal 53,638 56,354 --------- ------------- MBS 10,271 10,346 CDOs 173 173 --------- ------------- Total fixed maturity AFS securities $64,082 $66,873 ========= =============
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, including the portion of OTTI recognized in OCI, of AFS securities (dollars 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, 2010 ------------------------------------------------------------------------ LESS THAN OR EQUAL GREATER THAN TO TWELVE MONTHS TWELVE MONTHS TOTAL ----------------------------- ----------------------- ------------------ GROSS GROSS GROSS UNREALIZED UNREALIZED UNREALIZED FAIR LOSSES AND FAIR LOSSES AND FAIR LOSSES AND VALUE OTTI VALUE OTTI VALUE OTTI ------------------ ---------- ------ ---------------- ------- ---------- FIXED MATURITY SECURITIES Corporate bonds $5,155 $289 $1,944 $386 $ 7,099 $ 675 Foreign government bonds 19 -- 9 2 28 2 MBS: CMOs 447 116 700 131 1,147 247 MPTS 181 5 2 -- 183 5 CMBS 73 8 278 163 351 171 ABS CDOs -- -- 146 21 146 21 State and municipal bonds 1,849 81 26 10 1,875 91 Hybrid and redeemable preferred securities 199 9 547 125 746 134 ------------------ ---------- ------ ---------------- ------- ---------- Total fixed maturity securities 7,923 508 3,652 838 11,575 1,346 ------------------ ---------- ------ ---------------- ------- ---------- EQUITY SECURITIES Other securities 3 4 -- -- 3 4 ------------------ ---------- ------ ---------------- ------- ---------- Total equity securities 3 4 -- -- 3 4 ------------------ ---------- ------ ---------------- ------- ---------- Total AFS securities $7,926 $512 $3,652 $838 $11,578 $1,350 ================== ========== ====== ================ ======= ========== Total number of AFS securities in an unrealized loss position 1,196 ==========
S-26 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. INVESTMENTS (CONTINUED)
AS OF DECEMBER 31, 2009 ------------------------------------------------------------------------ LESS THAN OR EQUAL GREATER THAN TO TWELVE MONTHS TWELVE MONTHS TOTAL ----------------------------- ----------------------- ------------------ GROSS GROSS GROSS UNREALIZED UNREALIZED UNREALIZED FAIR LOSSES AND FAIR LOSSES AND FAIR LOSSES AND VALUE OTTI VALUE OTTI VALUE OTTI ------------------ ---------- ------ ---------------- ------- ---------- FIXED MATURITY SECURITIES Corporate bonds $4,163 $221 $5,638 $ 926 $ 9,801 $1,147 Foreign government bonds 30 -- 46 9 76 9 MBS: CMOs 382 151 870 287 1,252 438 MPTS 1,227 14 81 12 1,308 26 CMBS 152 13 619 317 771 330 ABS: CDOs 9 6 127 36 136 42 CLNs -- -- 322 278 322 278 State and municipal bonds 1,190 45 53 9 1,243 54 Hybrid and redeemable preferred securities 105 5 795 240 900 245 ------------------ ---------- ------ ---------------- ------- ---------- Total fixed maturity securities 7,258 455 8,551 2,114 15,809 2,569 ------------------ ---------- ------ ---------------- ------- ---------- EQUITY SECURITIES Banking securities 1 1 -- -- 1 1 Other financial services securities 4 6 -- -- 4 6 ------------------ ---------- ------ ---------------- ------- ---------- Total equity securities 5 7 -- -- 5 7 ------------------ ---------- ------ ---------------- ------- ---------- Total AFS securities $7,263 $462 $8,551 $2,114 $15,814 $2,576 ================== ========== ====== ================ ======= ========== Total number of AFS securities in an unrealized loss position 1,696 ==========
For information regarding our investments in VIEs, see Note 4. The fair value, gross unrealized losses, the portion of OTTI recognized in OCI (in millions) and number of AFS securities where the fair value had declined and remained below amortized cost by greater than 20% were as follows:
AS OF DECEMBER 31, 2010 ---------------------------------------------- GROSS UNREALIZED NUMBER FAIR ----------------------- OF VALUE LOSSES OTTI SECURITIES(1) ------ ------ ---------------- --------------- Less than six months $ 169 $ 73 $ 4 41 Six months or greater, but less than nine months 55 20 -- 13 Nine months or greater, but less than twelve months 39 15 1 13 Twelve months or greater 884 501 171 224 ------ ------ ---------------- --------------- Total $1,147 $609 $176 291 ====== ====== ================ =============== AS OF DECEMBER 31, 2009 ---------------------------------------------- GROSS UNREALIZED NUMBER FAIR ----------------------- OF VALUE LOSSES OTTI SECURITIES(1) ------ ------ ---------------- --------------- Less than six months $ 415 $ 125 $ 4 80 Six months or greater, but less than nine months 115 60 -- 25 Nine months or greater, but less than twelve months 409 160 93 96 Twelve months or greater 1,623 1,264 116 309 ------ ------ ---------------- --------------- Total $2,562 $1,609 $213 510 ====== ====== ================ ===============
(1) We may reflect a security in more than one aging category based on various purchase dates. S-27 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. INVESTMENTS (CONTINUED) We regularly review our investment holdings for OTTI. Our gross unrealized losses on AFS securities as of December 31, 2010, decreased $1.2 billion in comparison to December 31, 2009. This change was attributable to a decline in overall market yields, which was driven, in part, by improved credit fundamentals (i.e., market improvement and narrowing credit spreads). As discussed further below, we believe the unrealized loss position as of December 31, 2010, does not represent OTTI as we did not intend to sell these fixed maturity AFS securities, it is not more likely than not that we will be required to sell the fixed maturity AFS securities before recovery of their amortized cost basis, the estimated future cash flows were equal to or greater than the amortized cost basis of the debt securities or we had the ability and intent to hold the equity AFS securities for a period of time sufficient for recovery. Based upon this evaluation as of December 31, 2010, management believed we had the ability to generate adequate amounts of cash from our normal operations (e.g., insurance premiums and fees and investment income) to meet cash requirements with a prudent margin of safety without requiring the sale of our temporarily-impaired securities. As of December 31, 2010, the unrealized losses associated with our corporate bond securities were attributable primarily to securities that were backed by commercial loans and individual issuer companies. For our corporate bond securities with commercial loans as the underlying collateral, we evaluated the projected credit losses in the underlying collateral and concluded that we had sufficient subordination or other credit enhancement when compared with our estimate of credit losses for the individual security and we expected to recover the entire amortized cost for each security. For individual issuers, we performed detailed analysis of the financial performance of the issuer and determined that we expected to recover the entire amortized cost for each security. As of December 31, 2010, the unrealized losses associated with our MBS and ABS CDOs were attributable primarily to collateral losses and credit spreads. We assessed for credit impairment using a cash flow model as discussed above. The key assumptions included default rates, severities and prepayment rates. We estimated losses for a security by forecasting the underlying loans in each transaction. The forecasted loan performance was used to project cash flows to the various tranches in the structure, as applicable. Our forecasted cash flows also considered, as applicable, independent industry analyst reports and forecasts, sector credit ratings and other independent market data. Based upon our assessment of the expected credit losses of the security given the performance of the underlying collateral compared to our subordination or other credit enhancement, we expected to recover the entire amortized cost basis of each security. As of December 31, 2010, the unrealized losses associated with our hybrid and redeemable preferred securities were attributable primarily to wider credit spreads caused by illiquidity in the market and subordination within the capital structure, as well as credit risk of specific issuers. For our hybrid and redeemable preferred securities, we evaluated the financial performance of the issuer based upon credit performance and investment ratings and determined we expected to recover the entire amortized cost of each security. Changes in the amount of credit loss of OTTI recognized in net income (loss) where the portion related to other factors was recognized in OCI (in millions) on fixed maturity AFS securities were as follows:
FOR THE YEARS ENDED DECEMBER 31, ---------------------- 2010 2009 ------- -------------- Balance as of beginning-of-year $260 $ -- Cumulative effect from adoption of new accounting standard -- 30 Increases attributable to: Credit losses on securities for which an OTTI was not previously recognized 13 259 Credit losses on securities for which an OTTI was previously recognized 61 -- Decreases attributable to: Securities sold (25) (29) ------- -------------- Balance as of end-of-year $309 $260 ======= ==============
During the years ended December 31, 2010 and 2009, we recorded credit losses on securities for which an OTTI was not previously recognized as we determined the cash flows expected to be collected would not be sufficient to recover the entire amortized cost basis of the debt security. The credit losses we recorded on securities for which an OTTI was not previously recognized were attributable primarily to one or a combination of the following reasons: - Failure of the issuer of the security to make scheduled payments; - Deterioration of creditworthiness of the issuer; - Deterioration of conditions specifically related to the security; - Deterioration of fundamentals of the industry in which the issuer operates; - Deterioration of fundamentals in the economy including, but not limited to, higher unemployment and lower housing prices; and - Deterioration of the rating of the security by a rating agency. We recognize the OTTI attributed to the noncredit portion as a separate component in OCI referred to as unrealized OTTI on AFS securities. S-28 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. INVESTMENTS (CONTINUED) TRADING SECURITIES Trading securities at fair value (in millions) consisted of the following:
AS OF DECEMBER 31, ------------------ 2010 2009 ------ ----------- FIXED MATURITY SECURITIES Corporate bonds $1,674 $1,641 U.S. Government bonds 362 370 Foreign government bonds 29 29 MBS: CMOs 124 124 MPTS 123 60 CMBS 67 81 ABS CDOs 5 -- State and municipal bonds 22 18 Hybrid and redeemable preferred securities 51 41 ------ ----------- Total fixed maturity securities 2,457 2,364 EQUITY SECURITIES Other securities 2 2 ------ ----------- Total equity securities 2 2 ------ ----------- Total trading securities $2,459 $2,366 ====== ===========
The portion of the market adjustment for losses that relate to trading securities still held as of December 31, 2010, 2009 and 2008, was $86 million, $126 million and $172 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 U.S. with the largest concentrations in California and Texas, which accounted for approximately 31% and 29% of mortgage loans as of December 31, 2010 and 2009, respectively. The following provides the current and past due composition of our mortgage loans on real estate (in millions):
AS OF DECEMBER 31, --------------------- 2010 2009 --------- ----------- Current $6,419 $6,815 Valuation allowance associated with impaired mortgage loans on real estate (8) (8) Unamortized premium (discount) 20 28 --------- ----------- Total carrying value $6,431 $6,835 ========= ===========
The number of impaired mortgage loans on real estate, each of which had an associated specific valuation allowance, and the carrying value of impaired mortgage loans on real estate (dollars in millions) were as follows:
AS OF DECEMBER 31, --------------------- 2010 2009 ------- ------------- Number of impaired mortgage loans on real estate 6 2 ======= ============= Principal balance of impaired mortgage loans on real estate $52 $22 Valuation allowance associated with impaired mortgage loans on real estate (8) (8) ------- ------------- Carrying value of impaired mortgage loans on real estate $44 $14 ======= =============
The average carrying value on the impaired mortgage loans on real estate (in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, ---------------------- 2010 2009 2008 ---- ------------ ---- Average carrying value for impaired mortgage loans on real estate $29 $ 8 $-- Interest income recognized on impaired mortgage loans on real estate 3 -- -- Amount of interest income collected on impaired mortgage loans on real estate 3 -- -- ==== ============ ====
As described in Note 1, we use the loan-to-value and debt-service coverage ratios as credit quality indicators for our mortgage loans on real estate, which were as follows (dollars in millions):
AS OF DECEMBER 31, 2010 --------------------------- DEBT- SERVICE PRINCIPAL COVERAGE AMOUNT % RATIO --------- -------- -------- LOAN-TO-VALUE Less than 65% $4,677 72.9% 1.61 65% to 74% 1,429 22.3% 1.41 75% to 100% 143 2.2% 0.86 Greater than 100% 170 2.6% 1.15 --------- -------- Total mortgage loans on real estate $6,419 100.0% ========= ========
ALTERNATIVE INVESTMENTS As of December 31, 2010 and 2009, alternative investments included investments in approximately 95 and 99 different partnerships, respectively, and the portfolio represented less than 1% of our overall invested assets. S-29 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. INVESTMENTS (CONTINUED) NET INVESTMENT INCOME The major categories of net investment income (in millions) on our Consolidated Statements of Income (Loss) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 2010 2009 2008 --------- --------------- --------- Fixed maturity AFS securities $3,624 $3,373 $3,236 VIEs' fixed maturity AFS securities 14 -- -- Equity AFS securities 5 7 8 Trading securities 148 148 154 Mortgage loans on real estate 421 451 473 Real estate 16 17 20 Standby real estate equity commitments 1 1 3 Policy loans 167 169 177 Invested cash 5 8 45 Alternative investments 93 (54) (34) Consent fees 8 5 5 Other investments (7) 8 -- --------- --------------- --------- Investment income 4,495 4,133 4,087 Investment expense (133) (127) (112) --------- --------------- --------- Net investment income $4,362 $4,006 $3,975 ========= =============== =========
REALIZED GAIN (LOSS) RELATED TO CERTAIN INVESTMENTS The detail of the realized gain (loss) related to certain investments (in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 2010 2009 2008 -------- --------------- --------- Fixed maturity AFS securities: Gross gains $ 100 $ 154 $ 49 Gross losses (241) (687) (1,059) Equity AFS securities: Gross gains 9 5 1 Gross losses (4) (27) (33) Gain (loss) on other investments (4) (100) 31 Associated amortization of DAC, VOBA, DSI and DFEL and changes in other contract holder funds 8 157 244 -------- --------------- --------- Total realized gain (loss) related to certain investments $(132) $(498) $ (767) ======== =============== =========
Details underlying write-downs taken as a result of OTTI (in millions) that were recognized in net income (loss) and included in realized gain (loss) on AFS securities above, and the portion of OTTI recognized in OCI (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------ 2010 2009 2008 -------- --------------- ----------- OTTI RECOGNIZED IN NET INCOME (LOSS) Fixed maturity securities: Corporate bonds $ (88) $(209) $(527) MBS: CMOs (61) (237) (289) CMBS (41) -- (1) ABS CDOs (1) (39) (1) Hybrid and redeemable preferred securities (5) (67) (50) -------- --------------- ----------- Total fixed maturity securities (196) (552) (868) -------- --------------- ----------- Equity securities: Banking securities -- (10) -- Insurance securities -- (8) (1) Other financial services securities (3) (3) (24) Other securities -- (6) (7) -------- --------------- ----------- Total equity securities (3) (27) (32) -------- --------------- ----------- Gross OTTI recognized in net income (loss) (199) (579) (900) Associated amortization of DAC, VOBA, DSI and DFEL 51 198 218 -------- --------------- ----------- Net OTTI recognized in net income (loss), pre-tax $(148) $(381) $(682) ======== =============== =========== PORTION OF OTTI RECOGNIZED IN OCI Gross OTTI recognized in OCI $ 93 $ 339 $ -- Change in DAC, VOBA, DSI and DFEL (10) (77) -- -------- --------------- ----------- Net portion of OTTI recognized in OCI, pre-tax $ 83 $ 262 $ -- ======== =============== ===========
DETERMINATION OF CREDIT LOSSES ON CORPORATE BONDS AND ABS CDOS As of December 31, 2010 and 2009, we reviewed our corporate bond and ABS CDO portfolios for potential shortfall in contractual principal and interest based on numerous subjective and objective inputs. The factors used to determine the amount of credit loss for each individual security, include, but are not limited to, near term risk, substantial discrepancy between book and market value, sector or company-specific volatility, negative operating trends and trading levels wider than peers. S-30 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. INVESTMENTS (CONTINUED) DETERMINATION OF CREDIT LOSSES ON MBS As of December 31, 2010 and 2009, default rates were projected by considering underlying MBS loan performance and collateral type. Projected default rates on existing delinquencies vary between 25% to 100% depending on loan type and severity of delinquency status. In addition, we estimate the potential contributions of currently performing loans that may become delinquent in the future based on the change in delinquencies and loan liquidations experienced in the recent history. Finally, we develop a default rate timing curve by aggregating the defaults for all loans (delinquent loans, foreclosure and real estate owned and new delinquencies from currently performing loans) in the pool to project the future expected cash flows. We use certain available loan characteristics such as lien status, loan sizes and occupancy to estimate the loss severity of loans. Second lien loans are assigned 100% severity, if defaulted. For first lien loans, we assume a minimum of 30% severity with higher severity assumed for investor properties and further housing price depreciation. PAYABLES FOR COLLATERAL ON INVESTMENTS The carrying values of the payables for collateral on investments (in millions) included on our Consolidated Balance Sheets and the fair value of the related investments or collateral consisted of the following:
AS OF DECEMBER 31, ------------------------------------------ 2010 2009 -------------------- --------------------- CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE -------- ------ ----------- ------ Collateral payable held for derivative investments(1) $ 853 $ 853 $ 634 $ 634 Securities pledged under securities lending agreements(2) 199 192 501 479 Securities pledged under reverse repurchase agreements(3) 280 294 344 359 Securities pledged for Term Asset-Backed Securities Loan Facility ("TALF")(4) 280 318 345 386 Securities pledged for Federal Home Loan Bank of Indianapolis Securities ("FHLBI")(5) 100 115 100 111 -------- ------ ----------- ------ Total payables for collateral on investments $1,712 $1,772 $1,924 $1,969 ======== ====== =========== ======
(1) We obtain collateral based upon contractual provisions with our counterparties. These agreements take into consideration the counterparties' credit rating as compared to ours, the fair value of the derivative investments and specified thresholds that once exceeded result in the receipt of cash that is typically invested in cash and invested cash. See Note 6 for details about maximum collateral potentially required to post on our credit default swaps. (2) Our pledged securities under securities lending agreements are included in fixed maturity AFS securities 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 and invested cash or fixed maturity AFS securities. (3) Our pledged securities under reverse repurchase agreements are included in fixed maturity AFS securities 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 AFS securities. (4) Our pledged securities for TALF are included in fixed maturity AFS securities on our Consolidated Balance Sheets. We obtain collateral in an amount that has typically averaged 90% of the fair value of the TALF securities. The cash received in these transactions is invested in fixed maturity AFS securities. (5) Our pledged securities for FHLBI are included in fixed maturity AFS securities on our Consolidated Balance Sheets. We generally obtain collateral in an amount equal to 85% to 95% of the fair value of the FHLBI securities. The cash received in these transactions is typically invested in cash and invested cash or fixed maturity AFS securities. S-31 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. INVESTMENTS (CONTINUED) Increase (decrease) in payables for collateral on investments (in millions) included on the Consolidated Statements of Cash Flows consisted of the following:
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 2010 2009 2008 --------- --------------- -------- Collateral payable held for derivative investments $ 219 $ 651 $ (17) Securities pledged under securities lending agreements (302) 74 (228) Securities pledged under reverse repurchase agreements (64) (126) (10) Securities pledged for TALF (65) 345 -- Securities pledged for FHLBI -- 100 -- --------- --------------- -------- Total increase (decrease) in payables for collateral on investments $ (212) $1,044 $(255) ========= =============== ========
INVESTMENT COMMITMENTS As of December 31, 2010, our investment commitments were $887 million, which included $292 million of LPs, $53 million of standby commitments to purchase real estate upon completion and leasing, $354 million of private placements and $188 million of mortgage loans. CONCENTRATIONS OF FINANCIAL INSTRUMENTS As of December 31, 2010 and 2009, our most significant investments in one issuer were our investments in securities issued by the Federal Home Loan Mortgage Corporation with a fair value of $4.7 billion and $4.5 billion, or 6% of our invested assets portfolio, respectively, and our investments in securities issued by Fannie Mae with a fair value of $2.8 billion and $2.9 billion, or 3% and 4% of our invested assets portfolio, respectively. These investments are included in corporate bonds in the tables above. As of December 31, 2010, our most significant investments in one industry were our investment securities in the electric industry with a fair value of $6.4 billion, or 8% of our invested assets portfolio, and our investment securities in the CMO industry with a fair value of $6.2 billion, or 8% of our invested assets portfolio. As of December 31, 2009, our most significant investment in one industry was our investment securities in the CMO industry with a fair value of $6.6 billion, or 9% of the invested assets portfolio. We utilized the industry classifications to obtain the concentration of financial instruments amount; as such, this amount will not agree to the AFS securities table above. 6. DERIVATIVE INSTRUMENTS TYPES OF DERIVATIVE INSTRUMENTS AND DERIVATIVE STRATEGIES We maintain an overall risk management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate risk, foreign currency exchange risk, equity market risk, default risk, basis 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 used as part of our interest rate risk management strategy include interest rate swap agreements, interest rate cap agreements, interest rate futures, forward-starting interest rate swaps, consumer price index swaps, interest rate cap corridors, treasury locks and reverse treasury locks. Derivative instruments that are used as part of our foreign currency risk management strategy include foreign currency swaps, currency futures and foreign currency forwards. Call options based on LNC stock, call options based on the Standard & Poor's ("S&P") 500 Index(R) ("S&P 500"), total return swaps, variance swaps, put options and equity futures are used as part of our equity market risk management strategy. We also use credit default swaps as part of our credit risk management strategy. We evaluate and recognize our derivative instruments in accordance with the Derivatives and Hedging Topic of the FASB ASC. As of December 31, 2010, we had derivative instruments that were designated and qualifying as cash flow hedges. We also had embedded derivatives that were economic hedges, but were not designed to meet the requirements for hedge accounting treatment. See Note 1 for a detailed discussion of the accounting treatment for derivative instruments. Our derivative instruments are monitored by LNC's Asset Liability Management Committee and LNC's Equity Risk Management Committee as part of those committees' oversight of our derivative activities. These committees are responsible for implementing various hedging strategies that are developed through their analysis of financial simulation models and other internal and industry sources. The resulting hedging strategies are incorporated into our overall risk management strategies. We use a hedging strategy designed to mitigate the risk and income statement volatility caused by changes in the equity markets, interest rates and volatility associated with living benefit guarantees offered in our variable annuity products, including the LINCOLN SMARTSECURITY(R) Advantage GWB feature, the 4LATER(R) Advantage GIB feature and the I4LIFE(R) Advantage GIB feature. See "GLB Reserves Embedded Derivatives" below for further details. S-32 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. DERIVATIVE INSTRUMENTS (CONTINUED) See Note 22 for additional disclosures related to the fair value of our financial instruments and see Note 4 for derivative instruments related to our consolidated VIEs. 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 (dollars in millions) were as follows:
AS OF DECEMBER 31, 2010 ---------------------------------------------------------------------- ASSET CARRYING (LIABILITY) CARRYING NUMBER OR FAIR VALUE OR FAIR VALUE OF NOTIONAL ------------------------ ----------------------- INSTRUMENTS AMOUNTS GAIN LOSS GAIN LOSS ----------- -------- ------ ----------------- ---- ------------------ DERIVATIVE INSTRUMENTS DESIGNATED AND QUALIFYING AS HEDGING INSTRUMENTS Cash flow hedges: Interest rate swap agreements(1) 151 $ 926 $ 24 $ (71 -- $ -- Forward-starting interest rate swaps(1) 2 150 1 -- -- -- Foreign currency swaps(1) 13 340 43 (13) -- -- Reverse treasury locks(1) 5 1,000 11 (5) -- -- ----------- -------- ------ ----------------- ---- ------------------ Total derivative instruments designated and qualifying as hedging instruments 171 2,416 79 (89) -- -- ----------- -------- ------ ----------------- ---- ------------------ DERIVATIVE INSTRUMENTS NOT DESIGNATED AND NOT QUALIFYING AS HEDGING INSTRUMENTS Interest rate cap agreements(1) 3 150 -- -- -- -- Interest rate futures(1) 15,881 2,251 -- -- -- -- Equity futures(1) 13,375 907 -- -- -- -- Interest rate swap agreements(1) 81 7,955 34 (511) -- -- Credit default swaps(2) 9 145 -- -- -- (16) Total return swaps(1) 8 800 -- (21) -- -- Put options(1) 145 5,602 1,151 -- -- -- Call options (based on S&P 500)(1) 544 4,083 301 -- -- -- Variance swaps(1) 50 30 46 (34) -- -- Currency futures(1) 1,589 219 -- -- -- -- Consumer price index swaps(1) 100 55 -- (2) -- -- Interest rate cap corridors(1) 73 8,050 52 -- -- -- Embedded derivatives: Deferred compensation plans(2) 6 -- -- -- -- (315) Indexed annuity contracts(3) 132,260 -- -- -- -- (497) GLB reserves(3) 305,962 -- -- -- 518 (926) Reinsurance related(4) -- -- 417 -- -- (305) AFS securities(1) 1 -- 15 -- -- -- ----------- -------- ------ ----------------- ---- ------------------ Total derivative instruments not designated and not qualifying as hedging instruments 470,087 30,247 2,016 (568) 518 (2,059) ----------- -------- ------ ----------------- ---- ------------------ Total derivative instruments 470,258 $32,663 $2,095 $(657) $518 $(2,059) =========== ======== ====== ================= ==== ==================
S-33 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. DERIVATIVE INSTRUMENTS (CONTINUED)
AS OF DECEMBER 31, 2009 ----------------------------------------------------------------------- ASSET CARRYING (LIABILITY) CARRYING NUMBER OR FAIR VALUE OR FAIR VALUE OF NOTIONAL ------------------------ ----------------------- INSTRUMENTS AMOUNTS GAIN LOSS GAIN LOSS ----------- -------- ------ ----------------- ---- ------------------ DERIVATIVE INSTRUMENTS DESIGNATED AND QUALIFYING AS HEDGING INSTRUMENTS Cash flow hedges: Interest rate swap agreements(1) 85 $ 620 $ 24 $ (45) $ -- $ -- Foreign currency swaps(1) 13 340 33 (19) -- -- ----------- -------- ------ ------------------- ---- ------------------ Total derivative instruments designated and qualifying as hedging instruments 98 960 57 (64) -- -- ----------- -------- ------ ------------------- ---- ------------------ DERIVATIVE INSTRUMENTS NOT DESIGNATED AND NOT QUALIFYING AS HEDGING INSTRUMENTS Interest rate cap agreements(1) 20 1,000 -- -- -- -- Interest rate futures(1) 19,073 2,333 -- -- -- -- Equity futures(1) 21,149 1,147 -- -- -- -- Interest rate swap agreements(1) 81 6,232 63 (349) -- -- Foreign currency forwards(1) 17 1,035 12 (91) -- -- Credit default swaps(2) 14 220 -- -- -- (65) Put options(1) 114 4,093 935 -- -- -- Call options (based on LNC stock)(1) 1 9 -- -- -- -- Call options (based on S&P 500)(1) 559 3,440 215 -- -- -- Variance swaps(1) 36 26 66 (22) -- -- Currency futures(1) 3,664 505 -- -- -- -- Embedded derivatives: Deferred compensation plans(2) 6 -- -- -- -- (314) Indexed annuity contracts(3) 108,119 -- -- -- -- (419) GLB reserves(3) 261,309 -- -- -- 308 (984) Reinsurance related(4) -- -- 417 -- -- (140) AFS securities(1) 2 -- 19 -- -- -- ----------- -------- ------ ------------------- ---- ------------------ Total derivative instruments not designated and not qualifying as hedging instruments 414,164 20,040 1,727 (462) 308 (1,922) ----------- -------- ------ ------------------- ---- ------------------ Total derivative instruments 414,262 $21,000 $1,784 $(526) $308 $(1,922) =========== ======== ====== =================== ==== ==================
(1) Reported in derivative investments on our Consolidated Balance Sheets. (2) Reported in other liabilities on our Consolidated Balance Sheets. (3) Reported in future contract benefits on our Consolidated Balance Sheets. (4) Reported in reinsurance related embedded derivatives on our Consolidated Balance Sheets. S-34 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. DERIVATIVE INSTRUMENTS (CONTINUED) The maturity of the notional amounts of derivative instruments (in millions) was as follows:
REMAINING LIFE AS OF DECEMBER 31, 2010 -------------------------------------------------------- LESS THAN 1 - 5 6 - 10 11 - 30 OVER 30 1 YEAR YEARS YEARS YEARS YEARS TOTAL --------- ------ ------- -------- -------------- ------- DERIVATIVE INSTRUMENTS DESIGNATED AND QUALIFYING AS HEDGING INSTRUMENTS Cash flow hedges: Interest rate swap agreements $ 24 $ 84 $ 264 $ 540 $14 $ 926 Forward-starting interest rate swaps -- -- 50 100 -- 150 Foreign currency swaps -- 124 135 81 -- 340 Reverse treasury locks -- 850 150 -- -- 1,000 --------- ------ ------- -------- -------------- ------- Total derivative instruments designated and qualifying as hedging instruments 24 1,058 599 721 14 2,416 --------- ------ ------- -------- -------------- ------- DERIVATIVE INSTRUMENTS NOT DESIGNATED AND NOT QUALIFYING AS HEDGING INSTRUMENTS Interest rate cap agreements 150 -- -- -- -- 150 Interest rate futures 2,251 -- -- -- -- 2,251 Equity futures 907 -- -- -- -- 907 Interest rate swap agreements 203 1,819 1,719 4,214 -- 7,955 Credit default swaps -- 40 105 -- -- 145 Total return swaps 650 150 -- -- -- 800 Put options -- 1,589 4,013 -- -- 5,602 Call options (based on S&P 500) 3,311 772 -- -- -- 4,083 Variance swaps -- 4 26 -- -- 30 Currency futures 219 -- -- -- -- 219 Consumer price index swaps 4 15 15 19 2 55 Interest rate cap corridors -- -- 8,050 -- -- 8,050 --------- ------ ------- -------- -------------- ------- Total derivative instruments not designated and not qualifying as hedging instruments 7,695 4,389 13,928 4,233 2 30,247 --------- ------ ------- -------- -------------- ------- Total derivative instruments with notional amounts $7,719 $5,447 $14,527 $4,954 $16 $32,663 ========= ====== ======= ======== ============== =======
S-35 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. DERIVATIVE INSTRUMENTS (CONTINUED) The change in our unrealized gain (loss) on derivative instruments in accumulated OCI (in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, ---------------------- 2010 2009 ------- -------------- UNREALIZED GAIN (LOSS) ON DERIVATIVE INSTRUMENTS Balance as of beginning-of-year $(13) $(15) Other comprehensive income (loss): Unrealized holding gains (losses) arising during the year: Cash flow hedges: Interest rate swap agreements (24) 33 Forward-starting interest rate swaps 1 -- Foreign currency swaps 14 (21) Reverse treasury locks 5 -- AFS securities embedded derivatives 2 -- Change in foreign exchange rate adjustment 4 (31) Change in DAC, VOBA, DSI and DFEL (11) 11 Income tax benefit (expense) 3 5 Less: Reclassification adjustment for gains (losses) included in net income (loss): Cash flow hedges: Interest rate swap agreements(1) 4 4 Foreign currency swaps(1) 2 -- Associated amortization of DAC, VOBA, DSI and DFEL (9) (11) Income tax benefit (expense) 1 2 ------- -------------- Balance as of end-of-year $(17) $(13) ======= ==============
(1) The OCI offset is reported within net investment income on our Consolidated Statements of Income (Loss). (2) The OCI offset is reported within interest and debt ex- pense on our Consolidated Statements of Income (Loss). The gains (losses) on derivative instruments (in millions) recorded within net income (loss) on our Consolidated Statements of Income (Loss) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 2010 2009 2008 -------- --------------- ---------- DERIVATIVE INSTRUMENTS DESIGNATED AND QUALIFYING AS HEDGING INSTRUMENTS Cash flow hedges: Interest rate swap agreements(1) $ 4 $ 3 $ (3) Forward-starting interest rate swaps(1) (1) -- -- Foreign currency swaps(1) 2 1 (1) -------- --------------- ---------- Total derivative instruments designated and qualifying as hedging instruments 5 4 (4) -------- --------------- ---------- DERIVATIVE INSTRUMENTS NOT DESIGNATED AND NOT QUALIFYING AS HEDGING INSTRUMENTS Interest rate cap agreements(2) -- -- (1) Interest rate futures(2) 183 (60) -- Equity futures(2) (248) (55) -- Interest rate swap agreements(2) (8) (150) -- Foreign currency forwards(1) 43 23 -- Credit default swaps -- fees(1) 1 1 1 Credit default swaps -- marked-to-market(3) 7 (37) (51) Total return swaps(3) (133) -- -- Put options(2) (217) (136) -- Call options (based on LNC stock)(2) -- -- (8) Call options (based on S&P 500)(2) 114 84 (214) Variance swaps(2) (34) (38) -- Currency futures(2) (13) (18) -- Consumer price index swaps(2) (1) -- -- Interest rate cap corridors(1) 5 -- -- Embedded derivatives: Deferred compensation plans(3) (33) (50) 43 Indexed annuity contracts(2) (81) (75) 196 GLB reserves(2) 268 2,228 (2,625) Reinsurance related(2) (165) (155) 226 AFS securities(1) (4) 4 -- -------- --------------- ---------- Total derivative instruments not designated and not qualifying as hedging instruments (316) 1,566 (2,433) -------- --------------- ---------- Total derivative instruments $(311) $1,570 $(2,437) ======== =============== ==========
(1) Reported in net investment income on our Consolidated Statements of Income (Loss). (2) Reported in realized gain (loss) on our Consolidated State- ments of Income (Loss). (3) Reported in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income (Loss). S-36 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. DERIVATIVE INSTRUMENTS (CONTINUED) The location in the Consolidated Statements of Income (Loss) where the gains (losses) are recorded for each of the derivative instruments discussed below is specified in the table above. DERIVATIVE INSTRUMENTS DESIGNATED AND QUALIFYING AS CASH FLOW HEDGES Gains (losses) (in millions) on derivative instruments designated and qualifying as cash flow hedges were as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------------- 2010 2009 2008 ---- --------------- ---- Ineffective portion recognized in realized gain (loss) $ -- $ (1) $1 Gain (loss) recognized as a component of OCI with the offset to net investment income 6 4 2
As of December 31, 2010, $19 million of the deferred net losses on derivative instruments in accumulated OCI were expected to be reclassified to earnings during the next twelve months. This reclassification would be due primarily to the interest rate variances related to the interest rate swap agreements. For the years ended December 31, 2010, 2009 and 2008, 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 the interest rate risk of 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 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 (loss) as the related bond interest is accrued. In addition, we use interest rate swap agreements to hedge our exposure to fixed rate bond coupon payments and the change in underlying asset values as interest rates fluctuate. As of December 31, 2010, the latest maturity date for which we were hedging our exposure to the variability in future cash flows for these instruments was June 2042. FORWARD-STARTING INTEREST RATE SWAPS We use forward-starting interest rate swaps to hedge our exposure to interest rate fluctuations related to the forecasted purchase of certain AFS securities. The gains or losses resulting from the swap agreements are recorded in OCI. The gains or losses are reclassified from accumulated OCI to earnings over the life of the assets once the assets are purchased. FOREIGN CURRENCY SWAPS We use foreign currency swaps, which are traded over-the-counter, to hedge some of the foreign exchange risk of investments in fixed maturity securities denominated in foreign currencies. A foreign currency swap is a contractual agreement to exchange the currencies of two different countries at a specified rate of exchange in the future. The 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 (loss) as the related bond interest is accrued. As of December 31, 2010, the latest maturity date for which we were hedging our exposure to the variability in future cash flows for these instruments was July 2022. REVERSE TREASURY LOCKS We use reverse treasury locks to hedge the interest rate exposure related to the purchase of fixed rate securities or the anticipated future cash flows of floating rate fixed maturity securities due to changes in interest rates. These derivatives are primarily structured to hedge interest rate risk inherent in the assumptions used to price certain liabilities. The gains or losses resulting from the reverse treasury locks are recorded in OCI and are reclassified from accumulated OCI to earnings over the life of the assets once the assets are purchased. DERIVATIVE INSTRUMENTS NOT DESIGNATED AND NOT QUALIFYING AS HEDGING 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 We use interest rate cap agreements to provide a level of protection from the effect of rising interest rates for our annuity business, within our Retirement Solutions - Annuities and Retirement Solutions - Defined Contribution segments. 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. Our interest rate cap agreements provide an economic hedge of our annuity business. INTEREST RATE FUTURES AND EQUITY FUTURES We use interest rate futures and equity futures contracts to hedge the liability exposure on certain options in variable annuity products. These futures contracts require payment between our counterparty and us on a daily basis for changes in the futures index price. INTEREST RATE SWAP AGREEMENTS We use interest rate swap agreements to hedge the liability exposure on certain options in variable annuity products. S-37 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. DERIVATIVE INSTRUMENTS (CONTINUED) FOREIGN CURRENCY FORWARDS We used foreign currency forward contracts to hedge dividends received from LNC's former subsidiary, Lincoln UK. The foreign currency forward contracts obligated us to deliver a specified amount of currency at a future date and a specified exchange rate. 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 counter-party at par upon a default event by the bond issuer. A default event is defined as bankruptcy, failure to pay, obligation acceleration or restructuring. We sold credit default swaps to offer credit protection to contract holders and investors. The credit default swaps hedge the contract holders and investors against a drop in bond prices due to credit concerns of certain bond issuers. A credit default swap allows the investor to put the bond back to us at par upon a default event by the bond issuer. A default event is defined as bankruptcy, failure to pay, obligation acceleration or restructuring. Information related to our open credit default swap liabilities for which we are the seller (dollars in millions) was as follows:
AS OF DECEMBER 31, 2010 ----------------------------------------------------------------------------------------------------- CREDIT RATING MAXIMUM REASON FOR NATURE OF OF UNDERLYING NUMBER OF POTENTIAL MATURITY ENTERING RECOURSE OBLIGATION(1) INSTRUMENTS FAIR VALUE(2) PAYOUT --------------- ------------- ------------ --------------- ----------- ------------------ --------- 12/20/2012(3) (5) (6) BBB+ 4 $ -- $ 40 12/20/2016(4) (5) (6) BBB 3 (12) 65 03/20/2017(4) (5) (6) BBB- 2 (4) 40 ----------- ------------------ --------- 9 $(16) $145 =========== ================== ========= 03/20/2010(3) (7) (6) A- 1 $ -- $ 10 06/20/2010(3) (7) (6) A 1 -- 10 12/20/2012(3) (5) (6) BBB+ 4 -- 40 12/20/2016(4) (5) (6) B- 2 (19) 48 03/20/2017(4) (5) (6) BB+ 6 (46) 112 ----------- ------------------ --------- 14 $(65) $220 =========== ================== =========
(1) Represents average credit ratings based on the midpoint of the applicable ratings among Moody's, S&P and Fitch Ratings. (2) Broker quotes are used to determine the market value of credit default swaps. (3) These credit default swaps were sold to our contract holders, prior to 2007, where we determined there was a spread versus premium mismatch. (4) These credit default swaps were sold to a counter-party of the consolidated VIEs as discussed in Note 1. (5) Credit default swap was entered into in order to generate income by providing default protection in return for a quarterly payment. (6) Seller does not have the right to demand indemnification or compensation from third parties in case of a loss (payment) on the contract. (7) Credit default swap was entered into in order to generate income by providing protection on a highly rated basket of securities in return for a quarterly payment. Details underlying the associated collateral of our open credit default swaps for which we are the seller, if credit risk related contingent features were triggered (in millions) are as follows:
AS OF DECEMBER 31, ------------------ 2010 2009 ---- ------------- Maximum potential payout $145 $220 Less: Counterparty thresholds 10 30 ---- ------------- Maximum collateral potentially required to post $135 $190 ==== =============
Certain of our credit default swap agreements contain contractual provisions that allow for the netting of collateral with our counterparties related to all of our collateralized financing transactions that we have outstanding. If these netting agreements were not in place, we would have been required to post approximately $6 million as of December 31, 2010, after considering the fair values of the associated investments counter-parties' credit ratings as compared to ours and specified thresholds that once exceeded result in the payment of cash. TOTAL RETURN SWAPS We use total return swaps to hedge a portion of the liability related to our deferred compensation plans. We receive the total S-38 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. DERIVATIVE INSTRUMENTS (CONTINUED) return on a portfolio of indexes and pay a floating rate of interest. PUT OPTIONS We use put options to hedge the liability exposure on certain options in variable annuity products. Put options are contracts that require counterparties to pay us at a specified future date the amount, if any, by which a specified equity index is less than the strike rate stated in the agreement, applied to a notional amount. 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. CALL OPTIONS (BASED ON S&P 500) We use indexed annuity contracts to permit the holder to elect an interest rate return or an equity market component, where interest credited to the contracts is linked to the performance of the S&P 500. Contract holders may elect to rebalance index options at renewal dates, either annually or biannually. As of each renewal date, we have the opportunity to re-price the indexed component by establishing participation rates, subject to minimum guarantees. We purchase call options that are highly correlated to the portfolio allocation decisions of our contract holders, such that we are economically hedged with respect to equity returns for the current reset period. The mark-to-market of the options held generally offsets the change in value of the embedded derivative within the indexed annuity. VARIANCE SWAPS We use variance swaps to hedge the liability exposure on certain options in variable annuity products. Variance swaps are contracts entered into at no cost and whose payoff is the difference between the realized variance rate of an underlying index and the fixed variance rate determined as of inception. CURRENCY FUTURES We use currency futures to hedge foreign exchange risk associated with certain options in variable annuity products. Currency futures exchange one currency for another at a specified date in the future at a specified exchange rate. CONSUMER PRICE INDEX SWAPS We use consumer price index swaps to hedge the liability exposure on certain options in fixed/indexed annuity products. Consumer price index swaps are contracts entered into at no cost and whose payoff is the difference between the consumer price index inflation rate and the fixed rate determined as of inception. INTEREST RATE CAP CORRIDORS We use interest rate cap corridors to provide a level of protection from the effect of rising interest rates for our annuity business, within our Retirement Solutions - Annuities and Retirement Solutions - Defined Contribution segments. Interest rate cap corridors involve purchasing an interest rate cap at a specific cap rate and selling an interest rate cap with a higher cap rate. For each corridor, the amount of quarterly payments, if any, is determined by the rate at which the underlying index rate resets above the original capped rate. The corridor limits the benefit the purchaser can receive as the related interest rate index rises above the higher capped rate. There is no additional liability to us other than the purchase price associated with the interest rate cap corridor. Our interest rate cap corridors provide an economic hedge of our annuity business. DEFERRED COMPENSATION PLANS EMBEDDED DERIVATIVES 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 (loss). INDEXED ANNUITY CONTRACTS EMBEDDED DERIVATIVES We distribute indexed annuity contracts that permit the holder to elect an interest rate return or an equity market component, where interest credited to the contracts is linked to the performance of the S&P 500. This feature represents an embedded derivative under the Derivatives and Hedging Topic of the FASB ASC. Contract holders may elect to rebalance index options at renewal dates, either annually or biannually. As of each renewal date, we have the opportunity to re-price the indexed component by establishing participation rates, subject to minimum guarantees. We purchase S&P 500 call options that are highly correlated to the portfolio allocation decisions of our contract holders, such that we are economically hedged with respect to equity returns for the current reset period. The mark-to-market of the options held generally offsets the change in value of the embedded derivative within the indexed annuity. GLB RESERVES EMBEDDED DERIVATIVES We have certain GLB variable annuity products with GWB and GIB features that are embedded derivatives. Certain features of these guarantees, notably our GIB, 4LATER([R]) and LINCOLN LIFETIME INCOME(SM)ADVANTAGE features, have elements of both insurance benefits accounted for under the Financial Services - Insurance - Claim Costs and Liabilities for Future Policy Benefits Subtopic of the FASB ASC ("benefit reserves") and embedded derivatives accounted for under the Derivatives and Hedging and the Fair Value Measurements and Disclosures Topics of the FASB ASC ("embedded derivative reserves"). We calculate the value of the embedded derivative reserve and the benefit reservexx based on the specific characteristics of each GLB feature. As of December 31, 2010, we had $30.3 billion of account values that were attributable to variable annuities with a GWB feature and $11.4 billion of account values that were attributable to variable annuities with a GIB feature. We use a hedging strategy designed to mitigate the risk and income statement volatility caused by changes in the equity markets, interest rates and volatility associated with GWB and GIB features. The hedging strategy is designed such that changes in the value of the hedge contracts due to changes in equity markets, interest rates and implied volatilities move in the opposite direction of changes in embedded derivative reserves of the GWB and GIB caused by those same factors. As part of our current hedging program, equity markets, interest rates and volatility in market conditions are monitored on a S-39 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 6. DERIVATIVE INSTRUMENTS (CONTINUED) daily basis. We rebalance our hedge positions based upon changes in these factors as needed. While we actively manage our hedge positions, these hedge positions may not be totally effective in offsetting changes in the embedded derivative 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 and our ability to purchase hedging instruments at prices consistent with our desired risk and return trade-off. However, the hedging results do not impact LNL due to a funds withheld agreement with LNBAR, which causes the financial impact of the derivatives as well as the cash flow activity to be reflected on LNBAR. REINSURANCE RELATED EMBEDDED DERIVATIVES 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 as they occur are recorded through net income (loss). Offsetting these amounts are corresponding changes in the estimated fair value of trading securities in portfolios that support these arrangements. These embedded derivatives, which are included in reinsurance related embedded derivatives on our Consolidated Balance Sheets, were $(305) million and $(140) million as of December 31, 2010 and 2009, respectively. We are involved in an inter-company reinsurance agreement where we cede to LNBAR the risk under certain UL contracts for no lapse benefit guarantees. If our contract holders' account value is not sufficient to pay the cost of insurance charges required to keep the policy inforce, and the contract holder has made required deposits, LNBAR will reimburse us for the charges. These embedded derivatives, which are included in reinsurance related embedded derivatives on our Consolidated Balance Sheets, were $417 million as of Decem-ber 31, 2010 and 2009. AFS SECURITIES EMBEDDED DERIVATIVES We own various debt securities that either contain call options to exchange the debt security for other specified securities of the borrower, usually common stock, or contain call options to receive the return on equity-like indexes. The change in fair value of these embedded derivatives flows through net income (loss). CREDIT RISK We are exposed to credit loss in the event of nonperformance by our counterparties on various derivative contracts and reflect assumptions regarding the credit or nonperformance risk. The nonperformance risk is based upon assumptions for each counterparty's credit spread over the estimated weighted average life of the counterparty exposure less collateral held. As of December 31, 2010, the nonperformance risk adjustment was $10 million. The credit risk associated with such agreements is minimized by purchasing such agreements from financial institutions with long-standing, superior performance records. Additionally, we maintain a policy of requiring all derivative contracts to be governed by an International Swaps and Derivatives Association ("ISDA") Master Agreement. We 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 either party to post collateral when net exposures exceed pre-determined thresholds. These thresholds vary by counterparty and credit rating. We do not believe the inclusion of termination or collateralization events pose any material threat to the liquidity position of the Company. The amount of such exposure is essentially the net replacement cost or market value less collateral held for such agreements with each counterparty if the net market value is in our favor. As of December 31, 2010, the exposure was $175 million. The amounts recognized (in millions) by S&P credit rating of counterparty, for which we had the right to reclaim cash collateral or were obligated to return cash collateral, were as follows:
AS OF DECEMBER 31, 2010 AS OF DECEMBER 31, 2009 ----------------------- -------------------------- COLLATERAL COLLATERAL COLLATERAL COLLATERAL POSTED BY POSTED BY POSTED BY POSTED BY S&P COUNTER- LNC COUNTER- LNC CREDIT PARTY (HELD BY PARTY (HELD BY RATING OF (HELD BY COUNTER- (HELD BY COUNTER- COUNTERPARTY LNC) PARTY) LNC) PARTY) ------------ ---------- ------------ ---------- --------------- AAA $ 1 $ -- $ 3 $ -- AA 99 -- 140 -- AA- 65 -- 272 -- A+ 548 43 171 (13) A 422 202 328 (240) ---------- ------------ ---------- --------------- $1,135 $245 $914 $(253) ========== ============ ========== ===============
S-40 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. FEDERAL INCOME TAXES The federal income tax expense (benefit) on continuing operations (in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 2010 2009 2008 --------- --------------- -------- Current $ (179) $ 172 $(292) Deferred 526 (9) 224 --------- --------------- -------- Federal income tax expense (benefit) $ 347 $ 163 $ (68) ========= =============== ========
A reconciliation of the effective tax rate differences (in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 2010 2009 2008 -------- -------- ----------- Tax rate times pre-tax income $ 498 $ 88 $ 65 Effect of: Separate account dividend received deduction (94) (77) (82) Tax credits (42) (47) (25) Goodwill -- 238 -- Prior year tax return adjustment (13) (60) (34) Other items (2) 21 8 -------- -------- --- ------- Federal income tax expense (benefit) $ 347 $ 163 $ (68) ======== ======== =========== Effective tax rate 24% N/M N/M ======== ======== === =======
The effective tax rate is a ratio of tax expense over pre-tax income (loss). Since the pre-tax income of $251 million and $186 million in 2009 and 2008, respectively, resulted in a tax expense of $163 million in 2009 and a tax benefit of $68 million in 2008, the effective tax rate was not meaningful. The separate account dividend received deduction included in the table above is exclusive of any prior years' tax return resolution. The federal income tax asset (liability) (in millions), which is included in other liabilities on our Consolidated Balance Sheets, was as follows:
AS OF DECEMBER 31, --------------------- 2010 2009 ---------- ---------- Current $ (412) $ (250) Deferred (1,500) (523) ---------- ---------- Total federal income tax asset (liability) $(1,912) $ (773) ========== ==========
Significant components of our deferred tax assets and liabilities (in millions) were as follows:
AS OF DECEMBER 31, --------------------- 2010 2009 ---------- ---------- DEFERRED TAX ASSETS Future contract benefits and other contract holder funds $ 1,116 $1,676 Other investments 625 338 Reinsurance deferred gain 138 163 Modco embedded derivative asset 93 49 Compensation and benefit plans 136 151 Net capital loss 96 112 VIE 77 -- Other 73 58 ---------- ---------- Total deferred tax assets 2,354 2,547 ---------- ---------- DEFERRED TAX LIABILITIES DAC 1,982 1,947 VOBA 483 734 Net unrealized gain on AFS securities 988 38 Net unrealized gain on trading securities 86 55 Intangibles 179 192 Other 136 104 ---------- ---------- Total deferred tax liabilities 3,854 3,070 ---------- ---------- Net deferred tax asset (liability) $(1,500) $ (523) ========== ==========
LNL and its affiliates, with the exception of Jefferson-Pilot Life Insurance Company ("JPL"), Jefferson Pilot Financial Insurance Company ("JPFIC") and Jefferson Pilot LifeAmerica Insurance Company ("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 with LLANY on April 2, 2007. As of December 31, 2010, LNL had net capital loss carryforwards of $275 million which will expire in 2014. LNL believes that it is more likely than not that the capital losses will be fully utilized within the allowable carryforward period. The application of GAAP requires us to evaluate the recoverability of our deferred tax assets and establish a valuation allowance if necessary, to reduce our deferred tax asset to an amount that is more likely than not to be realizable. Considerable judgment and the use of estimates are required in determining whether a valuation allowance is necessary, and if so, the amount of such valuation allowance. In evaluating the need for a valuation allowance, we consider many factors, including: the nature and character of the deferred tax assets and liabilities; taxable income in prior carryback years; future reversals of temporary differences; the length of time carryovers can be utilized; and any tax planning strategies we would employ to avoid a tax benefit from expiring unused. Although realization is not assured, management believes it is S-41 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. FEDERAL INCOME TAXES more likely than not that the deferred tax assets, including our capital loss deferred tax asset, will be realized. As of December 31, 2010 and 2009, $181 million and $180 million, of our unrecognized tax benefits presented below, if recognized, would have impacted our income tax expense and our effective tax rate. We anticipate a change to our unrecognized tax benefits during 2011 in the range of none to $107 million.
FOR THE YEARS ENDED DECEMBER 31, ------------------ 2010 2009 ---------- ------- Balance as of beginning-of-year $293 $264 Increases for prior year tax positions 2 26 Decreases for prior year tax positions (6) (1) Increases for current year tax positions 8 11 Decreases for current year tax positions (7) (7) Decreases for settlements with taxing authorities (10) -- Decreases for lapse of statute of limitations (2) -- ---------- ------- Balance as of end-of-year $278 $293 ========== =======
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, 2010, 2009 and 2008, we recognized interest and penalty expense related to uncertain tax positions of $6 million, $11 million and $1 million, respectively. We had accrued interest and penalty expense related to the unrecognized tax benefits of $81 million and $75 million as of December 31, 2010 and 2009, respectively. We are subject to annual tax examinations from the Internal Revenue Service ("IRS"). During the third quarter of 2008, the IRS completed its examination for tax years 2003 and 2004 resulting in a proposed assessment. During the second quarter of 2010, the IRS completed its examination for tax years 2005 and 2006 resulting in a proposed assessment. Also, during the second quarter of 2010, the IRS completed its examination of tax year 2006 for the former Jefferson-Pilot Corporation ("JP") and its subsidiaries. We believe a portion of the assessments is inconsistent with the existing law and are protesting it through the established IRS appeals process. We do not anticipate that any adjustments that might result from such audits would be material to our consolidated results of operations or financial condition. We are currently under audit by the IRS for years 2007 and 2008. The JP subsidiaries acquired in the April 2006 merger are subject to a separate IRS examination cycle. For the former JP subsidiaries, JPL and JPFIC, the IRS is examining the tax years ended April 1, 2007 and July 1, 2007, respectively. 8. DAC, VOBA, DSI AND DFEL During the fourth quarter of 2008, we recorded a decrease to income (loss) totaling $242 million, for a reversion to the mean prospective unlocking of DAC, VOBA, DSI and DFEL as a result of significant and sustained declines in the equity markets during 2008. During 2010 and 2009, we did not have a reversion to the mean prospective unlocking of DAC, VOBA, DSI and DFEL. The pre-tax impact for these items is included within the prospective unlocking line items in the changes in DAC, VOBA, DSI and DFEL tables below. Changes in DAC (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 2010 2009 2008 --------- --------- --------- Balance as of beginning-of-year $7,310 $7,421 $5,765 Reinsurance assumed (ceded) (38) 48 (230) Transfer of business to a third party -- (37) -- Deferrals 1,636 1,614 1,811 Amortization, net of interest: Prospective unlocking -- assumption changes (30) (15) (368) Prospective unlocking -- model refinements 145 -- 44 Retrospective unlocking 17 82 (120) Other amortization, net of interest (841) (748) (712) Adjustment related to realized (gains) losses (61) 91 137 Adjustment related to unrealized (gains) losses (662) (1,146) 1,094 --------- --------- --------- Balance as of end-of-year $7,476 $7,310 $7,421 ========= ========= =========
S-42 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 8. DAC, VOBA, DSI AND DFEL (CONTINUED) Changes in VOBA (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 2010 2009 2008 --------- --------- --------- Balance as of beginning-of-year $2,086 $3,763 $2,809 Transfer of business to a third party -- (255) -- Deferrals 26 30 40 Amortization: Prospective unlocking -- assumption changes (41) (20) (7) Prospective unlocking -- model refinements (7) -- 6 Retrospective unlocking 11 (44) (38) Other amortization (361) (349) (335) Accretion of interest(1) 89 102 116 Adjustment related to realized (gains) losses (7) 43 98 Adjustment related to unrealized (gains) losses (418) (1,184) 1,074 --------- --------- --------- Balance as of end-of-year $1,378 $2,086 $3,763 ========= ========= =========
(1) The interest accrual rates utilized to calculate the accretion of interest ranged from 3.50% to 7.25%. Estimated future amortization of VOBA, net of interest (in millions), as of December 31, 2010, was as follows: 2011 $213 2012 187 2013 166 2014 140 2015 126
Changes in DSI (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------------ 2010 2009 2008 ------- ------- -------- Balance as of beginning-of-year $361 $310 $ 279 Deferrals 66 76 96 Amortization, net of interest: Prospective unlocking -- assumption changes (3) -- (37) Retrospective unlocking 5 11 (6) Other amortization, net of interest (53) (38) (28) Adjustment related to realized (gains) losses (11) 3 6 Adjustment related to unrealized (gains) losses (41) (1) -- ------- ------- -------- Balance as of end-of-year $324 $361 $ 310 ======= ======= ========
Changes in DFEL (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------------- 2010 2009 2008 --------- ------- ------- Balance as of beginning-of-year $1,273 $ 948 $ 768 Reinsurance assumed (ceded) 22 -- (47) Transfer of business to a third party . -- (11) -- Deferrals 546 496 428 Amortization, net of interest: Prospective unlocking -- assumption changes (57) (22) (37) Prospective unlocking -- model refinements 56 -- 25 Retrospective unlocking (23) (3) (41) Other amortization, net of interest (167) (141) (150) Adjustment related to realized (gains) losses (4) 5 2 Adjustment related to unrealized (gains) losses (174) 1 -- --------- ------- ------- Balance as of end-of-year $1,472 $1,273 $ 948 =========================
S-43 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 9. REINSURANCE The following summarizes reinsurance amounts (in millions) recorded on our Consolidated Statements of Income (Loss), excluding amounts attributable to the indemnity reinsurance transaction with Swiss Re:
FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 2010 2009 2008 ---------- ---------- ---------- Direct insurance premiums and fees $ 6,338 $ 5,936 $ 5,863 Reinsurance assumed 22 10 18 Reinsurance ceded (1,361) (1,227) (1,056) ---------- ---------- ---------- Total insurance premiums and fees, net $ 4,999 $ 4,719 $ 4,825 ========== ========== ========== Direct insurance benefits $ 4,324 $ 3,530 $ 4,254 Reinsurance recoveries netted against benefits (1,754) (1,080) (1,600) ---------- ---------- ---------- Total benefits, net $ 2,570 $ 2,450 $ 2,654 ========== ========== ==========
We cede insurance to other companies. The portion of risks exceeding our retention limit is reinsured with other insurers. We seek reinsurance coverage within the businesses that sell life insurance and annuities in order to limit our exposure to mortality losses and enhance our capital management. As discussed in Note 25, a portion of this reinsurance activity is with affiliated companies. Under our reinsurance program, we reinsure approximately 40% to 45% of the mortality risk on newly issued non-term life insurance contracts and approximately 35% 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, VUL and term life insurance contracts. The retention per single insured life for corporate-owned life insurance is $2 million. 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, 2010, the reserves associated with these reinsurance arrangements totaled $935 million. To cover products other than life insurance, we acquire other reinsurance 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 $3.6 billion as of December 31, 2010. Swiss Re has funded a trust, with a balance of $1.7 billion as of December 31, 2010, to support this business. As a result of Swiss Re's S&P financial strength rating dropping below AA-, Swiss Re funded an additional trust during the fourth quarter of 2009 with a balance of approximately $1.5 billion as of December 31, 2010, 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 are reported within trading securities or mortgage loans on real estate on our Consolidated Balance Sheets. Our liabilities for funds withheld and embedded derivatives as of December 31, 2010, included $1.8 billion and $78 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 on business sold through reinsurance on our Consolidated Balance Sheets. 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 from the date of sale. During 2010, 2009 and 2008 we amortized $75 million, $50 million and $50 million, after-tax, respectively, of deferred gain on business sold through reinsurance. 10. 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, 2010 ------------------------------------------------------------------------- ACQUISITION CUMULATIVE BALANCE IMPAIRMENT AS OF AS OF CAPITAL DISPOSITIONS BALANCE BEGINNING- BEGINNING- CONTRIBUTION AND AS OF END- OF-YEAR OF-YEAR VALUE IMPAIRMENT OTHER OF-YEAR ----------- ------------- ------------ ---------- ------------ ---------- Retirement Solutions: Annuities $1,040 $(600) $-- $-- $-- $ 440 Defined Contribution 20 -- -- -- -- 20 Insurance Solutions: Life Insurance 2,186 -- -- -- -- 2,186 Group Protection 274 -- -- -- -- 274 Other Operations 170 (79) -- -- 6 97 ----------- ------------- ------------ ---------- ------------ ---------- Total goodwill $3,690 $(679) $-- $-- $ 6 $3,017 =========== ============= ============ ========== ============ ==========
S-44 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. GOODWILL AND SPECIFICALLY IDENTIFIABLE INTANGIBLE ASSETS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2009 ----------- ---------------------------------------------------------------- ACQUISITION CUMULATIVE BALANCE IMPAIRMENT AS OF AS OF CAPITAL DISPOSITIONS BALANCE BEGINNING- BEGINNING- CONTRIBUTION AND AS OF END- OF-YEAR OF-YEAR VALUE IMPAIRMENT OTHER OF-YEAR ----------- ------------- ------------ ---------- ------------ ------------- Retirement Solutions: Annuities $1,040 $-- $ -- $(600) $-- $ 440 Defined Contribution 20 -- -- -- -- 20 Insurance Solutions: Life Insurance 2,186 -- -- -- -- 2,186 Group Protection 274 -- -- -- -- 274 Other Operations -- -- 174 (79) (4) 91 ----------- ---------- ------------ ------------- ------------- ------------ Total goodwill $3,520 $-- $174 $(679) $(4) $3,011 =========== ========== ============ ============= ============= ============
Included in the acquisition accounting adjustments above were adjustments related to income tax deductions recognized when stock options attributable to mergers were exercised or the release of unrecognized tax benefits acquired through mergers. We perform a Step 1 goodwill impairment analysis on all of our reporting units at least annually on October 1. The Step 1 analysis for the reporting units within our Insurance Solutions and Retirement Solutions businesses utilizes primarily a discounted cash flow valuation technique ("income approach"), although limited available market data is also considered. In determining the estimated fair value, we consider discounted cash flow calculations, the level of LNC's share price and assumptions that market participants would make in valuing the reporting unit. This analysis requires us to make judgments about revenues, earnings projections, capital market assumptions and discount rates. For our Media reporting unit, we primarily use discounted cash flow calculations to determine the implied fair value. As of October 1, 2010, all of our reporting units passed the Step 1 analysis, and although Insurance Solutions - Life Insurance carrying value of the net assets was within the estimated fair value range, we deemed it necessary to validate the carrying value of goodwill through a Step 2 analysis. In our Step 2 analysis of Insurance Solutions - Life Insurance, we estimated the implied fair value of the reporting unit's goodwill, including assigning the reporting unit's fair value determined in Step 1 to all of its net assets (recognized and unrecognized) as if the reporting unit were acquired in a business combination as of October 1, 2010, and determined there was no impairment due to the implied fair value of goodwill being in excess of the carrying value of goodwill. As of October 1, 2009 all of our reporting units passed the Step 1 analysis, except for our Media reporting unit, which required a Step 2 analysis to be completed. We utilized very detailed forecasts of cash flows and market observable inputs in determining a fair value of the net assets for each of the reporting units similar to what would be estimated in a business combination between market participants. The implied fair value of goodwill for our Media reporting unit was lower than its carrying amount; therefore, goodwill was impaired and written down to its fair value for this reporting unit. The impairment recorded in Other Operations for our Media business was a result of declines in current and forecasted advertising revenue for the entire radio market. Our impairment tests showed the implied fair value of our Media reporting unit was lower than its carrying amount; therefore, we recorded non-cash impairments of goodwill of $79 million and specifically identifiable intangible assets of $50 million. As of March 31, 2009, we performed a Step 1 goodwill impairment analysis on all of our reporting units as a result of our performing an interim test due to volatile capital markets that provided indicators that a potential impairment could be present. All of our reporting units passed the Step 1 analysis, except for our Retirement Solutions - Annuities reporting unit, which required a Step 2 analysis to be completed. Based upon our Step 2 analysis, we recorded goodwill impairment for the Retirement Solutions - Annuities reporting unit in the first quarter of 2009 for $600 million, which was attributable primarily to higher discount rates driven by higher debt costs and equity market volatility, deterioration in sales and declines in equity markets. There were no indicators of impairment as of December 31, 2009, due primarily to the continued improvement in the equity markets and lower discount rates. S-45 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. GOODWILL AND SPECIFICALLY IDENTIFIABLE INTANGIBLE ASSETS (CONTINUED) 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, --------------------------------------------- 2010 2009 --------------------- ----------------------- GROSS GROSS CARRYING ACCUMULATED CARRYING ACCUMULATED AMOUNT AMORTIZATION AMOUNT AMORTIZATION -------- ------------ ---------- ------------ Insurance Solutions -- Life Insurance: Sales force $100 $19 $100 $15 Retirement Solutions -- Defined Contribution: Mutual fund contract rights(1)(2) 2 -- 2 -- Other Operations: FCC licenses(1)(3) 118 -- 118 -- Other 4 3 4 3 -------- ------------ ---------- ------------ Total $224 $22 $224 $18 ======== ==== ======= ========== ============
(1) No amortization recorded as the intangible asset has indefinite life. (2) We recorded mutual fund contract rights impairment of $1 million for the year ended December 31, 2009. (3) We recorded FCC licenses impairment of $49 million for the year ended December 31, 2009. Future estimated amortization of specifically identifiable intangible assets (in millions) as of December 31, 2010, was as follows: 2011 $4 2012 4 2013 4 2014 4 2015 4
11. GUARANTEED BENEFIT FEATURES Information on the GDB features outstanding (dollars in millions) was as follows (our variable contracts with guarantees may offer more than one type of guarantee in each contract; therefore, the amounts listed are not mutually exclusive):
AS OF DECEMBER 31, ----------------------- 2010 2009 ----------- ----------- RETURN OF NET DEPOSITS Total account value $52,211 $44,712 Net amount at risk(1) 816 1,888 Average attained age of contract holders 58 YEARS 57 years MINIMUM RETURN Total account value(2) $ 187 $ 203 Net amount at risk(1) 46 65 Average attained age of contract holders 70 YEARS 69 years Guaranteed minimum return 5% 5%
AS OF DECEMBER 31, ------------------ 2010 2009 -------- --------- ANNIVERSARY CONTRACT VALUE Total account value $23,483 $21,431 Net amount at risk(1) 2,183 4,021 Average attained age of contract holders 66 YEARS 65 years
(1) Represents the amount of death benefit in excess of the account balance. The decrease in net amount at risk when comparing December 31, 2010, to December 31, 2009, was attributable primarily to the rise in equity markets and associated increase in the account values. (2) The decrease in total account value when comparing December 31, 2010, to December 31, 2009, was attributable primarily to an increase in contract surrender rates. The determination of GDB liabilities is based on models that involve a range of scenarios and assumptions, including those regarding expected market rates of return and volatility, S-46 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. GUARANTEED BENEFIT FEATURES (CONTINUED) contract surrender rates and mortality experience. The following summarizes the balances of and changes in the liabilities for GDB (in millions), which were recorded in future contract benefits on our Consolidated Balance Sheets:
FOR THE YEARS ENDED DECEMBER 31, ------------------------ 2010 2009 2008 ------- -------- ------- Balance as of beginning-of-year $ 71 $ 277 $ 38 Changes in reserves 57 (33) 312 Benefits paid (84) (173) (73) ------- -------- ------- Balance as of end-of-year $ 44 $ 71 $277 ======= ======== =======
Account balances of variable annuity contracts with guarantees (in millions) were invested in separate account investment options as follows:
AS OF DECEMBER 31, --------------------- 2010 2009 ---------- ---------- ASSET TYPE Domestic equity $35,659 $32,489 International equity 14,172 12,379 Bonds 15,913 9,942 Money market 5,725 6,373 ---------- ---------- Total $71,469 $61,183 ========== ========== Percent of total variable annuity separate account values 98% 97%
Future contract benefits also include reserves for our products with secondary guarantees for our products sold through our Insurance Solutions - Life Insurance segment. These UL and VUL products with secondary guarantees represented approximately 40% of permanent life insurance in force as of December 31, 2010, and approximately 52% of total sales for these products for the year ended December 31, 2010. 12. OTHER CONTRACT HOLDER FUNDS Details of other contract holder funds (in millions) were as follows:
AS OF DECEMBER 31, ------------------ 2010 2009 ------- ---------- Fixed account values, including the fixed portion of variable and other contract holder funds $64,582 $61,254 DFEL 1,472 1,273 Contract holder dividends payable 484 494 Premium deposit funds 98 100 Undistributed earnings on participating business 85 56 ------- ---------- Total other contract holder funds $66,721 $63,177 ======= ==========
As of December 31, 2010 and 2009, participating policies comprised approximately 1.20% and 1.30%, respectively, of the face amount of insurance in force, and dividend expenses were $82 million, $89 million and $92 million for the years ended December 31, 2010, 2009 and 2008, respectively. S-47 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 13. SHORT-TERM AND LONG-TERM DEBT Details underlying short-term and long-term debt (in millions) were as follows:
AS OF DECEMBER 31, ------------------ 2010 2009 ------ ----------- Short-term debt Short-term debt(1) $ 10 $ 21 ====== =========== Long-term debt 2.75% note, due 2013 $ 4 $ -- LIBOR + 0.03% note, due 2017 250 250 LIBOR + 3.41% note, due 2040 500 -- LIBOR + 1.00% note, due 2037 375 375 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 $2,429 $1,925 ====== ===========
(1) The short-term debt represents short-term notes payable to LNC. Future principal payments due on long-term debt (in millions) as of December 31, 2010, were as follows: 2013 $ 4 Thereafter 2,425 ------ Total $2,429 ======
CREDIT FACILITIES Credit facilities (in millions) were as follows:
AS OF DECEMBER 31, 2010 ----------------------- EXPIRATION MAXIMUM BORROWINGS DATE AVAILABLE OUTSTANDING ---------- ----------------------- CREDIT FACILITIES Credit facility with the FHLBI(1) N/A $630 $350
(1) Our borrowing capacity under this credit facility does not have an expiration date and continues while our investment in the FHLBI common stock remains outstanding. We have pledged securities, included in fixed maturity AFS securities on our Consolidated Balance Sheets, that are associated with this credit facility. On December 31, 2009, LNC made a capital contribution of $171 million to forgive an outstanding balance on a note due to LNC from a consolidated subsidiary of LNL. The caption "Capital contribution from Lincoln National Corporation" in the accompanying Consolidated Statements of Stockholder's Equity includes the $171 million capital contribution. In the third quarter of 2008, LNL made an investment of $19 million in the FHLBI, a AAA-rated entity, and made an additional investment of $2 million in the second quarter of 2009. In 2010, LNL made an additional investment of $11 million in the FHLBI. This relationship provides us with another source of liquidity as an alternative to commercial paper and repurchase agreements as well as provides funding at comparatively low borrowing rates. We are allowed to borrow up to 20 times the amount of our common stock investment in the FHLBI through a credit facility with the FHLBI. Our borrowing capacity under this credit facility does not have an expiration date and continues while our investment in the FHLBI common stock remains outstanding as long as we maintain a satisfactory level of credit-worthiness and we do not incur a material adverse change in our financial, business, regulatory or other areas that would materially affect our operations and viability. All borrowings from the FHLBI are required to be secured by certain investments owned by LNL. On December 4, 2008, the LNC and LNL Boards of Directors approved an additional common stock investment of $56 million, which would increase our total borrowing capacity up to $1.5 billion upon completion of that incremental investment. As of December 31, 2010, based on our actual common stock investment, we had borrowing capacity of up to approximately $630 million from the FHLBI. We had a $250 million floating-rate term loan outstanding under the facility due June 20, 2017, which may be prepaid at any time (classified within long-term debt on our Consolidated Balance Sheets as presented in the above table). During the second quarter of 2010, we also borrowed $100 million at a rate of 0.7% that is due May 25, 2011 (classified within payables for collateral on investments on our Consolidated Balance Sheets). On July 1, 2010, we issued a note of $500 million to LNC. This note calls for us to pay the principal amount of the note on or before June 5, 2040, and interest to be paid annually at an annual rate of LIBOR + 3.41%. On September 10, 2010, we issued a note of $4 million to LFM. This note calls for us to pay the principal amount of the note on or before September 10, 2013, and interest to be paid semiannually at an annual rate of 2.75%. 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%. We issued a surplus note for $500 million to LNC in 1998. This note calls for us to pay the principal amount of the note 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 note 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. S-48 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 14. CONTINGENCIES AND COMMITMENTS CONTINGENCIES REGULATORY AND LITIGATION MATTERS Regulatory bodies, such as state insurance departments, the SEC, Financial Industry Regulatory Authority and other regulatory bodies regularly make inquiries and conduct examinations or investigations concerning our compliance with, among other things, insurance laws, securities laws and laws governing the activities of broker-dealers. In the ordinary course of its business, LNL and its subsidiaries are involved in various pending or threatened legal proceedings, including purported class actions, arising from the conduct of business. In some instances, these proceedings include claims for unspecified or substantial punitive damages and similar types of relief in addition to amounts for alleged contractual liability or requests for equitable relief. After consultation with legal counsel and a review of available facts, it is management's opinion that these proceedings, after consideration of any reserves and rights to indemnification, ultimately will be resolved without materially affecting the consolidated financial position of 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 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 properties in Fort Wayne, Indiana. 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 five years each in accordance with the lease agreement. These agreements also provide us with the right of first refusal to purchase the properties at a price defined in the agreements and the option to purchase the leased properties at fair market value on the last day of any renewal period. Total rental expense on operating leases for the years ended December 31, 2010, 2009 and 2008, was $40 million, $47 million and $49 million, respectively. Future minimum rental commitments (in millions) as of December 31, 2010, were as follows: 2011 $30 2012 26 2013 20 2014 13 2015 9
INFORMATION TECHNOLOGY COMMITMENT In February 2004, LNC completed renegotiations and extended the contract with IBM Global Services for information technology services for the Fort Wayne operations through February 2010. Following the original termination date of this agreement, LNC exercised contractual rights to extend this agreement through February 2012. Annual costs are dependent on usage but are expected to be approximately $9 million. MEDIA COMMITMENTS LFM has future commitments of approximately $31 million through 2015 related primarily to employment contracts and rating service contracts. VULNERABILITY FROM CONCENTRATIONS As of December 31, 2010, we did not have a concentration of: business transactions with a particular customer or lender; sources of supply of labor or services used in the business; or a market or geographic area in which business is conducted that makes us 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 ("ALVA") product offered in our Retirement Solutions - Annuities segment is significant to this segment. The ALVA product accounted for 25%, 28% and 37% of Retirement Solutions - Annuities' variable annuity product deposits in 2010, 2009 and 2008, respectively, and represented approximately 58%, 61% and 62% of our total Retirement Solutions - Annuities' variable annuity product account values as of December 31, 2010, 2009 and 2008, respectively. In addition, fund choices for certain of our other variable annuity products offered in our Retirement Solutions - Annuities segment include American Fund Insurance Series(SM) ("AFIS") funds. For the Retirement Solutions - Annuities segment, AFIS funds accounted for 29%, 33% and 44% of variable annuity product deposits in 2010, 2009 and 2008, respectively, and represented 66%, 69% and 70% of the segment's total variable annuity product account values as of December 31, 2010, 2009 and 2008, respectively. STANDBY REAL ESTATE EQUITY COMMITMENTS Historically, we have entered into standby commitments, which obligated us to purchase real estate at a specified cost if a third-party sale did not occur within approximately one year after construction was completed. These commitments were used by a developer to obtain a construction loan from an outside lender on favorable terms. In return for issuing the commitment, we received an annual fee and a percentage of the profit when the property was sold. Our expectation is that we will be obligated to fund those commitments that remain outstanding. As of December 31, 2010, and December 31, 2009, we had standby real estate equity commitments totaling $53 million and $220 million, respectively. During 2010, we funded commitments of $142 million and recorded a loss of $8 million reported within realized gain (loss) on our Consolidated Statements of Income (Loss). During 2009, we suspended entering into new standby real estate commitments. OTHER CONTINGENCY MATTERS State guaranty funds assess insurance companies to cover losses to contract holders of insolvent or rehabilitated companies. Mandatory assessments may be partially recovered through a reduction in future premium taxes in some states. We have accrued for expected assessments net of estimated future premium tax deductions of $10 million and $12 million as of December 31, 2010 and 2009, respectively. S-49 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 15. SHARES AND 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, ------------------------------------------ 2010 2009 2008 ---------- ----------------- ------------- UNREALIZED GAIN (LOSS) ON AFS SECURITIES Balance as of beginning-of-year $ 36 $ (2,562) $ 76 Cumulative effect from adoption of new accounting standards 181 (79) -- Unrealized holding gains (losses) arising during the year 2,322 6,021 (7,316) Change in foreign currency exchange rate adjustment (6) 26 (66) Change in DAC, VOBA, DSI and other contract holder funds (1,164) (2,294) 2,522 Income tax benefit (expense) (417) (1,328) 1,703 Less: Reclassification adjustment for gains (losses) included in net income (loss) (136) (555) (1,042) Associated amortization of DAC, VOBA, DSI and DFEL 17 168 244 Income tax benefit (expense) 42 135 279 ---------- ----------------- ------------- Balance as of end-of-year $ 1,029 $ 36 $(2,562) ========== ================= ============= UNREALIZED OTTI ON AFS SECURITIES Balance as of beginning-of-year $ (108) $ -- $ -- (Increases) attributable to: Cumulative effect from adoption of new accounting standards -- (18) -- Gross OTTI recognized in OCI during the year (93) (339) -- Change in DAC, VOBA, DSI and DFEL 10 77 -- Income tax benefit (expense) 29 92 -- Decreases attributable to: Sales, maturities or other settlements of AFS securities 82 151 -- Change in DAC, VOBA, DSI and DFEL (20) (28) -- Income tax benefit (expense) (22) (43) -- ---------- ----------------- ------------- Balance as of end-of-year $ (122) $ (108) $ -- ========== ================= =============
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 2010 2009 2008 ----------- --------- ------- UNREALIZED GAIN (LOSS) ON DERIVATIVE INSTRUMENTS Balance as of beginning-of-year $ (13) $ (15) $ (19) Unrealized holding gains (losses) arising during the year (2) 12 (42) Change in foreign currency exchange rate adjustment 4 (31) (36) Change in DAC, VOBA, DSI and DFEL (11) 11 27 Income tax benefit (expense) 3 5 1 Less: Reclassification adjustment for gains (losses) included in net income (loss) 6 4 (83) Associated amortization of DAC, VOBA, DSI and DFEL (9) (11) -- Income tax benefit (expense) 1 2 29 ----------- --------- ------- Balance as of end-of-year $ (17) $ (13) $ (15) =========== ========= ======= FUNDED STATUS OF EMPLOYEE BENEFIT PLANS Balance as of beginning-of-year $ (17) $ (32) $ (4) Adjustment arising during the year 4 23 (45) Income tax benefit (expense) (1) (8) 17 ----------- --------- ------- Balance as of end-of-year $ (14) $ (17) $ (32) =========== ========= =======
S-50 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 16. REALIZED (GAIN) LOSS Details underlying realized gain (loss) (in millions) reported on our Consolidated Statements of Income (Loss) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ----------------------- 2010 2009 2008 ------ ------- ------- Total realized gain (loss) related to certain investments(1) $(132) $(498) $(767) Realized gain (loss) related to certain derivative instruments, including those associated with our consolidated VIEs, and trading securities(2) (41) (77) (78) Indexed annuity net derivative results(3): Gross gain (loss) 34 8 13 Associated amortization of DAC, VOBA, DSI and DFEL (15) (5) (6) Guaranteed living benefits(4): Gross gain (loss) (30) (10) 2 Associated amortization of DAC, VOBA, DSI and DFEL (64) (8) 12 Realized gain (loss) on sale of subsidiaries/businesses -- 1 -- ------ ------- ------- Total realized gain (loss) $(248) $(589) $(824) ====== ======== =======
(1) See "Realized Gain (Loss) Related to Certain Investments" section in Note 5. (2) Represents changes in the fair values of certain derivative investments (including the credit default swaps and contingent forwards associated with our consolidated VIEs), total return swaps (embedded derivatives that are theoretically included in our various modified coinsurance and coinsurance with funds withheld reinsurance arrange- ments that have contractual returns related to various as- sets and liabilities associated with these arrangements) and trading securities. (3) Represents the net difference between the change in the fair value of the S&P 500 call options that we hold and the change in the fair value of the embedded derivative liabilities of our indexed annuity products along with changes in the fair value of embedded derivative liabilities related to index call options we may purchase in the future to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products. The year ended December 31, 2008, included a $10 million gain from the initial impact of adopting the Fair Value Measurements and Disclosures Topic of the FASB ASC. (4) Represents the net difference in the change in embedded derivative reserves of our GLB products and the change in the fair value of the derivative instruments we own to hedge, including the cost of purchasing the hedging instruments. (5) Represents the change in the fair value of the derivatives used to hedge our GDB riders. 17. UNDERWRITING, ACQUISITION, INSURANCE, RESTRUCTURING AND OTHER EXPENSES Details underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------ 2010 2009 2008 --------- --------------- ---------- Commissions $1,859 $1,565 $ 1,710 General and administrative expenses 1,293 1,203 1,215 Expenses associated with reserve financing and unrelated LOCs 16 1 -- DAC and VOBA deferrals and interest, net of amortization (644) (652) (437) Broker-dealer expenses 212 190 215 Other intangibles amortization 4 4 4 Media expenses 59 40 -- Taxes, licenses and fees 192 180 195 Merger-related expenses 9 16 50 Restructuring charges (recoveries) for expense initiatives (1) 32 8 --------- --------------- ---------- Total $2,999 $2,579 $ 2,960 ========= =============== ==========
All merger-related and restructuring charges are included in underwriting, acquisition, insurance and other expenses primarily within Other Operations on our Consolidated Statements of Income (Loss) in the year incurred. 2008 RESTRUCTURING PLAN Starting in December 2008, we implemented a restructuring plan in response to the economic downturn and sustained market volatility, which focused on reducing expenses. Our cumulative pre-tax charges amounted to $39 million for severance, benefits and related costs associated with the plan for workforce reduction and other restructuring actions. S-51 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 18. PENSION, POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT PLANS LNC and LNL maintain qualified funded defined benefit pension plans in which many of our employees and agents are participants. LNC and LNL also maintain non-qualified, unfunded defined benefit pension plans for certain employees and agents, certain former employees of JP and certain former employees of CIGNA Corporation. In addition, for certain former employees we have supplemental retirement plans that provide defined benefit pension benefits in excess of limits imposed by federal tax law. All of our defined benefit pension plans were frozen as of December 31, 2007, or earlier. For our frozen plans, there are no new participants and no future accruals of benefits from the date of the freeze. The eligibility requirements for each plan are described in each plan document and vary for each plan based on completion of a specified period of continuous service and date of hire, subject to age limitations. The frozen pension plan benefits are calculated either on a traditional or cash balance formula. Those formulas are based upon years of credited service and eligible earnings as defined in each plan document. The traditional formula provides benefits stated in terms of a single life annuity payable at age 65. The cash balance formula provides benefits stated as a lump sum hypothetical account balance. That account balance equals the sum of the employee's accumulated annual benefit credits plus interest credits. Benefit credits, which are based on years of service and base salary plus bonus, ceased as of the date the plan was frozen. Interest Credits continue until the participant's benefit is paid. LNC and LNL also sponsor a voluntary employees' beneficiary association ("VEBA") trust that provides postretirement medical, dental and life insurance benefits to retired full-time employees and agents who, depending on the plan, have worked for us for 10 years and attained age 55 (age 60 for agents). VEBAs are a special type of tax-exempt trust used to provide benefits that are subject to preferential tax treatment under the Internal Revenue Code. Medical and dental benefits are available to spouses and other eligible dependents of retired employees and agents. Retirees may be required to contribute toward the cost of these benefits. Eligibility and the amount of required contribution for these benefits varies based upon a variety of factors including years of service and year of retirement. Effective January 1, 2008, the postretirement plan providing benefits to former employees of JP was amended such that only employees who had attained age 55 with a minimum of 10 years of service by December 31, 2007, and who later retire on or after age 60 with 15 years of service will be eligible to receive life insurance benefits when they retire. S-52 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 18. PENSION, POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT PLANS (CONTINUED) OBLIGATIONS, FUNDED STATUS AND ASSUMPTIONS Information (in millions) with respect to our benefit plans' assets and obligations was as follows:
AS OF OR FOR THE YEARS ENDED DECEMBER 31, ---------------------------------------------------- 2010 2009 2010 2009 ------- ----------- ------------------------ ------- OTHER PENSION BENEFITS POSTRETIREMENT BENEFITS ------------------- -------------------------------- CHANGE IN PLAN ASSETS Fair value as of beginning-of-year $119 $101 $ 4 $ 4 Actual return on plan assets 17 25 1 -- Company and participant contributions -- -- 3 3 Benefits paid (8) (7) (3) (3) ------- ----------- ------------------------ ------- Fair value as of end-of-year 128 119 5 4 ------- ----------- ------------------------ ------- CHANGE IN BENEFIT OBLIGATION Balance as of beginning-of-year 112 115 20 20 Interest cost 7 7 2 1 Plan participants' contributions -- -- 1 1 Actuarial (gains) losses 5 (3) 1 1 Benefits paid (8) (7) (3) (3) ------- ----------- ------------------------ ------- Balance as of end-of-year 116 112 21 20 ------- ----------- ------------------------ ------- Funded status of the plans $ 12 $ 7 $(16) $(16) ======= =========== ======================== ======= AMOUNTS RECOGNIZED ON THE CONSOLIDATED BALANCE SHEETS Other assets $ 15 $ 12 $ -- $ -- Other liabilities (3) (5) (16) (16) ------- ----------- ------------------------ ------- Net amount recognized $ 12 $ 7 $(16) $(16) ======= =========== ======================== ======= AMOUNTS RECOGNIZED IN ACCUMULATED OCI, NET OF TAX Net (gain) loss $ 15 $ 19 $ -- $ (1) Prior service credit -- -- (1) (1) ------- ----------- ------------------------ ------- Net amount recognized $ 15 $ 19 $ (1) $ (2) ======= =========== ======================== ======= RATE OF INCREASE IN COMPENSATION Retiree life insurance plan N/A N/A 4.00% 4.00% All other plans N/A N/A N/A N/A WEIGHTED-AVERAGE ASSUMPTIONS Benefit obligations: Weighted-average discount rate 5.25% 6.00% 5.00% 6.00% Expected return on plan assets 8.00% 8.00% 6.50% 6.50% Net periodic benefit cost: Weighted-average discount rate 6.00% 6.00% 6.00% 6.00% Expected return on plan assets 8.00% 8.00% 6.50% 6.50%
Consistent with our benefit plans' year end, we use December 31 as the measurement date. The discount rate was determined based on a corporate yield curve as of December 31, 2010, and projected benefit obligation cash flows for the pension plans. We reevaluate this assumption each plan year. For 2011, our discount rate for the pension plans will be 6%. The expected return on plan assets was determined based on historical and expected future returns of the various asset categories, using the plans' target plan allocation. We reevaluate this assumption each plan year. For 2011, our expected return on plan assets is 8.00% for the plans. The approximate expected return on plan assets by asset class for the pension plans is as follows: Fixed maturity securities 5.73% Common stock: Domestic equity 9.88% International equity 8.48% Cash and invested assets --%
S-53 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 18. PENSION, POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT PLANS (CONTINUED) The calculation of the accumulated other postretirement benefit obligation assumes a weighted-average annual rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) as follows:
AS OF OR FOR THE YEARS ENDED DECEMBER 31, --------------------------- 2010 2009 2008 ------- ----------- ------- Pre-65 health care cost trend rate 9.5% 10% 10% Post-65 health care cost trend rate 9.5% 13% 12% Ultimate trend rate 5% 5% 5% Year that the rate reaches the ultimate trend rate 2020 2020 2019
We expect the health care cost trend rate for 2011 to be 9.00% for both the pre-65 and the post-65 population. A one-percentage point increase in assumed health care cost trend rates would have increased the accumulated postretirement benefit obligation by less than $1 million and total service and interest cost components by less than $1 million. A one-percentage point decrease in assumed health care cost trend rates would have decreased the accumulated postretirement benefit obligation by $1 million and total service and interest cost components by less than $1 million. Information for our pension plans with an accumulated benefit obligation in excess of plan assets (in millions) was as follows:
AS OF DECEMBER 31, ------------------ 2010 2009 ---- ------------- Accumulated benefit obligation $94 $90 Projected benefit obligation 94 90 Fair value of plan assets 91 85 COMPONENTS OF NET PERIODIC BENEFIT COST
The components of net periodic benefit cost for our pension plans' and other postretirement plans' expense (recovery) (in millions) were as follows:
FOR THE YEARS ENDED DECEMBER 31, -------------------------------------------------------------------- PENSION BENEFITS OTHER POSTRETIREMENT BENEFITS ------- --------------------------- -------------------------------- 2010 2009 2008 2010 2009 2008 ------- ------------------- ------- ---- ------- ------------------- Interest cost $ 7 $ 7 $ 7 $ 1 $ 1 $ 1 Expected return on plan assets (9) (7) (11) -- -- -- Recognized net actuarial loss (gain) 2 5 1 -- (1) (1) ------- ------------------- ------- ---- ------- ------------------- Net periodic benefit expense (recovery) $-- $ 5 $ (3) $ 1 $-- $-- ======= =================== ======= ==== ======= ===================
We expect our 2011 pension plans' income to be approximately $2 million. For 2011, the estimated amount of amortization from accumulated OCI into net periodic benefit expense related to net actuarial loss or gain is expected to be an approximate $1 million loss for our pension plans and less than $1 million gain for our other postretirement plans. PLAN ASSETS As of December 31, 2010 and 2009, our pension plans' asset target allocations by asset category based on estimated fair values were as follows: Fixed maturity securities 50% Common stock: Domestic equity 35% International equity 15% Cash and invested assets --%
The investment objectives for the assets related to our pension plans are to: - Maintain sufficient liquidity to pay obligations of the plans as they come due; - Minimize the effect of a single investment loss and large losses to the plans through prudent risk/reward diversification consistent with sound fiduciary standards; - Maintain an appropriate asset allocation policy; - Earn a return commensurate with the level of risk assumed through the asset allocation policy; and - Control costs of administering and managing the plans' investment operations. S-54 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 18. PENSION, POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT PLANS (CONTINUED) Investments can be made in various asset classes and styles, including, but not limited to: domestic and international equity, fixed income securities, derivatives, and other asset classes the investment managers deem prudent. Our plans follow a strategic asset allocation policy that strives to systemically increase the percentage of assets in liability-matching fixed income investments as funding levels increase. We currently target asset weightings as follows: domestic equity allocations (35%) are split into large cap (25%), small cap (5%) and hedge funds (5%). Fixed maturity securities represents core fixed income investments. The performance of the pension trust assets are monitored on a quarterly basis relative to the plan's objectives. Our qualified pension plans' assets have been combined into a master retirement trust where a variety of qualified managers, including manager of managers, are expected to have returns that exceed the median of similar funds over 3-year periods, above an appropriate index over 5-year periods and meet real return standards over 10-year periods. Managers are monitored for adherence to approved investment policy guidelines and managers not meeting these criteria are subject to additional due diligence review, corrective action or possible termination. FAIR VALUE OF PLAN ASSETS See "Fair Value Measurement" in Note 1 for discussion of how we categorize our pension plans' assets, into a three-level fair value hierarchy. The following summarizes our fair value measurements of pension plans' assets (in millions) on a recurring basis by the three-level fair value hierarchy:
AS OF DECEMBER 31, 2010 ------------------------------------------ QUOTED PRICES IN ACTIVE MARKETS FOR SIGNIFICANT SIGNIFICANT IDENTICAL OBSERVABLE UNOBSERVABLE TOTAL ASSETS INPUTS INPUTS FAIR (LEVEL 1) (LEVEL 2) (LEVEL 3) VALUE ----------- ----------- ------------ ----- ASSET CLASS Fixed maturity securities: Corporate bonds $-- $ 37 $-- $ 37 U.S. Government bonds -- 14 -- 14 Foreign government bonds -- 2 3 5 MBS: CMOs -- 1 -- 1 CMBS -- 1 -- 1 Common stock 16 43 3 62 Cash and invested assets -- 8 -- 8 ----------- ----------- ------------ ----- Total $16 $106 $ 6 $128 =========== =========== ============ =====
AS OF DECEMBER 31, 2009 ------------------------------------------ QUOTED PRICES IN ACTIVE MARKETS FOR SIGNIFICANT SIGNIFICANT IDENTICAL OBSERVABLE UNOBSERVABLE TOTAL ASSETS INPUTS INPUTS FAIR (LEVEL 1) (LEVEL 2) (LEVEL 3) VALUE ----------- ----------- ------------ ----- ASSET CLASS Fixed maturity securities: Corporate bonds $-- $ 47 $-- $ 47 U.S. Government bonds -- 4 -- 4 Foreign government bonds -- 2 -- 2 MBS: CMOs -- 1 -- 1 CMBS -- 2 -- 2 State and municipal bonds -- 1 -- 1 Common stock 18 42 -- 60 Cash and invested assets -- 2 -- 2 ----------- ----------- ------------ ----- Total $18 $101 $-- $119 =========== =========== ============ =====
S-55 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 18. PENSION, POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT PLANS (CONTINUED) The following summarizes changes to our pension plan assets (in millions) classified within Level 3 of the fair value hierarchy as reported above:
FOR THE YEAR ENDED DECEMBER 31, 2010 ------------------------------------------------------------ RETURN ON ASSETS TRANSFERS ----------------- PURCHASES, IN OR BEGINNING SOLD SALES AND OUT OF ENDING FAIR HELD AT DURING SETTLEMENTS, LEVEL 3, FAIR VALUE YEAR END THE YEAR NET NET VALUE --------- -------- -------- ------------ ------------ ------ Fixed maturity securities: Foreign government bonds $-- $-- $-- $3 $-- $3 Common stock -- -- -- 3 -- 3 --------- -------- -------- ------------ ------------ ------ Total $-- $-- $-- $6 $-- $6 ========= ======== ======== ============ ============ ======
FOR THE YEAR ENDED DECEMBER 31, 2009 ------------------------------------------------------------ RETURN ON ASSETS TRANSFERS ----------------- PURCHASES, IN OR BEGINNING SOLD SALES AND OUT OF ENDING FAIR HELD AT DURING SETTLEMENTS, LEVEL 3, FAIR VALUE YEAR END THE YEAR NET NET VALUE --------- -------- -------- ------------ ------------ ------ Fixed maturity securities: Corporate bonds $ 1 $-- $-- $-- $(1) $-- ========= ======== ======== ============ ============ ======
VALUATION METHODOLOGIES AND ASSOCIATED INPUTS FOR PENSION PLANS' ASSETS The fair value measurements of our pension plans' assets are based on assumptions used by market participants in pricing the security. The most appropriate valuation methodology is selected based on the specific characteristics of the security, and the valuation methodology is consistently applied to measure the security's fair value. The fair value measurement is based on a market approach, which utilizes prices and other relevant information generated by market transactions involving identical or comparable securities. Sources of inputs to the market approach include third-party pricing services, independent broker quotations or pricing matrices. Both observable and unobservable inputs are used in the valuation methodologies. Observable inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators, industry and economic events are monitored and further market data is acquired if certain triggers are met. For certain security types, additional inputs may be used, or some of the inputs described above may not be applicable. For broker-quoted only securities, quotes from market makers or broker-dealers are obtained from sources recognized to be market participants. In order to validate the pricing information and broker-dealer quotes, procedures are employed, where possible, that include comparisons with similar observable positions, comparisons with subsequent sales, discussions with brokers and observations of general market movements for those security classes. For those securities trading in less liquid or illiquid markets with limited or no pricing information, unobservable inputs are used in order to measure the fair value of these securities. In cases where this information is not available, such as for privately placed securities, fair value is estimated using an internal pricing matrix. This matrix relies on judgment concerning the discount rate used in calculating expected future cash flows, credit quality, industry sector performance and expected maturity. Prices received from third parties are not adjusted; however, the third-party pricing services' valuation methodologies and related inputs are evaluated and additional evaluation is performed to determine the appropriate level within the fair value hierarchy. The observable and unobservable inputs to the valuation methodologies are based on general standard inputs. The standard inputs used in order of priority are benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. Depending on the type of security or the daily market activity, standard inputs may be prioritized differently or may not be available for all securities on any given day. Cash and invested cash is carried at cost, which approximates fair value. This category includes highly liquid debt instruments purchased with a maturity of three months or less. Due to the nature of these assets, we believe these assets should be classified as Level 2. PLAN CASH FLOWS It is our practice to make contributions to the qualified pension plans to comply with minimum funding requirements of the Employee Retirement Income Security Act of 1974, as amended and with guidance issued there under. In accordance with such practice, no contributions were required for the years ended December 31, 2010 or 2009. Based on our calculations, we do not expect to be required to make any contributions to our qualified pension plans in 2011 under applicable pension law. S-56 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 18. PENSION, POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT PLANS (CONTINUED) For our nonqualified pension plans, we fund the benefits as they become due to retirees. The amount expected to be contributed to the nonqualified pension plans during 2011 is less than $1 million. We expect the following benefit payments (in millions):
PENSION PLANS OTHER POSTRETIREMENT PLANS ------- --------------------------------- NOT DEFINED REFLECTING REFLECTING BENEFIT MEDICARE MEDICARE MEDICARE PENSION PART D PART D PART D PLANS SUBSIDY SUBSIDY SUBSIDY ------- ---------- ----------- ---------- 2011 $8 $2 $-- $2 2012 9 2 -- 2 2013 9 2 -- 2 2014 9 2 -- 2 2015 9 2 -- 2 Following five years thereafter 43 10 (1) 11
19. DEFINED CONTRIBUTION AND DEFERRED COMPENSATION PLANS DEFINED CONTRIBUTION PLANS LNC and we sponsor contributory defined contribution plans for eligible employees and agents, respectively, which includes money purchase plans. LNC and we make contributions and matching contributions to each of the active plans, respectively, in accordance with the plan document and various limitations under Section 401(a) of the Internal Revenue Code of 1986, as amended. For the years ended December 31, 2010, 2009 and 2008, expenses for these plans were $60 million, $61 million and $58 million respectively. DEFERRED COMPENSATION PLANS LNC and we sponsor six separate non-qualified, unfunded, deferred compensation plans for various groups: employees, agents and non-employee directors. The investment earnings expenses for certain investment options within the respective plans are hedged by total return swaps. Participant's account values increase or decrease due to investment earnings driven by market fluctuation. Our expenses increase or decrease in direct proportion to the market's change for the participants' investment options. The total return swaps allow us to minimize the investment earnings expenses. Presented below for the respective plans we have netted the investment earnings due to market fluctuation with the results of the total return swaps. For further discussion on our total return swaps related to our deferred compensation plans, see Note 6. Information (in millions) with respect to these plans was as follows:
AS OF DECEMBER 31, ------------------ 2010 2009 ---- ------------- Total liabilities(1) $315 $314 Investment held to fund liabilities(2) 130 118
(1) Reported in other liabilities on our Consolidated Balance Sheets. (2) Reported in other assets on our Consolidated Balance Sheets. THE DEFERRED COMPENSATION PLAN FOR EMPLOYEES Eligible participants in this plan 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 (identical to those offered under our qualified defined contribution plans) used as investment measures for calculating the investment return notionally credited to their deferrals. Under the terms of the plan, we agree to pay out amounts based upon the aggregate performance of the investment measures selected by the participant. We make matching contributions to these plans based upon amounts placed into the deferred compensation plans by individuals after participants have exceeded applicable limits of the Internal Revenue Code. The amount of our contribution is calculated in accordance with the plan document, which is similar to our qualified S-57 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 19. DEFINED CONTRIBUTION AND DEFERRED COMPENSATION PLANS (CONTINUED) defined contribution plans. Expenses (in millions) for this plan were as follows:
FOR THE YEARS ENDED DECEMBER 31, ----------------------------- 2010 2009 2008 ---- ---- ------------------- Employer matching contributions $6 $ 4 $5 Increase (decrease) in measurement of liabilites, net of total return swap 1 6 1 ---- ---- ------------------- Total plan expenses $7 $10 $6 ==== ==== ===================
DEFERRED COMPENSATION PLAN FOR AGENTS LNL sponsors three deferred compensation plans for certain eligible agents. Eligible participants in these plans may elect to defer payment of a portion of their compensation as defined by the various plans. The plans' participants may select from a menu of "phantom" investment options (identical to those offered under our qualified defined contribution plans) used as investment measures for calculating the investment return notionally credited to their deferrals. Under the terms of this plan, we agree to pay out amounts based upon the aggregate performance of the investment measures selected by the participant. We make matching contributions to these plans based upon amounts placed into the deferred compensation plans by individuals after participants have exceeded applicable limits of the Internal Revenue Code. The amount of our contribution is calculated in accordance with the plan document, which is similar to our qualified defined contribution plans. Expenses (in millions) for these plans were as follows:
FOR THE YEARS ENDED DECEMBER 31, ------------------- 2010 2009 2008 ---- ---- --------- Employer matching contributions $3 $2 $2 Increase (decrease) in measurement of liabilites, net of total return swap 3 4 -- ---- ---- --------- Total plan expenses $6 $6 $2 ==== ==== =========
DEFERRED COMPENSATION PLAN FOR NON-EMPLOYEE DIRECTORS The plan allows for non-employee directors to defer a portion of their annual retainers and, in addition, we credit deferred stock units annually. The menu of "phantom" investment options is identical to those offered in the employees' plan. For the years ended December 31, 2010, 2009 and 2008, expenses for this plan were $2 million, $1 million and less than $1 million, respectively. The terms of the plan for non-employee directors provide that plan participants who select LNC's stock as the measure for their investment return will receive shares of LNC's stock in settlement of this portion of their accounts at the time of distribution. In addition, participants are precluded from diversifying any portion of their deferred compensation plan account that has been credited to the stock unit fund. Consequently, changes in value of LNC's stock do not affect the expenses associated with this portion of the deferred compensation plan. DEFERRED COMPENSATION PLAN FOR FORMER JEFFERSON-PILOT AGENTS Eligible former agents of JP may participate in this deferred compensation plan. Eligible agents are allowed to defer commissions and bonuses and specify where these deferral commissions will be invested in selected notional mutual funds. Agents participate in the plan with the understanding that the return on these funds cannot be received until a specified age or in the event of a significant lifestyle change. The funded amount is rebalanced to match the funds that have been elected under the agent deferred compensation plan. The plan obligation increases with contributions, deferrals and investment income, and decreases with withdrawals and investment losses. The plan's assets increase with investment gains, decrease with investment losses and payouts of death benefits. For the years ended December 31, 2010, 2009 and 2008, expenses (income) for this plan were $2 million, $1 million and ($2) million, respectively. 20. STOCK-BASED INCENTIVE COMPENSATION PLANS Our employees and agents are included in LNC's various incentive plans that provide for the issuance of stock options, performance shares (performance-vested shares as opposed to time-vested shares), SARS, restricted stock units, and restricted stock awards ("nonvested stock"). 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, ----------------------- 2010 2009 2008 ------- ------- ------- Stock options $ 5 $ 6 $ 8 Performance shares (1) (1) 2 SARs -- 1 4 Restricted stock units and nonvested stock 11 6 5 ------- ------- ------- Total $15 $12 $19 ======= ======= ======= Recognized tax benefit $ 5 $ 4 $ 7
S-58 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 21. STATUTORY INFORMATION AND RESTRICTIONS We prepare financial statements in accordance with SAP prescribed or permitted by the insurance departments of our states of domicile, which may vary materially from GAAP. Prescribed SAP includes the Accounting Practices and Procedures Manual of the National Association of Insurance Commissioners ("NAIC") as well as state laws, regulations and administrative rules. Permitted SAP encompasses all accounting practices not so prescribed. The principal differences between statutory financial statements and financial statements prepared in accordance with GAAP are that statutory financial statements do not reflect DAC, some bond portfolios may be carried at amortized cost, assets and liabilities are presented net of reinsurance, contract holder liabilities are generally valued using more conservative assumptions and certain assets are non-admitted. We are subject to the applicable laws and regulations of our states of domicile. Changes in these laws and regulations could change capital levels or capital requirements for the Company. Specified statutory information (in millions) was as follows:
AS OF DECEMBER 31, ---------------------- 2010 2009 --------- ------------ Capital and surplus $6,750 $6,300
FOR THE YEARS ENDED DECEMBER 31, ---------------------- 2010 2009 2008 ---- ---- ------------ Net gain (loss) from operations, after-tax $553 $867 $ 510 Net income (loss) 430 (35) (261) Dividends to LNC 684 405 400
The increase in statutory net income (loss) for the year ended December 31, 2010, from that of 2009 was primarily due to a significant decrease in realized losses on investments due to improving market conditions throughout 2010. The increase in statutory net income (loss) for the year ended December 31, 2009, from that of 2008 was primarily due to the improved market conditions in 2009. The new statutory reserving standard (commonly called "VACARVM") that was developed by the NAIC replaced current statutory reserve practices for variable annuities with guaranteed benefits, such as GWBs, and was effective December 31, 2009. The actual effect of adoption was relatively neutral to RBC ratios and future dividend capacity of our insurance subsidiaries with a slight decrease in statutory reserves offset by a higher capital requirement. We utilize captive reinsurance structures, as well as third-party reinsurance arrangements, to lessen the negative effect on statutory capital and dividend capacity in our life insurance subsidiaries. Our states of domicile, Indiana for LNL and New York for LLANY, have adopted certain prescribed accounting practices that differ from those found in NAIC SAP. These prescribed practices are the use of continuous Commissioners Annuity Reserve Valuation Method ("CARVM") in the calculation of reserves as prescribed by the state of New York and the calculation of reserves on universal life policies based on the Indiana universal life method as prescribed by the state of In-diana. We also have several accounting practices permitted by the states of domicile that differ from those found in NAIC SAP. Specifically, these are accounting for the lesser of the face amount of all amounts outstanding under an LOC and the value of the Valuation of Life Insurance Policies Model Regulation ("XXX") additional statutory reserves as an admitted asset and a form of surplus as of December 31, 2009; and the use of a more conservative valuation interest rate on certain annuities as of December 31, 2010 and 2009. The effects on statutory surplus compared to NAIC statutory surplus from the use of these prescribed and permitted practices (in millions) were as follows:
AS OF DECEMBER 31, --------------------- 2010 2009 ------- ------------- Calculation of reserves using the Indiana universal life method $314 $328 Calculation of reserves using continuous CARVM (5) (6) Conservative valuation rate on certain variable annuities (15) (11) Lesser of LOC and XXX additional reserve as surplus 457 412
We are subject to certain insurance department regulatory restrictions as to the transfer of funds and payment of dividends to the holding company. Under Indiana laws and regulations, LNL may pay dividends to LNC without prior approval of the Indiana Insurance Commissioner (the "Commissioner"), only from unassigned surplus and must receive prior approval of the Commissioner to pay a dividend if such dividend, along with all other dividends paid within the preceding twelve consecutive months, would exceed the statutory limitation. The current statutory limitation is the greater of 10% of the insurer's contract holders' surplus, or statutory net gain from operations for the previous calendar twelve-month period (both shown on the last annual statement on file with the Commissioner), but in no event to exceed statutory unassigned surplus. As discussed above, we may not consider the benefit from the statutory accounting principles relating to our deferred tax assets in calculating available dividends. Indiana law gives the Commissioner broad discretion to disapprove requests for dividends in excess of these limits. New York, the state of domicile of LLANY, has similar restrictions, except that in New York it is the lesser of 10% of surplus to contract holders as of the immediately preceding calendar year-end or net gain from operations for the immediately preceding calendar year, not including realized capital gains. We expect we could pay dividends of approximately $611 million in 2011 without prior approval from the respective state commissioners. All payments of principal and interest on the surplus notes must be approved by the respective Commissioner of Insurance. S-59 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 22. FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying values and estimated fair values of our financial instruments (in millions) were as follows:
AS OF DECEMBER 31, ----------------------------------------------- 2010 2009 ----------------------- ----------------------- CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE ----------- ----------- ----------- ----------- ASSETS AFS securities: Fixed maturity securities $ 66,289 $ 66,289 $ 58,889 $ 58,889 VIEs' fixed maturity securities 584 584 -- -- Equity securities 140 140 155 155 Trading securities 2,459 2,459 2,366 2,366 Mortgage loans on real estate 6,431 6,847 6,835 6,967 Derivative investments 1,021 1,021 841 841 Other investments 978 978 975 975 Cash and invested cash 1,904 1,904 2,553 2,553 Reinsurance related embedded derivatives 112 112 277 277 Separate account assets 84,630 84,630 73,500 73,500 LIABILITIES Future contract benefits: Indexed annuity contracts embedded derivatives (497) (497) (419) (419) GLB reserves embedded derivatives (408) (408) (676) (676) Other contract holder funds: Remaining guaranteed interest and similar contracts (1,119) (1,119) (940) (940) Account values of certain investment contracts (26,061) (27,067) (24,039) (24,244) Short-term debt (10) (10) (21) (21) Long-term debt (2,429) (2,335) (1,925) (1,714) VIEs' liabilities - derivative instruments (209) (209) -- -- Other liabilities: Deferred compensation plans embedded derivatives (315) (315) (314) (314) Credit default swaps (16) (16) (65) (65)
VALUATION METHODOLOGIES AND ASSOCIATED INPUTS FOR FINANCIAL INSTRUMENTS NOT CARRIED AT FAIR VALUE The following discussion outlines the methodologies and assumptions used to determine the fair value of our financial instruments not carried at fair value on our Consolidated Balance Sheets. Considerable judgment is required to develop these assumptions used to measure fair value. Accordingly, the estimates shown are not necessarily indicative of the amounts that would be realized in a one-time, current market exchange of all of our financial instruments. MORTGAGE LOANS ON REAL ESTATE The fair value of mortgage loans on real estate is established using a discounted cash flow method based on credit rating, maturity and future income. The ratings for mortgages in good standing are based on property type, location, market conditions, occupancy, debt-service coverage, loan-to-value, quality of tenancy, borrower and payment record. The fair value for impaired mortgage loans is based on the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's market price or the fair value of the collateral if the loan is collateral dependent. OTHER INVESTMENTS The carrying value of our assets classified as other investments approximates their fair value. Other investments include LPs and other privately held investments that are accounted for using the equity method of accounting. OTHER CONTRACT HOLDER FUNDS Other contract holder funds include remaining guaranteed interest and similar contracts and account values of certain investment contracts. The fair value for the remaining guaranteed interest and similar contracts is estimated using discounted cash flow calculations as of the balance sheet date. These calculations are based on interest rates currently offered on similar contracts with maturities that are consistent with those remaining for the contracts being valued. As of December 31, 2010 and 2009, the remaining guaranteed interest and similar contracts carrying value approximates fair value. The fair value of the account values of certain investment contracts is based on their approximate surrender value as of the balance sheet date. S-60 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 22. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) SHORT-TERM AND LONG-TERM DEBT The fair value of long-term debt is based on quoted market prices or estimated using discounted cash flow analysis determined in conjunction with our incremental borrowing rate as of the balance sheet date for similar types of borrowing arrangements where quoted prices are not available. For short-term debt, excluding current maturities of long-term debt, the carrying value approximates fair value. FINANCIAL INSTRUMENTS CARRIED AT FAIR VALUE We did not have any assets or liabilities measured at fair value on a nonrecurring basis as of December 31, 2010, or December 31, 2009, and we noted no changes in our valuation methodologies between these periods. The following summarizes our financial instruments carried at fair value (in millions) on a recurring basis by the fair value hierarchy levels described above:
AS OF DECEMBER 31, 2010 ----------------------------------------------------- QUOTED PRICES IN ACTIVE MARKETS FOR SIGNIFICANT SIGNIFICANT IDENTICAL OBSERVABLE UNOBSERVABLE TOTAL ASSETS INPUTS INPUTS FAIR (LEVEL 1) (LEVEL 2) (LEVEL 3) VALUE --------- ---------------- -------------- ----------- ASSETS Investments: Fixed maturity AFS securities: Corporate bonds $ 58 $ 48,304 $ 2,353 $ 50,715 U.S. Government bonds 117 3 2 122 Foreign government bonds -- 381 113 494 MBS: CMOs -- 5,461 24 5,485 MPTS -- 2,801 95 2,896 CMBS -- 1,863 102 1,965 ABS CDOs -- 2 171 173 State and municipal bonds -- 3,085 -- 3,085 Hybrid and redeemable preferred securities 18 1,222 114 1,354 VIEs' fixed maturity securities -- 584 -- 584 Equity AFS securities: Banking securities -- 2 -- 2 Insurance securities 3 -- 33 36 Other financial services securities -- 8 24 32 Other securities 34 2 34 70 Trading securities 2 2,383 74 2,459 Derivative investments -- (473) 1,494 1,021 Cash and invested cash -- 1,904 -- 1,904 Reinsurance related embedded derivatives -- 112 -- 112 Separate account assets -- 84,630 -- 84,630 --------- ---------------- -------------- ----------- Total assets $232 $152,274 $ 4,633 $157,139 ========= ================ ============== =========== LIABILITIES Future contract benefits: Indexed annuity contracts embedded derivatives $ -- $ -- $ (497) $ (497) GLB reserves embedded derivatives -- -- (408) (408) VIEs' liabilities -- derivative instruments -- -- (209) (209) Other liabilities: Deferred compensation plans embedded derivatives -- -- (315) (315) Credit default swaps -- -- (16) (16) --------- ---------------- -------------- ----------- Total liabilities $ -- $ -- $(1,445) $ (1,445) ========= ================ ============== ===========
S-61 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 22. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
AS OF DECEMBER 31, 2009 ----------------------------------------------------- QUOTED PRICES IN ACTIVE MARKETS FOR SIGNIFICANT SIGNIFICANT IDENTICAL OBSERVABLE UNOBSERVABLE TOTAL ASSETS INPUTS INPUTS FAIR (LEVEL 1) (LEVEL 2) (LEVEL 3) VALUE --------- ---------------- -------------- ----------- ASSETS Investments: Fixed maturity AFS securities: Corporate bonds $ 55 $ 41,904 $ 2,117 $ 44,076 U.S. Government bonds 112 33 3 148 Foreign government bonds -- 397 92 489 MBS: CMOs -- 5,593 34 5,627 MPTS -- 2,808 101 2,909 CMBS -- 1,796 252 2,048 ABS: CDOs -- 4 153 157 CLNs -- -- 322 322 State and municipal bonds -- 1,943 -- 1,943 Hybrid and redeemable preferred securities 15 1,005 150 1,170 Equity AFS securities: Banking securities 23 1 -- 24 Insurance securities 3 -- 43 46 Other financial services securities -- 6 22 28 Other securities 34 -- 23 57 Trading securities 2 2,274 90 2,366 Derivative investments -- (397) 1,238 841 Cash and invested cash -- 2,553 -- 2,553 Reinsurance related embedded derivatives -- 277 -- 277 Separate account assets -- 73,500 -- 73,500 --------- ---------------- -------------- ----------- Total assets $244 $133,697 $ 4,640 $138,581 ========= ================ ============== =========== LIABILITIES Future contract benefits: Indexed annuity contracts embedded derivatives $ -- $ -- $ (419) $ (419) GLB reserves embedded derivatives -- -- (676) (676) Other liabilities: Deferred compensation plans embedded derivatives -- -- (314) (314) Credit default swaps -- -- (65) (65) --------- ---------------- -------------- ----------- Total liabilities $ -- $ -- $(1,474) $ (1,474) ========= ================ ============== ===========
S-62 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 22. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) The following summarizes changes to our financial instruments carried at fair value (in millions) and classified within Level 3 of the fair value hierarchy. This summary excludes any impact of amortization of DAC, VOBA, DSI and DFEL. The gains and losses below may include changes in fair value due in part to observable inputs that are a component of the valuation methodology.
FOR THE YEAR ENDED DECEMBER 31, 2010 ---------------------------------------------------------------------------- GAINS SALES, TRANSFERS ITEMS (LOSSES) ISSUANCES, IN OR INCLUDED IN MATURITIES, OUT BEGINNING IN OCI SETTLEMENTS, OF ENDING FAIR NET AND CALLS, LEVEL 3, FAIR VALUE INCOME OTHER(1) NET NET(2) VALUE ------------ ----------- ------------- --------------- ------------ -------- Investments:(3) Fixed maturity AFS securities: Corporate bonds $2,117 $ (42) $ 53 $279 $ (54) $2,353 U.S. Government bonds 3 -- -- (4) 3 2 Foreign government bonds 92 -- 8 (4) 17 113 MBS: CMOs 34 (5) 7 (8) (4) 24 MPTS 101 -- 3 (9) -- 95 CMBS 252 (47) 84 (72) (115) 102 ABS: CDOs 153 1 30 (13) -- 171 CLNs 322 -- 278 -- (600) -- Hybrid and redeemable preferred securities 150 2 (23) (15) -- 114 Equity AFS securities: Insurance securities 43 -- 2 (12) -- 33 Other financial services securities 22 -- 7 (5) -- 24 Other securities 23 -- (1) 12 -- 34 Trading securities 90 2 (10) (7) (1) 74 Derivative investments 1,238 (166) 7 415 -- 1,494 Future contract benefits:(4) Indexed annuity contracts embedded derivatives (419) (81) -- 3 -- (497) GLB reserves embedded derivatives (676) 268 -- -- -- (408) VIEs' liabilities -- derivative instruments(5) -- 16 -- -- (225) (209) Other liabilities: Deferred compensation plans embedded derivatives(6) (314) (33) -- 32 -- (315) Credit default swaps(7) (65) 7 -- 42 -- (16) ------------ ----------- ------------- --------------- ------------ -------- Total, net $3,166 $ (78) $445 $634 $(979) $3,188 ============ =========== ============= =============== ============ ========
S-63 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 22. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2009 ---------------------------------------------------------------------------- GAINS SALES, TRANSFERS ITEMS (LOSSES) ISSUANCES, IN OR INCLUDED IN MATURITIES, OUT BEGINNING IN OCI SETTLEMENTS, OF ENDING FAIR NET AND CALLS, LEVEL 3, FAIR VALUE INCOME OTHER(1) NET NET(2) VALUE ------------ ----------- ------------- --------------- ------------ -------- Investments:(3) Fixed maturity AFS securities: Corporate bonds $ 2,383 $ (46) $317 $ (161) $(376) $2,117 U.S. Government bonds 3 -- -- -- -- 3 Foreign government bonds 60 1 2 10 19 92 MBS: CMOs 160 (7) 34 (13) (140) 34 MPTS 18 -- 1 97 (15) 101 CMBS 238 1 57 (44) -- 252 ABS: CDOs 150 (35) 61 (21) (2) 153 CLNs 50 -- 272 -- -- 322 State and municipal bonds 117 -- (1) (17) (99) -- Hybrid and redeemable preferred securities 113 (21) 47 3 8 150 Equity AFS securities: Insurance securities 50 (7) 20 (20) -- 43 Other financial services securities 20 (2) 7 (3) -- 22 Other securities 23 2 (1) (1) -- 23 Trading securities 77 35 -- (7) (15) 90 Derivative investments 78 (87) (7) 1,254 -- 1,238 Future contract benefits:(4) Indexed annuity contracts embedded derivatives (252) (75) -- (92) -- (419) GLB reserves embedded derivatives (2,904) 2,228 -- -- -- (676) Other liabilities: Deferred compensation plans embedded derivatives(6) (223) (50) -- (41) -- (314) Credit default swaps(7) (51) (37) -- 23 -- (65) ------------ ----------- ------------- --------------- ------------ -------- Total, net $ 110 $1,900 $809 $ 967 $(620) $3,166 ============ =========== ============= =============== ============ ========
S-64 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 22. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
FOR THE YEAR ENDED DECEMBER 31, 2008 -------------------------------------------------------------------------- GAINS SALES, TRANSFERS ITEMS (LOSSES) ISSUANCES, IN OR INCLUDED IN MATURITIES, OUT BEGINNING IN OCI SETTLEMENTS, OF ENDING FAIR NET AND CALLS, LEVEL 3, FAIR VALUE INCOME OTHER(1) NET NET(2) VALUE ---------- ----------- ------------- --------------- ------------ -------- Investments:(3) Fixed maturity AFS securities: Corporate bonds $2,461 $ (150) $ (442) $ (10) $ 524 $ 2,383 U.S. Government bonds 3 -- -- -- -- 3 Foreign government bonds 79 -- (12) (7) -- 60 MBS: CMOs 275 (21) (53) (12) (29) 160 MPTS 52 -- (11) 1 (24) 18 CMBS 362 -- (193) 27 42 238 ABS: CDOs 184 1 (85) 50 -- 150 CLNs 660 -- (360) -- (250) 50 State and municipal bonds 138 -- (2) (32) 13 117 Hybrid and redeemable preferred securities 111 -- (41) 35 8 113 Equity AFS securities: Banking securities -- (1) -- 1 -- -- Insurance securities 2 (1) (18) 67 -- 50 Other financial services securities 35 (23) (2) 10 -- 20 Other securities 17 (5) 3 8 -- 23 Trading securities 107 (28) -- (13) 11 77 Derivative investments 195 (237) 29 91 -- 78 Future contract benefits:(4) Indexed annuity contracts embedded derivatives (389) 196 -- (59) -- (252) GLB reserves embedded derivatives (279) (2,625) -- -- -- (2,904) Other liabilities: Deferred compensation plans embedded derivatives(6) (271) 43 -- 5 -- (223) Credit default swaps(7) -- (51) -- -- -- (51) ---------- ----------- ------------- --------------- ------------ ---------- Total, net $3,742 $(2,902) $(1,187) $162 $ 295 $ 110 ========== =========== ============= =============== ============ ==========
(1) The changes in fair value of the interest rate swaps are offset by an adjustment to derivative investments. See "Derivatives Instruments Designated and Qualifying as Fair Value Hedges" section in Note 6. (2) Transfers in or out of Level 3 for AFS and trading securities are displayed at amortized cost as of the beginning-of-period. For AFS and trading securities, the difference between beginning-of-year amortized cost and beginning-of-year fair value was included in OCI and earnings, respectively, in prior years. (3) Amortization and accretion of premiums and discounts are included in net investment income on our Consolidated Statements of Income (Loss). Gains (losses) from sales, maturities, settlements and calls and OTTI are included in realized gain (loss) on our Consolidated Statements of Income (Loss). (4) Gains (losses) from sales, maturities, settlements and calls are included in realized gain (loss) on our Consolidated Statements of Income (Loss). (5) The changes in fair value of the credit default swaps and contingency forwards are included in realized gain (loss) on our Consolidated Statements of Income (Loss). (6) Deferrals and subsequent changes in fair value for the participants' investment options are reported in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income (Loss). (7) Gains (losses) from sales, maturities, settlements and calls are included in net investment income on our Consolidated Statements of Income (Loss). S-65 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 22. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) The following summarizes changes in unrealized gains (losses) included in net income, excluding any impact of amortization of DAC, VOBA, DSI and DFEL and changes in future contract benefits, related to financial instruments carried at fair value classified within Level 3 that we still held (in millions):
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 2010 2009 2008 -------- --------------- ---------- Investments:(1) Trading securities $ -- $ 33 $ (23) Derivative investments (163) (86) (129) Future contract benefits:(1) Indexed annuity contracts embedded derivatives 44 (17) 23 GLB reserves embedded derivatives 419 2,366 (1,061) VIEs' liabilities -- derivative instruments(1) 16 -- -- Other liabilities: Deferred compensation plans embedded derivatives(2) (33) (50) 43 Credit default swaps(3) (12) (14) (51) -------- --------------- ---------- Total, net $ 271 $2,232 $(1,198) ======== =============== ==========
(1) Included in realized gain (loss) on our Consolidated Statements of Income (Loss). (2) Included in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income (Loss). (3) Included in net investment income on our Consolidated Statements of Income (Loss). The following provides the components of the transfers in and out of Level 3 (in millions) as reported above:
FOR THE YEAR ENDED DECEMBER 31, 2010 ------------------------------- TRANSFERS TRANSFERS IN TO OUT OF LEVEL 3 LEVEL 3 TOTAL ---------- ----------- -------- Investments: Fixed maturity AFS securities: Corporate bonds $ 144 $(198) $ (54) U.S. Government bonds 3 -- 3 Foreign government bonds 17 -- 17 MBS: CMOs -- (4) (4) CMBS 3 (118) (115) ABS CLNs -- (600) (600) Trading securities -- (1) (1) Future contract benefits: VIEs' liabilities -- derivative instruments (225) -- (225) ---------- ----------- -------- Total, net $ (58) $(921) $(979) ========== =========== ========
Transfers in and out of Level 3 are generally the result of observable market information on a security no longer being available or becoming available to our pricing vendors. For the year ended December 31, 2010, our corporate bonds and CMBS transfers in and out were attributable primarily to the securities' observable market information being available or no longer being available, respectively, and the ABS CLNs transfer out of Level 3 and VIEs' liabilities - derivative instruments transfer into Level 3 are related to new accounting guidance that is discussed in Note 4. For the year ended December 31, 2010, there were no significant transfers between Level 1 and 2 of the fair value hierarchy. 23. SEGMENT INFORMATION We provide products and services in two operating businesses and report results through four business segments as follows:
BUSINESS CORRESPONDING SEGMENTS -------------------- ---------------------- Retirement Solutions Annuities Defined Contribution Insurance Solutions Life Insurance Group Protection
We also have Other Operations, which includes the financial data for operations that are not directly related to the business segments. Our reporting segments reflect the manner by which our chief operating decision makers view and manage the business. The following is a brief description of these segments and Other Operations. RETIREMENT SOLUTIONS The Retirement Solutions business provides its products through two segments: Annuities and Defined Contribution. The 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 Defined Contribution segment provides employer-sponsored variable and fixed annuities, defined benefit, individual retirement accounts and mutual-fund based programs in the retirement plan marketplaces. INSURANCE SOLUTIONS The Insurance Solutions business provides its products through two segments: Life Insurance and Group Protection. S-66 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 23. SEGMENT INFORMATION (CONTINUED) The Life Insurance segment offers wealth protection and transfer opportunities through term insurance, a linked-benefit product (which is a UL policy linked with riders that provide for long-term care costs) and both single and survivorship versions of UL and VUL, including corporate-owned UL and VUL insurance and bank-owned UL and VUL insurance products. The Group Protection segment offers group life, disability and dental insurance to employers, and its products are marketed primarily through a national distribution system of regional group offices. These offices develop business through employee benefit brokers, third-party administrators and other employee benefit firms. OTHER OPERATIONS Other Operations includes investments related to excess capital, investments in media properties and other corporate investments; benefit plan net liability; the unamortized deferred gain on indemnity reinsurance related to the sale of reinsurance to Swiss Re in 2001; the results of certain disability income business due to the rescission of a reinsurance agreement with Swiss Re; the Institutional Pension business, which is a closed-block of pension business, the majority of which was sold on a group annuity basis, and is currently in run-off; and debt costs. We are actively managing our remaining radio station clusters to maximize performance and future value. Segment operating revenues and income (loss) from operations are internal measures used by our management and Board of Directors to evaluate and assess the results of our segments. Income (loss) from operations is GAAP net income excluding the after-tax effects of the following items, as applicable: - Realized gains and losses associated with the following ("excluded realized gain (loss)"): - Sale or disposal of securities; - Impairments of securities; - Change in the fair value of derivative instruments, embedded derivatives within certain reinsurance arrangements and our trading securities; - Change in the fair value of the derivatives we own to hedge our GDB riders within our variable annuities; - Change in the GLB embedded derivative reserves, net of the change in the fair value of the derivatives we own to hedge the changes in the embedded derivative reserves; and - Changes in the fair value of the embedded derivative liabilities related to index call options we may purchase in the future to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products accounted for under the Derivatives and Hedging and the Fair Value Measurements and Disclosures Topics of the FASB ASC. - Change in reserves accounted for under the Financial Services - Insurance - Claim Costs and Liabilities for Future Policy Benefits Subtopic of the FASB ASC resulting from benefit ratio unlocking on our GDB and GLB riders ("benefit ratio unlocking"); - Income (loss) from the initial adoption of new accounting standards; - Income (loss) from reserve changes (net of related amortization) on business sold through reinsurance; - Gain (loss) on early extinguishment of debt; - Losses from the impairment of intangible assets; and - Income (loss) from discontinued operations. Operating revenues represent GAAP revenues excluding the pre-tax effects of the following items, as applicable: - Excluded realized gain (loss); - Amortization of DFEL arising from changes in GDB and GLB benefit ratio unlocking; - Amortization of deferred gains arising from the reserve changes on business sold through reinsurance; and - Revenue adjustments from the initial adoption of new accounting standards. We use our prevailing corporate federal income tax rate of 35% while taking into account any permanent differences for events recognized differently in our financial statements and federal income tax returns when reconciling our non-GAAP measures to the most comparable GAAP measure. Operating revenues and income (loss) from operations do not replace revenues and net income as the GAAP measures of our consolidated results of operations. S-67 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 23. SEGMENT INFORMATION (CONTINUED) Segment information (in millions) was as follows:
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------- 2010 2009 2008 --------- --------------- --------- REVENUES Operating revenues: Retirement Solutions: Annuities $2,412 $2,085 $2,191 Defined Contribution 970 911 913 --------- --------------- --------- Total Retirement Solutions 3,382 2,996 3,104 --------- --------------- --------- Insurance Solutions: Life Insurance 4,156 3,990 4,005 Group Protection 1,831 1,713 1,640 --------- --------------- --------- Total Insurance Solutions 5,987 5,703 5,645 --------- --------------- --------- Other Operations 470 449 433 Excluded realized gain (loss), pre-tax (317) (643) (863) Amortization of deferred gains from reserve changes on business sold through reinsurance, pre-tax 3 3 3 Amortization of DFEL associated with benefit ratio unlocking, pre-tax -- -- 1 --------- --------------- --------- Total revenues $9,525 $8,508 $8,323 ========= =============== =========
FOR THE YEARS ENDED DECEMBER 31, ---------------------------------- 2010 2009 2008 --------- --------------- -------- NET INCOME (LOSS) Income (loss) from operations: Retirement Solutions: Annuities $ 463 $ 355 $ 154 Defined Contribution 146 124 117 --------- --------------- -------- Total Retirement Solutions 609 479 271 --------- --------------- -------- Insurance Solutions: Life Insurance 595 617 489 Group Protection 72 124 104 --------- --------------- -------- Total Insurance Solutions 667 741 593 --------- --------------- -------- Other Operations 3 (7) (47) Excluded realized gain (loss), after-tax (206) (418) (561) Income (expense) from reserve changes (net of related amortization) on business sold through reinsurance, after-tax 2 2 2 Impairment of intangibles, after-tax -- (709) -- Benefit ratio unlocking, after-tax -- -- (4) --------- --------------- -------- Net income (loss) $1,075 $ 88 $ 254 ========= =============== ========
FOR THE YEARS ENDED DECEMBER 31, -------------------------- 2010 2009 2008 ------ ------------ ------ NET INVESTMENT INCOME Retirement Solutions: Annuities $1,107 $1,020 $ 958 Defined Contribution 769 732 695 ------ ------------ ------ Total Retirement Solutions 1,876 1,752 1,653 ------ ------------ ------ Insurance Solutions: Life Insurance 2,040 1,827 1,867 Group Protection 141 127 117 ------ ------------ ------ Total Insurance Solutions 2,181 1,954 1,984 ------ ------------ ------ Other Operations 305 300 338 ------ ------------ ------ Total net investment income $4,362 $4,006 $3,975 ====== ============ ======
S-68 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 23. SEGMENT INFORMATION (CONTINUED)
FOR THE YEARS ENDED DECEMBER 31, -------------------------- 2010 2009 2008 ------ ------------ ------ AMORTIZATION OF DAC AND VOBA, NET OF INTEREST Retirement Solutions: Annuities $ 402 $356 $ 729 Defined Contribution 78 71 130 ------ ------------ ------ Total Retirement Solutions 480 427 859 ------ ------------ ------ Insurance Solutions: Life Insurance 492 519 519 Group Protection 46 46 36 ------ ------------ ------ Total Insurance Solutions 538 565 555 ------ ------------ ------ Total amortization of DAC and VOBA, net of interest $1,018 $992 $1,414 ====== ============ ======
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 2010 2009 2008 -------- --------------- -------- FEDERAL INCOME TAX EXPENSE (BENEFIT) Retirement Solutions: Annuities $ 91 $ 42 $ (76) Defined Contribution 55 45 26 -------- --------------- -------- Total Retirement Solutions 146 87 (50) -------- --------------- -------- Insurance Solutions: Life Insurance 279 271 240 Group Protection 38 67 56 -------- --------------- -------- Total Insurance Solutions 317 338 296 -------- --------------- -------- Other Operations (6) (21) (11) Excluded realized gain (loss) (111) (225) (302) Reserve changes (net of related amortization) on business sold through reinsurance 1 1 1 Impairment of intangibles -- (16) -- Benefit ratio unlocking -- (1) (2) -------- --------------- -------- Total federal income tax expense (benefit) $ 347 $ 163 $ (68) ======== =============== ========
AS OF DECEMBER 31, ------------------ 2010 2009 -------- --------- ASSETS Retirement Solutions: Annuities $ 91,789 $ 80,700 Defined Contribution 28,563 26,689 -------- --------- Total Retirement Solutions 120,352 107,389 -------- --------- Insurance Solutions: Life Insurance 55,083 50,825 Group Protection 3,254 2,845 -------- --------- Total Insurance Solutions 58,337 53,670 -------- --------- Other Operations 13,323 13,148 -------- --------- Total assets $192,012 $174,207 ======== =========
S-69 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 24. SUPPLEMENTAL DISCLOSURES OF CASH FLOW DATA The following summarizes our supplemental cash flow data (in millions):
FOR THE YEARS ENDED DECEMBER 31, ---------------------------- 2010 2009 2008 ---- --------------- ------- Interest paid $ 94 $ 96 $ 81 Income taxes paid (received) 345 (15) (23) Significant non-cash investing and financing transactions: Funds withheld agreement with LNBAR: Carrying value of assets $ -- $ 790 $ -- Carrying value of liabilities -- (790) -- ---- --------------- ------- Total acquired from LNBAR $ -- $ -- $ -- ==== =============== ======= Capital contribution of LFM: Carrying value of assets (includes cash and invested cash) $ -- $ 364 $ -- Carrying value of liabilities -- (84) -- ---- --------------- ------- Total capital contribution of LFM $ -- $ 280 $ -- ==== =============== =======
FOR THE YEARS ENDED DECEMBER 31, -------------------------------- 2010 2009 2008 ---- --------------- ----------- Reinsurance assumed from FPP: Carrying value of assets $ -- $ 63 $ -- Carrying value of liabilities -- (63) -- ---- --------------- --- ------- Total reinsurance assumed from FPP $ -- $ -- $ -- ==== =============== =========== Sale of subsidiaries/business Proceeds from sale of subsidiaries/business $ -- $ 6 $ -- Assets disposed (includes cash and invested cash) -- (5) -- ---- --------------- --- ------- Gain on sale of subsidiary/ business $ -- $ 1 $ -- ==== =============== =========== Reinsurance ceded to LNBAR: Carrying value of assets $188 $ -- $ 360 Carrying value of liabilities (188) -- (360) ---- --------------- ----------- Total reinsuranced ceded to LNBAR $ -- $ -- $ -- ==== =============== ===========
25. TRANSACTIONS WITH AFFILIATES Transactions with affiliates (in millions) recorded on our consolidated financial statements were as follows:
AS OF DECEMBER 31, --------------------- 2010 2009 -------- ------------ Assets with affiliates: Corporate bonds(1) $ 100 $ 100 Reinsurance on ceded reinsurance contracts(2) 2,322 2,414 Reinsurance on assumed reinsurance contracts(3) 417 417 Cash management agreement investment(4) 173 142 Service agreement receivable(4) (12) (51) Liabilities with affiliates: Inter-company short-term debt(5) 10 21 Inter-company long-term debt(6) 2,179 1,675
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 2010 2009 2008 -------- --------------- -------- Revenues with affiliates: Premiums paid on ceded reinsurance contracts(7) $(308) $(235) $(222) Net investment income on cash management agreement(8) -- 1 11 Fees for management of general account(8) -- (68) (65) Benefits and expenses with affiliates: Reinsurance (recoveries) benefits on ceded reinsurance contracts(9) (765) (158) (655) Service agreement payments(10) (58) 21 (2) Transfer pricing arrangement(10) -- (32) (32) Interest expense on inter-company debt(11) 98 90 83
(1) Reported in fixed maturity AFS securities on our Consolidated Balance Sheets. (2) Reported in reinsurance recoverables on our Consolidated Balance Sheets. (3) Reported in reinsurance related embedded derivatives on our Consolidated Balance Sheets. (4) Reported in other assets on our Consolidated Balance Sheets. S-70 THE LINCOLN NATIONAL LIFE INSURANCE COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 25. TRANSACTIONS WITH AFFILIATES (CONTINUED) (5) Reported in short-term debt on our Consolidated Balance Sheets. (6) Reported in long-term debt on our Consolidated Balance Sheets. (7) Reported in insurance premiums on our Consolidated Statements of Income (Loss). (8) Reported in net investment income on our Consolidated Statement of Income (Loss). (9) Reported in benefits on our Consolidated Statements of Income (Loss). 10) Reported in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income (Loss). (11) Reported in interest and debt expense on our Consolidated Statements of Income (Loss). CORPORATE BONDS LNC issues corporate bonds to us for a predetermined face value to be repaid by LNC at a predetermined maturity with a specified interest rate. We purchase these investments for our segmented portfolios that have yield, duration and other characteristics. CASH MANAGEMENT AGREEMENT In order to manage our capital more efficiently, we participate in an inter-company cash management program where LNC can lend to or borrow from us to meet short-term borrowing needs. The cash management program is essentially a series of demand loans, which are permitted under applicable insurance laws, among LNC and its affiliates that reduces overall borrowing costs by allowing LNC and its subsidiaries to access internal resources instead of incurring third-party transaction costs. The borrowing and lending limit is currently the lesser of 3% of our admitted assets and 25% of its surplus, in both cases, as of its most recent year end. SERVICE AGREEMENT 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. FEES FOR MANAGEMENT OF GENERAL ACCOUNT AND TRANSFER PRICING ARRANGEMENT On January 4, 2010, LNC closed on a purchase and sale agreement pursuant to which all of the outstanding capital stock of Delaware Management Holdings, Inc. ("Delaware") was sold. In addition, we entered into investment advisory agreements with Delaware, pursuant to which Delaware will continue to manage the majority of our general account insurance assets. A transfer pricing arrangement is in place between LFD and Delaware related to the wholesaling of Delaware's investment products. CEDED REINSURANCE CONTRACTS As discussed in Note 9, we cede and accept reinsurance from affiliated companies. We cede certain guaranteed benefit risks (including certain GDB and GWB benefits) to LNBAR. We also cede reserves related to certain risks for certain UL policies, which resulted from recent actuarial reserving guidelines. As discussed in Note 3, we cede to LNBAR the risk under certain UL contracts for no-lapse benefit guarantees. 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 $1.8 billion and $2.4 billion as of December 31, 2010 and 2009, respectively. The letters of credit are issued by banks and represent guarantees of performance under the reinsurance agreement, and are guaranteed by LNC. S-71 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT L L-1 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT L STATEMENTS OF ASSETS AND LIABILITIES DECEMBER 31, 2010
MORTALITY & CONTRACT EXPENSE CONTRACT REDEMPTIONS GUARANTEE PURCHASES DUE TO CHARGES PAYABLE DUE FROM THE THE LINCOLN TO THE LINCOLN LINCOLN NATIONAL NATIONAL LIFE NATIONAL LIFE LIFE INSURANCE INSURANCE INSURANCE SUBACCOUNT INVESTMENTS COMPANY TOTAL ASSETS COMPANY COMPANY NET ASSETS ---------------------------------------------------------------------------------------------------------------------------------- ABVPSF Global Thematic Growth Class B $ 2,785,417 $ 28 $ 2,785,445 $ -- $ 76 $ 2,785,369 ABVPSF Growth Class B 1,177,364 130 1,177,494 -- 32 1,177,462 ABVPSF Growth and Income Class B 901,280 564 901,844 -- 24 901,820 American Century VP Balanced Class I 17,458,678 -- 17,458,678 32,231 469 17,425,978 American Century VP Inflation Protection Class I 806,481 -- 806,481 14,160 22 792,299 American Funds Global Growth Class 2 5,567,866 -- 5,567,866 1,946 149 5,565,771 American Funds Growth Class 2 24,730,596 7,248 24,737,844 -- 664 24,737,180 American Funds Growth-Income Class 2 8,177,229 -- 8,177,229 2,724 221 8,174,284 American Funds International Class 2 16,878,705 -- 16,878,705 7,157 458 16,871,090 BlackRock Global Allocation V.I. Class I 883,955 225 884,180 -- 24 884,156 Delaware VIP Diversified Income Standard Class 7,354,755 1,174 7,355,929 -- 199 7,355,730 Delaware VIP High Yield Standard Class 3,101,077 -- 3,101,077 37,669 84 3,063,324 Delaware VIP REIT Service Class 10,851,926 -- 10,851,926 20,805 295 10,830,826 Delaware VIP Small Cap Value Service Class 8,831,055 -- 8,831,055 824 240 8,829,991 Delaware VIP Smid Cap Growth Service Class 2,741,709 -- 2,741,709 39,395 74 2,702,240 Dreyfus Opportunistic Small Cap Initial Class 30,524,786 -- 30,524,786 21,900 829 30,502,057 Dreyfus Stock Index Initial Class 57,034,778 1,369 57,036,147 -- 1,534 57,034,613 DWS VIP Alternative Asset Allocation Plus Class A 82,333 1,253 83,586 -- 2 83,584 DWS VIP Equity 500 Index Class A 2,424,263 399 2,424,662 -- 66 2,424,596 DWS VIP Small Cap Index Class A 2,075,252 7,419 2,082,671 -- 56 2,082,615 Fidelity VIP Asset Manager Initial Class 44,117,440 -- 44,117,440 1,302 1,193 44,114,945 Fidelity VIP Contrafund Service Class 2 19,347,328 -- 19,347,328 13,570 523 19,333,235 Fidelity VIP Equity-Income Initial Class 43,404,352 -- 43,404,352 26,028 1,163 43,377,161 Fidelity VIP Growth Initial Class 72,061,554 2,568 72,064,122 -- 1,950 72,062,172 Fidelity VIP Money Market Initial Class 22,220 -- 22,220 -- -- 22,220 Janus Aspen Series Worldwide Institutional Class 11,500,448 -- 11,500,448 7,506 309 11,492,633 LVIP Baron Growth Opportunities Service Class 16,382,621 2,643 16,385,264 -- 443 16,384,821 LVIP Cohen & Steers Global Real Estate Standard Class 631,671 68 631,739 -- 17 631,722 LVIP Delaware Bond Standard Class 8,045,731 5,866 8,051,597 -- 217 8,051,380 LVIP Delaware Foundation Aggressive Allocation Standard Class 83,272 -- 83,272 -- 2 83,270 LVIP Delaware Foundation Conservative Allocation Standard Class 1,016,852 476 1,017,328 -- 26 1,017,302 LVIP Delaware Foundation Moderate Allocation Standard Class 154,359 -- 154,359 4 154,355 LVIP Delaware Growth and Income Standard Class 4,279,064 -- 4,279,064 24,393 115 4,254,556 LVIP Delaware Social Awareness Standard Class 14,039,203 1,398 14,040,601 -- 378 14,040,223 LVIP Global Income Standard Class 147,016 447 147,463 -- 4 147,459 LVIP Janus Capital Appreciation Standard Class 1,591,312 207 1,591,519 -- 43 1,591,476
See accompanying notes. L-2
MORTALITY & CONTRACT EXPENSE CONTRACT REDEMPTIONS GUARANTEE PURCHASES DUE TO CHARGES PAYABLE DUE FROM THE THE LINCOLN TO THE LINCOLN LINCOLN NATIONAL NATIONAL LIFE NATIONAL LIFE LIFE INSURANCE INSURANCE INSURANCE SUBACCOUNT INVESTMENTS COMPANY TOTAL ASSETS COMPANY COMPANY NET ASSETS ---------------------------------------------------------------------------------------------------------------------------------- LVIP Mondrian International Value Standard Class $ 5,075,887 $ -- $ 5,075,887 $ 6,042 $135 $ 5,069,710 LVIP SSgA Bond Index Standard Class 485,643 10 485,653 -- 13 485,640 LVIP SSgA Emerging Markets 100 Standard Class 1,342,669 883 1,343,552 -- 36 1,343,516 LVIP SSgA Global Tactical Allocation Standard Class 1,938,139 25 1,938,164 -- 52 1,938,112 LVIP SSgA International Index Standard Class 111,647 31 111,678 -- 3 111,675 LVIP T. Rowe Price Structured Mid-Cap Growth Standard Class 18,424,362 -- 18,424,362 3,299 497 18,420,566 LVIP Wilshire 2010 Profile Standard Class 832,452 279 832,731 -- 22 832,709 LVIP Wilshire 2020 Profile Standard Class 2,238,345 144 2,238,489 -- 61 2,238,428 LVIP Wilshire 2030 Profile Standard Class 2,288,145 680 2,288,825 -- 62 2,288,763 LVIP Wilshire 2040 Profile Standard Class 787,899 547 788,446 -- 21 788,425 LVIP Wilshire Conservative Profile Standard Class 3,721,910 13 3,721,923 -- 102 3,721,821 LVIP Wilshire Moderate Profile Standard Class 4,877,765 1,517 4,879,282 -- 132 4,879,150 LVIP Wilshire Moderately Aggressive Profile Standard Class 5,201,067 789 5,201,856 -- 141 5,201,715 NB AMT Mid-Cap Growth I Class 7,390,094 14,173 7,404,267 -- 201 7,404,066 NB AMT Partners I Class 6,069,713 -- 6,069,713 19,189 163 6,050,361 T. Rowe Price International Stock Class I 14,529,601 -- 14,529,601 19,772 392 14,509,437
See accompanying notes. L-3 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT L STATEMENTS OF OPERATIONS YEAR ENDED DECEMBER 31, 2010
DIVIDENDS FROM MORTALITY AND NET INVESTMENT EXPENSE INVESTMENT SUBACCOUNT INCOME GUARANTEE CHARGES INCOME (LOSS) ------------------------------------------------------------------------------------------------------------- ABVPSF Global Thematic Growth Class B $ 48,947 $ (24,574) $ 24,373 ABVPSF Growth Class B 575 (10,912) (10,337) ABVPSF Growth and Income Class B -- (9,371) (9,371) American Century VP Balanced Class I 321,655 (167,757) 153,898 American Century VP Inflation Protection Class I 16,853 (9,087) 7,766 American Funds Global Growth Class 2 76,204 (49,780) 26,424 American Funds Growth Class 2 163,779 (226,267) (62,488) American Funds Growth-Income Class 2 112,708 (74,322) 38,386 American Funds International Class 2 329,919 (164,940) 164,979 BlackRock Global Allocation V.I. Class I 9,960 (5,718) 4,242 Delaware VIP Diversified Income Standard Class 354,446 (74,385) 280,061 Delaware VIP High Yield Standard Class 219,815 (28,107) 191,708 Delaware VIP REIT Service Class 250,405 (96,351) 154,054 Delaware VIP Small Cap Value Service Class 34,235 (73,056) (38,821) Delaware VIP Smid Cap Growth Service Class -- (5,675) (5,675) Delaware VIP Trend Service Class -- (16,218) (16,218) Dreyfus Opportunistic Small Cap Initial Class 204,293 (264,036) (59,743) Dreyfus Stock Index Initial Class 986,433 (536,439) 449,994 DWS VIP Alternative Asset Allocation Plus Class A 640 (539) 101 DWS VIP Equity 500 Index Class A 43,914 (22,852) 21,062 DWS VIP Small Cap Index Class A 16,860 (17,835) (975) Fidelity VIP Asset Manager Initial Class 712,268 (428,176) 284,092 Fidelity VIP Contrafund Service Class 2 179,450 (173,521) 5,929 Fidelity VIP Equity-Income Initial Class 741,652 (408,435) 333,217 Fidelity VIP Growth Initial Class 178,653 (648,688) (470,035) Fidelity VIP Money Market Initial Class 27 -- 27 Janus Aspen Series Worldwide Institutional Class 67,007 (106,933) (39,926) LVIP Baron Growth Opportunities Service Class -- (145,903) (145,903) LVIP Cohen & Steers Global Real Estate Standard Class -- (4,760) (4,760) LVIP Delaware Bond Standard Class 281,759 (77,943) 203,816 LVIP Delaware Foundation Aggressive Allocation Standard Class 1,775 (474) 1,301 LVIP Delaware Foundation Conservative Allocation Standard Class 16,250 (9,125) 7,125 LVIP Delaware Foundation Moderate Allocation Standard Class 3,430 (564) 2,866 LVIP Delaware Growth and Income Standard Class 38,374 (41,376) (3,002) LVIP Delaware Social Awareness Standard Class 79,993 (131,264) (51,271) LVIP Global Income Standard Class 3,283 (1,118) 2,165 LVIP Janus Capital Appreciation Standard Class 11,021 (14,836) (3,815) LVIP Mondrian International Value Standard Class 168,202 (52,357) 115,845 LVIP SSgA Bond Index Standard Class 9,389 (3,384) 6,005 LVIP SSgA Emerging Markets 100 Standard Class 13,977 (8,074) 5,903 LVIP SSgA Global Tactical Allocation Standard Class 19,050 (17,970) 1,080 LVIP SSgA International Index Standard Class 1,329 (881) 448 LVIP T. Rowe Price Structured Mid-Cap Growth Standard Class -- (162,468) (162,468) LVIP Wilshire 2010 Profile Standard Class 8,393 (7,066) 1,327 LVIP Wilshire 2020 Profile Standard Class 18,450 (18,323) 127 LVIP Wilshire 2030 Profile Standard Class 17,874 (19,637) (1,763) LVIP Wilshire 2040 Profile Standard Class 5,603 (5,926) (323) LVIP Wilshire Conservative Profile Standard Class 127,145 (33,571) 93,574 LVIP Wilshire Moderate Profile Standard Class 132,019 (43,633) 88,386 LVIP Wilshire Moderately Aggressive Profile Standard Class 135,366 (46,370) 88,996 NB AMT Mid-Cap Growth I Class -- (64,189) (64,189) NB AMT Partners I Class 38,902 (57,811) (18,909) T. Rowe Price International Stock Class I 124,294 (137,205) (12,911)
L-4
DIVIDENDS FROM TOTAL NET REALIZED NET REALIZED NET REALIZED GAIN (LOSS) GAIN ON GAIN (LOSS) SUBACCOUNT ON INVESTMENTS INVESTMENTS ON INVESTMENTS ------------------------------------------------------------------------------------------------------------- ABVPSF Global Thematic Growth Class B $ 24,457 $ -- $ 24,457 ABVPSF Growth Class B 4,998 -- 4,998 ABVPSF Growth and Income Class B (127,148) -- (127,148) American Century VP Balanced Class I (337,191) -- (337,191) American Century VP Inflation Protection Class I 13,835 -- 13,835 American Funds Global Growth Class 2 (75,202) -- (75,202) American Funds Growth Class 2 (365,602) -- (365,602) American Funds Growth-Income Class 2 (220,050) -- (220,050) American Funds International Class 2 (283,079) -- (283,079) BlackRock Global Allocation V.I. Class I (1,794) 4,533 2,739 Delaware VIP Diversified Income Standard Class 167,884 17,755 185,639 Delaware VIP High Yield Standard Class 54,613 -- 54,613 Delaware VIP REIT Service Class (755,331) -- (755,331) Delaware VIP Small Cap Value Service Class (90,940) -- (90,940) Delaware VIP Smid Cap Growth Service Class 6,265 -- 6,265 Delaware VIP Trend Service Class 138,811 91,044 229,855 Dreyfus Opportunistic Small Cap Initial Class (2,431,636) -- (2,431,636) Dreyfus Stock Index Initial Class 235,053 -- 235,053 DWS VIP Alternative Asset Allocation Plus Class A 13 522 535 DWS VIP Equity 500 Index Class A (44,199) -- (44,199) DWS VIP Small Cap Index Class A (96,588) -- (96,588) Fidelity VIP Asset Manager Initial Class (795,664) 214,332 (581,332) Fidelity VIP Contrafund Service Class 2 (646,763) 8,166 (638,597) Fidelity VIP Equity-Income Initial Class (1,814,947) -- (1,814,947) Fidelity VIP Growth Initial Class (1,516,229) 219,574 (1,296,655) Fidelity VIP Money Market Initial Class -- 11 11 Janus Aspen Series Worldwide Institutional Class (574,438) -- (574,438) LVIP Baron Growth Opportunities Service Class 374,507 -- 374,507 LVIP Cohen & Steers Global Real Estate Standard Class 8,876 -- 8,876 LVIP Delaware Bond Standard Class 173,146 165,277 338,423 LVIP Delaware Foundation Aggressive Allocation Standard Class 70 -- 70 LVIP Delaware Foundation Conservative Allocation Standard Class (19,695) -- (19,695) LVIP Delaware Foundation Moderate Allocation Standard Class 49 -- 49 LVIP Delaware Growth and Income Standard Class (59,604) -- (59,604) LVIP Delaware Social Awareness Standard Class (271,912) -- (271,912) LVIP Global Income Standard Class 2,120 -- 2,120 LVIP Janus Capital Appreciation Standard Class 30,567 -- 30,567 LVIP Mondrian International Value Standard Class (505,619) -- (505,619) LVIP SSgA Bond Index Standard Class 4,185 -- 4,185 LVIP SSgA Emerging Markets 100 Standard Class 39,616 -- 39,616 LVIP SSgA Global Tactical Allocation Standard Class (36,809) -- (36,809) LVIP SSgA International Index Standard Class 2,699 -- 2,699 LVIP T. Rowe Price Structured Mid-Cap Growth Standard Class (332,465) -- (332,465) LVIP Wilshire 2010 Profile Standard Class 8,338 -- 8,338 LVIP Wilshire 2020 Profile Standard Class 29,154 -- 29,154 LVIP Wilshire 2030 Profile Standard Class 14,846 -- 14,846 LVIP Wilshire 2040 Profile Standard Class 7,184 -- 7,184 LVIP Wilshire Conservative Profile Standard Class 11,585 -- 11,585 LVIP Wilshire Moderate Profile Standard Class (16,661) -- (16,661) LVIP Wilshire Moderately Aggressive Profile Standard Class (45,414) -- (45,414) NB AMT Mid-Cap Growth I Class 5,227 -- 5,227 NB AMT Partners I Class (383,291) -- (383,291) T. Rowe Price International Stock Class I (111,148) 41,431 (69,717) NET CHANGE IN UNREALIZED NET INCREASE APPRECIATION OR IN NET ASSETS DEPRECIATION RESULTING SUBACCOUNT ON INVESTMENTS FROM OPERATIONS ------------------------------------------------------------------------------------------------- ABVPSF Global Thematic Growth Class B $ 364,366 $ 413,196 ABVPSF Growth Class B 152,544 147,205 ABVPSF Growth and Income Class B 227,546 91,027 American Century VP Balanced Class I 1,906,650 1,723,357 American Century VP Inflation Protection Class I 17,675 39,276 American Funds Global Growth Class 2 583,151 534,373 American Funds Growth Class 2 4,174,540 3,746,450 American Funds Growth-Income Class 2 944,335 762,671 American Funds International Class 2 1,027,559 909,459 BlackRock Global Allocation V.I. Class I 48,185 55,166 Delaware VIP Diversified Income Standard Class 44,706 510,406 Delaware VIP High Yield Standard Class 134,166 380,487 Delaware VIP REIT Service Class 2,778,316 2,177,039 Delaware VIP Small Cap Value Service Class 2,157,007 2,027,246 Delaware VIP Smid Cap Growth Service Class 312,117 312,707 Delaware VIP Trend Service Class 176,900 390,537 Dreyfus Opportunistic Small Cap Initial Class 9,730,224 7,238,845 Dreyfus Stock Index Initial Class 6,319,048 7,004,095 DWS VIP Alternative Asset Allocation Plus Class A 4,963 5,599 DWS VIP Equity 500 Index Class A 324,029 300,892 DWS VIP Small Cap Index Class A 514,193 416,630 Fidelity VIP Asset Manager Initial Class 5,646,678 5,349,438 Fidelity VIP Contrafund Service Class 2 3,277,772 2,645,104 Fidelity VIP Equity-Income Initial Class 6,912,566 5,430,836 Fidelity VIP Growth Initial Class 15,598,643 13,831,953 Fidelity VIP Money Market Initial Class -- 38 Janus Aspen Series Worldwide Institutional Class 2,101,697 1,487,333 LVIP Baron Growth Opportunities Service Class 3,170,967 3,399,571 LVIP Cohen & Steers Global Real Estate Standard Class 71,404 75,520 LVIP Delaware Bond Standard Class 13,160 555,399 LVIP Delaware Foundation Aggressive Allocation Standard Class 5,540 6,911 LVIP Delaware Foundation Conservative Allocation Standard Class 98,418 85,848 LVIP Delaware Foundation Moderate Allocation Standard Class 7,614 10,529 LVIP Delaware Growth and Income Standard Class 535,476 472,870 LVIP Delaware Social Awareness Standard Class 1,662,879 1,339,696 LVIP Global Income Standard Class 4,830 9,115 LVIP Janus Capital Appreciation Standard Class 123,484 150,236 LVIP Mondrian International Value Standard Class 411,419 21,645 LVIP SSgA Bond Index Standard Class 516 10,706 LVIP SSgA Emerging Markets 100 Standard Class 135,684 181,203 LVIP SSgA Global Tactical Allocation Standard Class 175,826 140,097 LVIP SSgA International Index Standard Class 7,803 10,950 LVIP T. Rowe Price Structured Mid-Cap Growth Standard Class 4,540,486 4,045,553 LVIP Wilshire 2010 Profile Standard Class 61,871 71,536 LVIP Wilshire 2020 Profile Standard Class 174,844 204,125 LVIP Wilshire 2030 Profile Standard Class 215,675 228,758 LVIP Wilshire 2040 Profile Standard Class 73,027 79,888 LVIP Wilshire Conservative Profile Standard Class 204,711 309,870 LVIP Wilshire Moderate Profile Standard Class 390,835 462,560 LVIP Wilshire Moderately Aggressive Profile Standard Class 490,859 534,441 NB AMT Mid-Cap Growth I Class 1,701,416 1,642,454 NB AMT Partners I Class 1,172,959 770,759 T. Rowe Price International Stock Class I 1,823,793 1,741,165
See accompanying notes. L-5 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT L STATEMENTS OF CHANGES IN NET ASSETS YEARS ENDED DECEMBER 31, 2009 AND 2010
ABVPSF GLOBAL ABVPSF AMERICAN THEMATIC ABVPSF GROWTH AND CENTURY GROWTH GROWTH INCOME VP BALANCED CLASS B CLASS B CLASS B CLASS I SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT ------------------------------------------------------------------------------------------------ NET ASSETS AT JANUARY 1, 2009 $1,709,433 $ 880,928 $ 780,345 $17,309,845 Changes From Operations: - Net investment income (loss) (21,097) (9,382) 22,807 731,685 - Net realized gain (loss) on investments (111,238) (40,969) (84,764) (836,714) - Net change in unrealized appreciation or depreciation on investments 1,035,392 319,437 224,885 2,335,704 ---------- ---------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 903,057 269,086 162,928 2,230,675 Changes From Unit Transactions: - Contract purchases 637,131 153,070 255,415 1,108,037 - Contract withdrawals (663,746) (176,484) (180,495) (3,083,004) ---------- ---------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (26,615) (23,414) 74,920 (1,974,967) ---------- ---------- ---------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 876,442 245,672 237,848 255,708 ---------- ---------- ---------- ----------- NET ASSETS AT DECEMBER 31, 2009 2,585,875 1,126,600 1,018,193 17,565,553 Changes From Operations: - Net investment income (loss) 24,373 (10,337) (9,371) 153,898 - Net realized gain (loss) on investments 24,457 4,998 (127,148) (337,191) - Net change in unrealized appreciation or depreciation on investments 364,366 152,544 227,546 1,906,650 ---------- ---------- ---------- ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 413,196 147,205 91,027 1,723,357 Changes From Unit Transactions: - Contract purchases 212,026 102,507 190,153 767,893 - Contract withdrawals (425,728) (198,850) (397,553) (2,630,825) ---------- ---------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (213,702) (96,343) (207,400) (1,862,932) ---------- ---------- ---------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 199,494 50,862 (116,373) (139,575) ---------- ---------- ---------- ----------- NET ASSETS AT DECEMBER 31, 2010 $2,785,369 $1,177,462 $ 901,820 $17,425,978 ========== ========== ========== ===========
L-6
AMERICAN AMERICAN AMERICAN AMERICAN CENTURY FUNDS AMERICAN FUNDS FUNDS VP INFLATION GLOBAL GROWTH FUNDS GROWTH-INCOME INTERNATIONAL PROTECTION CLASS I CLASS 2 GROWTH CLASS 2 CLASS 2 CLASS 2 SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT -------------------------------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $ -- $ 3,972,915 $17,724,499 $ 6,288,093 $13,474,872 Changes From Operations: - Net investment income (loss) 2,011 20,289 (59,750) 43,216 90,411 - Net realized gain (loss) on investments 313 (391,732) (1,131,334) (497,622) (899,377) - Net change in unrealized appreciation or depreciation on investments 4,803 1,858,004 7,716,345 2,256,494 5,983,851 --------- ----------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 7,127 1,486,561 6,525,261 1,802,088 5,174,885 Changes From Unit Transactions: - Contract purchases 470,107 934,086 3,804,261 1,320,115 2,989,355 - Contract withdrawals (28,456) (1,085,082) (4,088,195) (1,538,257) (3,287,572) --------- ----------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 441,651 (150,996) (283,934) (218,142) (298,217) --------- ----------- ----------- ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 448,778 1,335,565 6,241,327 1,583,946 4,876,668 --------- ----------- ----------- ----------- ----------- NET ASSETS AT DECEMBER 31, 2009 448,778 5,308,480 23,965,826 7,872,039 18,351,540 Changes From Operations: - Net investment income (loss) 7,766 26,424 (62,488) 38,386 164,979 - Net realized gain (loss) on investments 13,835 (75,202) (365,602) (220,050) (283,079) - Net change in unrealized appreciation or depreciation on investments 17,675 583,151 4,174,540 944,335 1,027,559 --------- ----------- ----------- ----------- ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 39,276 534,373 3,746,450 762,671 909,459 Changes From Unit Transactions: - Contract purchases 760,533 997,419 3,289,482 1,266,978 2,061,493 - Contract withdrawals (456,288) (1,274,501) (6,264,578) (1,727,404) (4,451,402) --------- ----------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 304,245 (277,082) (2,975,096) (460,426) (2,389,909) --------- ----------- ----------- ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 343,521 257,291 771,354 302,245 (1,480,450) --------- ----------- ----------- ----------- ----------- NET ASSETS AT DECEMBER 31, 2010 $ 792,299 $ 5,565,771 $24,737,180 $ 8,174,284 $16,871,090 ========= =========== =========== =========== =========== BLACKROCK DELAWARE VIP GLOBAL DIVERSIFIED DELAWARE VIP DELAWARE VIP ALLOCATION V.I. INCOME HIGH YIELD REIT CLASS I STANDARD CLASS STANDARD CLASS SERVICE CLASS SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT --------------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $ -- $ 5,810,708 $1,304,781 $ 8,600,927 Changes From Operations: - Net investment income (loss) 3,846 322,716 113,915 241,085 - Net realized gain (loss) on investments 5 3,547 (46,105) (2,440,589) - Net change in unrealized appreciation or depreciation on investments 2,388 1,156,628 699,933 3,647,675 --------- ----------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 6,239 1,482,891 767,743 1,448,171 Changes From Unit Transactions: - Contract purchases 377,829 1,723,251 1,138,412 1,261,495 - Contract withdrawals (197) (1,640,078) (549,929) (2,329,816) --------- ----------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 377,632 83,173 588,483 (1,068,321) --------- ----------- ---------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 383,871 1,566,064 1,356,226 379,850 --------- ----------- ---------- ----------- NET ASSETS AT DECEMBER 31, 2009 383,871 7,376,772 2,661,007 8,980,777 Changes From Operations: - Net investment income (loss) 4,242 280,061 191,708 154,054 - Net realized gain (loss) on investments 2,739 185,639 54,613 (755,331) - Net change in unrealized appreciation or depreciation on investments 48,185 44,706 134,166 2,778,316 --------- ----------- ---------- ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 55,166 510,406 380,487 2,177,039 Changes From Unit Transactions: - Contract purchases 590,635 1,310,906 993,340 1,598,811 - Contract withdrawals (145,516) (1,842,354) (971,510) (1,925,801) --------- ----------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 445,119 (531,448) 21,830 (326,990) --------- ----------- ---------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 500,285 (21,042) 402,317 1,850,049 --------- ----------- ---------- ----------- NET ASSETS AT DECEMBER 31, 2010 $ 884,156 $ 7,355,730 $3,063,324 $10,830,826 ========= =========== ========== ===========
See accompanying notes. L-7
DELAWARE VIP DELAWARE VIP DREYFUS SMALL CAP SMID CAP DELAWARE VIP OPPORTUNISTIC VALUE GROWTH TREND SMALL CAP SERVICE CLASS SERVICE CLASS SERVICE CLASS INITIAL CLASS SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT ----------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $ 5,464,975 $ -- $ 1,339,330 $23,995,706 Changes From Operations: - Net investment income (loss) (18,207) -- (15,298) 156,849 - Net realized gain (loss) on investments (494,423) -- (146,905) (4,166,822) - Net change in unrealized appreciation or depreciation on investments 2,136,651 -- 859,964 9,180,262 ----------- ---------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 1,624,021 -- 697,761 5,170,289 Changes From Unit Transactions: - Contract purchases 1,178,868 -- 453,441 979,457 - Contract withdrawals (1,321,968) -- (370,561) (3,730,206) ----------- ---------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (143,100) -- 82,880 (2,750,749) ----------- ---------- ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 1,480,921 -- 780,641 2,419,540 ----------- ---------- ----------- ----------- NET ASSETS AT DECEMBER 31, 2009 6,945,896 -- 2,119,971 26,415,246 Changes From Operations: - Net investment income (loss) (38,821) (5,675) (16,218) (59,743) - Net realized gain (loss) on investments (90,940) 6,265 229,855 (2,431,636) - Net change in unrealized appreciation or depreciation on investments 2,157,007 312,117 176,900 9,730,224 ----------- ---------- ----------- ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 2,027,246 312,707 390,537 7,238,845 Changes From Unit Transactions: - Contract purchases 1,700,642 2,588,975 373,843 1,111,241 - Contract withdrawals (1,843,793) (199,442) (2,884,351) (4,263,275) ----------- ---------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (143,151) 2,389,533 (2,510,508) (3,152,034) ----------- ---------- ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 1,884,095 2,702,240 (2,119,971) 4,086,811 ----------- ---------- ----------- ----------- NET ASSETS AT DECEMBER 31, 2010 $ 8,829,991 $2,702,240 $ -- $30,502,057 =========== ========== =========== ===========
L-8
DWS VIP DWS VIP DWS VIP DREYFUS ALTERNATIVE ASSET EQUITY 500 SMALL CAP STOCK INDEX ALLOCATION PLUS INDEX INDEX INITIAL CLASS CLASS A CLASS A CLASS A SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT ---------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $51,067,523 $ -- $1,974,628 $1,555,651 Changes From Operations: - Net investment income (loss) 553,364 (1) 39,158 13,499 - Net realized gain (loss) on investments 1,841,589 -- (148,210) (104,956) - Net change in unrealized appreciation or depreciation on investments 9,024,904 2 637,900 476,981 ----------- ------- ---------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 11,419,857 1 528,848 385,524 Changes From Unit Transactions: - Contract purchases 2,408,454 1,606 579,650 285,104 - Contract withdrawals (8,371,573) -- (591,904) (404,243) ----------- ------- ---------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (5,963,119) 1,606 (12,254) (119,139) ----------- ------- ---------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS 5,456,738 1,607 516,594 266,385 ----------- ------- ---------- ---------- NET ASSETS AT DECEMBER 31, 2009 56,524,261 1,607 2,491,222 1,822,036 Changes From Operations: - Net investment income (loss) 449,994 101 21,062 (975) - Net realized gain (loss) on investments 235,053 535 (44,199) (96,588) - Net change in unrealized appreciation or depreciation on investments 6,319,048 4,963 324,029 514,193 ----------- ------- ---------- ---------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 7,004,095 5,599 300,892 416,630 Changes From Unit Transactions: - Contract purchases 1,981,230 77,811 334,814 320,259 - Contract withdrawals (8,474,973) (1,433) (702,332) (476,310) ----------- ------- ---------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (6,493,743) 76,378 (367,518) (156,051) ----------- ------- ---------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS 510,352 81,977 (66,626) 260,579 ----------- ------- ---------- ---------- NET ASSETS AT DECEMBER 31, 2010 $57,034,613 $83,584 $2,424,596 $2,082,615 =========== ======= ========== ========== FIDELITY VIP FIDELITY VIP CONTRAFUND FIDELITY VIP FIDELITY VIP ASSET MANAGER SERVICE EQUITY-INCOME GROWTH INITIAL CLASS CLASS 2 INITIAL CLASS INITIAL CLASS SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT ---------------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $38,475,274 $13,197,378 $37,627,702 $ 58,726,912 Changes From Operations: - Net investment income (loss) 553,114 33,534 491,577 (319,894) - Net realized gain (loss) on investments (1,799,520) (1,092,445) (3,710,321) (3,853,240) - Net change in unrealized appreciation or depreciation on investments 11,184,773 5,496,557 12,923,548 18,557,650 ----------- ----------- ----------- ------------ NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 9,938,367 4,437,646 9,704,804 14,384,516 Changes From Unit Transactions: - Contract purchases 1,929,635 2,792,110 2,555,205 2,473,089 - Contract withdrawals (6,120,627) (2,720,622) (6,871,845) (9,139,051) ----------- ----------- ----------- ------------ NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (4,190,992) 71,488 (4,316,640) (6,665,962) ----------- ----------- ----------- ------------ TOTAL INCREASE (DECREASE) IN NET ASSETS 5,747,375 4,509,134 5,388,164 7,718,554 ----------- ----------- ----------- ------------ NET ASSETS AT DECEMBER 31, 2009 44,222,649 17,706,512 43,015,866 66,445,466 Changes From Operations: - Net investment income (loss) 284,092 5,929 333,217 (470,035) - Net realized gain (loss) on investments (581,332) (638,597) (1,814,947) (1,296,655) - Net change in unrealized appreciation or depreciation on investments 5,646,678 3,277,772 6,912,566 15,598,643 ----------- ----------- ----------- ------------ NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 5,349,438 2,645,104 5,430,836 13,831,953 Changes From Unit Transactions: - Contract purchases 1,621,980 2,577,051 2,193,538 2,458,181 - Contract withdrawals (7,079,122) (3,595,432) (7,263,079) (10,673,428) ----------- ----------- ----------- ------------ NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (5,457,142) (1,018,381) (5,069,541) (8,215,247) ----------- ----------- ----------- ------------ TOTAL INCREASE (DECREASE) IN NET ASSETS (107,704) 1,626,723 361,295 5,616,706 ----------- ----------- ----------- ------------ NET ASSETS AT DECEMBER 31, 2010 $44,114,945 $19,333,235 $43,377,161 $ 72,062,172 =========== =========== =========== ============
See accompanying notes. L-9
LVIP JANUS ASPEN COHEN & SERIES LVIP BARON STEERS GLOBAL FIDELITY VIP WORLDWIDE GROWTH REAL ESTATE MONEY MARKET INSTITUTIONAL OPPORTUNITIES STANDARD INITIAL CLASS CLASS SERVICE CLASS CLASS SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT ------------------------------------------------------------------------------------------------------------ NET ASSETS AT JANUARY 1, 2009 $ 58,416 $ 9,009,222 $ 11,860,923 $ 87,068 Changes From Operations: - Net investment income (loss) 364 43,086 (123,295) (2,038) - Net realized gain (loss) on investments -- (932,991) (343,328) (2,510) - Net change in unrealized appreciation or depreciation on investments -- 3,921,335 4,503,877 77,329 --------- ----------- ------------ --------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 364 3,031,430 4,037,254 72,781 Changes From Unit Transactions: - Contract purchases 182,249 583,757 1,197,826 332,878 - Contract withdrawals (227,209) (1,382,369) (2,132,978) (129,865) --------- ----------- ------------ --------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (44,960) (798,612) (935,152) 203,013 --------- ----------- ------------ --------- TOTAL INCREASE (DECREASE) IN NET ASSETS (44,596) 2,232,818 3,102,102 275,794 --------- ----------- ------------ --------- NET ASSETS AT DECEMBER 31, 2009 13,820 11,242,040 14,963,025 362,862 Changes From Operations: - Net investment income (loss) 27 (39,926) (145,903) (4,760) - Net realized gain (loss) on investments 11 (574,438) 374,507 8,876 - Net change in unrealized appreciation or depreciation on investments -- 2,101,697 3,170,967 71,404 --------- ----------- ------------ --------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 38 1,487,333 3,399,571 75,520 Changes From Unit Transactions: - Contract purchases 107,402 413,673 1,143,632 297,712 - Contract withdrawals (99,040) (1,650,413) (3,121,407) (104,372) --------- ----------- ------------ --------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 8,362 (1,236,740) (1,977,775) 193,340 --------- ----------- ------------ --------- TOTAL INCREASE (DECREASE) IN NET ASSETS 8,400 250,593 1,421,796 268,860 --------- ----------- ------------ --------- NET ASSETS AT DECEMBER 31, 2010 $ 22,220 $11,492,633 $ 16,384,821 $ 631,722 ========= =========== ============ =========
L-10
LVIP LVIP LVIP DELAWARE DELAWARE DELAWARE LVIP FOUNDATION FOUNDATION FOUNDATION DELAWARE AGGRESSIVE CONSERVATIVE MODERATE BOND ALLOCATION ALLOCATION ALLOCATION STANDARD STANDARD STANDARD STANDARD CLASS CLASS CLASS CLASS SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT ---------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $ 5,865,412 $ -- $ 799,875 $ -- Changes From Operations: - Net investment income (loss) 234,472 194 17,028 -- - Net realized gain (loss) on investments 6,844 4 (66,488) -- - Net change in unrealized appreciation or depreciation on investments 865,613 1,502 219,045 1 ----------- ------- ---------- -------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 1,106,929 1,700 169,585 1 Changes From Unit Transactions: - Contract purchases 2,179,905 19,190 204,405 47 - Contract withdrawals (1,705,884) (63) (204,006) -- ----------- ------- ---------- -------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 474,021 19,127 399 47 ----------- ------- ---------- -------- TOTAL INCREASE (DECREASE) IN NET ASSETS 1,580,950 20,827 169,984 48 ----------- ------- ---------- -------- NET ASSETS AT DECEMBER 31, 2009 7,446,362 20,827 969,859 48 Changes From Operations: - Net investment income (loss) 203,816 1,301 7,125 2,866 - Net realized gain (loss) on investments 338,423 70 (19,695) 49 - Net change in unrealized appreciation or depreciation on investments 13,160 5,540 98,418 7,614 ----------- ------- ---------- -------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 555,399 6,911 85,848 10,529 Changes From Unit Transactions: - Contract purchases 2,471,018 56,475 160,254 145,246 - Contract withdrawals (2,421,399) (943) (198,659) (1,468) ----------- ------- ---------- -------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 49,619 55,532 (38,405) 143,778 ----------- ------- ---------- -------- TOTAL INCREASE (DECREASE) IN NET ASSETS 605,018 62,443 47,443 154,307 ----------- ------- ---------- -------- NET ASSETS AT DECEMBER 31, 2010 $ 8,051,380 $83,270 $1,017,302 $154,355 =========== ======= ========== ======== LVIP DELAWARE LVIP LVIP GROWTH DELAWARE LVIP JANUS AND SOCIAL GLOBAL CAPITAL INCOME AWARENESS INCOME APPRECIATION STANDARD STANDARD STANDARD STANDARD CLASS CLASS CLASS CLASS SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT -------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $4,008,978 $12,023,926 $ -- $1,310,114 Changes From Operations: - Net investment income (loss) 5,134 (34,544) 972 (1,742) - Net realized gain (loss) on investments (293,683) 31,175 (1) (75,460) - Net change in unrealized appreciation or depreciation on investments 1,108,916 3,230,382 (1,973) 505,666 ---------- ----------- -------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 820,367 3,227,013 (1,002) 428,464 Changes From Unit Transactions: - Contract purchases 432,903 779,973 67,638 293,255 - Contract withdrawals (896,128) (2,020,163) (75) (443,304) ---------- ----------- -------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (463,225) (1,240,190) 67,563 (150,049) ---------- ----------- -------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS 357,142 1,986,823 66,561 278,415 ---------- ----------- -------- ---------- NET ASSETS AT DECEMBER 31, 2009 4,366,120 14,010,749 66,561 1,588,529 Changes From Operations: - Net investment income (loss) (3,002) (51,271) 2,165 (3,815) - Net realized gain (loss) on investments (59,604) (271,912) 2,120 30,567 - Net change in unrealized appreciation or depreciation on investments 535,476 1,662,879 4,830 123,484 ---------- ----------- -------- ---------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 472,870 1,339,696 9,115 150,236 Changes From Unit Transactions: - Contract purchases 361,120 627,947 139,249 224,415 - Contract withdrawals (945,554) (1,938,169) (67,466) (371,704) ---------- ----------- -------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (584,434) (1,310,222) 71,783 (147,289) ---------- ----------- -------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS (111,564) 29,474 80,898 2,947 ---------- ----------- -------- ---------- NET ASSETS AT DECEMBER 31, 2010 $4,254,556 $14,040,223 $147,459 $1,591,476 ========== =========== ======== ==========
See accompanying notes. L-11
LVIP LVIP LVIP SSgA MONDRIAN SSgA LVIP SSgA GLOBAL INTERNATIONAL BOND EMERGING TACTICAL VALUE INDEX MARKETS ALLOCATION STANDARD STANDARD 100 STANDARD STANDARD CLASS CLASS CLASS CLASS SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT ----------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $ 6,132,921 $ -- $ -- $1,645,101 Changes From Operations: - Net investment income (loss) 129,924 1,173 4,491 87,708 - Net realized gain (loss) on investments (788,221) (76) 16,125 (252,571) - Net change in unrealized appreciation or depreciation on investments 1,668,085 (2,094) 47,252 520,014 ----------- --------- ---------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 1,009,788 (997) 67,868 355,151 Changes From Unit Transactions: - Contract purchases 857,569 142,038 723,423 472,139 - Contract withdrawals (1,776,598) (36,994) (216,811) (721,905) ----------- --------- ---------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (919,029) 105,044 506,612 (249,766) ----------- --------- ---------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS 90,759 104,047 574,480 105,385 ----------- --------- ---------- ---------- NET ASSETS AT DECEMBER 31, 2009 6,223,680 104,047 574,480 1,750,486 Changes From Operations: - Net investment income (loss) 115,845 6,005 5,903 1,080 - Net realized gain (loss) on investments (505,619) 4,185 39,616 (36,809) - Net change in unrealized appreciation or depreciation on investments 411,419 516 135,684 175,826 ----------- --------- ---------- ---------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 21,645 10,706 181,203 140,097 Changes From Unit Transactions: - Contract purchases 533,620 583,676 1,197,242 370,008 - Contract withdrawals (1,709,235) (212,789) (609,409) (322,479) ----------- --------- ---------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS (1,175,615) 370,887 587,833 47,529 ----------- --------- ---------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS (1,153,970) 381,593 769,036 187,626 ----------- --------- ---------- ---------- NET ASSETS AT DECEMBER 31, 2010 $ 5,069,710 $ 485,640 $1,343,516 $1,938,112 =========== ========= ========== ==========
L-12
LVIP T. ROWE PRICE LVIP LVIP LVIP SSgA STRUCTURED WILSHIRE WILSHIRE INTERNATIONAL MID-CAP 2010 2020 INDEX GROWTH PROFILE PROFILE STANDARD STANDARD STANDARD STANDARD CLASS CLASS CLASS CLASS SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT ----------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $ -- $12,193,479 $ 435,193 $ 919,581 Changes From Operations: - Net investment income (loss) 540 (120,152) 5,413 9,728 - Net realized gain (loss) on investments 15 (1,037,111) (23,989) (40,767) - Net change in unrealized appreciation or depreciation on investments 824 6,235,684 116,607 270,293 -------- ----------- --------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 1,379 5,078,421 98,031 239,254 Changes From Unit Transactions: - Contract purchases 58,943 939,416 416,641 519,396 - Contract withdrawals (331) (1,960,413) (230,825) (330,202) -------- ----------- --------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 58,612 (1,020,997) 185,816 189,194 -------- ----------- --------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS 59,991 4,057,424 283,847 428,448 -------- ----------- --------- ---------- NET ASSETS AT DECEMBER 31, 2009 59,991 16,250,903 719,040 1,348,029 Changes From Operations: - Net investment income (loss) 448 (162,468) 1,327 127 - Net realized gain (loss) on investments 2,699 (332,465) 8,338 29,154 - Net change in unrealized appreciation or depreciation on investments 7,803 4,540,486 61,871 174,844 -------- ----------- --------- ---------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 10,950 4,045,553 71,536 204,125 Changes From Unit Transactions: - Contract purchases 90,080 954,600 197,252 1,236,699 - Contract withdrawals (49,346) (2,830,490) (155,119) (550,425) -------- ----------- --------- ---------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 40,734 (1,875,890) 42,133 686,274 -------- ----------- --------- ---------- TOTAL INCREASE (DECREASE) IN NET ASSETS 51,684 2,169,663 113,669 890,399 -------- ----------- --------- ---------- NET ASSETS AT DECEMBER 31, 2010 $111,675 $18,420,566 $ 832,709 $2,238,428 ======== =========== ========= ========== LVIP LVIP LVIP LVIP WILSHIRE WILSHIRE WILSHIRE WILSHIRE 2030 2040 CONSERVATIVE MODERATE PROFILE PROFILE PROFILE PROFILE STANDARD STANDARD STANDARD STANDARD CLASS CLASS CLASS CLASS SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT -------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $ 504,196 $ 242,878 $2,543,244 $ 4,005,220 Changes From Operations: - Net investment income (loss) 11,560 1,758 89,020 125,031 - Net realized gain (loss) on investments 4,606 (4,726) (66,126) (278,934) - Net change in unrealized appreciation or depreciation on investments 267,185 108,154 569,085 1,002,457 ---------- --------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 283,351 105,186 591,979 848,554 Changes From Unit Transactions: - Contract purchases 923,723 250,418 729,155 915,065 - Contract withdrawals (95,443) (80,784) (680,833) (1,390,739) ---------- --------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 828,280 169,634 48,322 (475,674) ---------- --------- ---------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 1,111,631 274,820 640,301 372,880 ---------- --------- ---------- ----------- NET ASSETS AT DECEMBER 31, 2009 1,615,827 517,698 3,183,545 4,378,100 Changes From Operations: - Net investment income (loss) (1,763) (323) 93,574 88,386 - Net realized gain (loss) on investments 14,846 7,184 11,585 (16,661) - Net change in unrealized appreciation or depreciation on investments 215,675 73,027 204,711 390,835 ---------- --------- ---------- ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 228,758 79,888 309,870 462,560 Changes From Unit Transactions: - Contract purchases 610,139 294,129 541,376 834,099 - Contract withdrawals (165,961) (103,290) (312,970) (795,609) ---------- --------- ---------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 444,178 190,839 228,406 38,490 ---------- --------- ---------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 672,936 270,727 538,276 501,050 ---------- --------- ---------- ----------- NET ASSETS AT DECEMBER 31, 2010 $2,288,763 $ 788,425 $3,721,821 $ 4,879,150 ========== ========= ========== ===========
See accompanying notes. L-13
LVIP WILSHIRE MODERATELY AGGRESSIVE NB AMT T. ROWE PRICE PROFILE MID-CAP NB AMT INTERNATIONAL STANDARD GROWTH I PARTNERS I STOCK CLASS CLASS CLASS CLASS I SUBACCOUNT SUBACCOUNT SUBACCOUNT SUBACCOUNT ---------------------------------------------------------------------------------------------------- NET ASSETS AT JANUARY 1, 2009 $3,230,340 $ 5,224,044 $ 4,271,182 $10,481,445 Changes From Operations: - Net investment income (loss) 135,552 (54,344) 81,762 209,299 - Net realized gain (loss) on investments (94,399) (301,034) (278,459) (614,204) - Net change in unrealized appreciation or depreciation on investments 870,477 1,870,190 2,286,806 5,479,092 ---------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM OPERATIONS 911,630 1,514,812 2,090,109 5,074,187 Changes From Unit Transactions: - Contract purchases 1,051,788 969,258 783,347 1,000,364 - Contract withdrawals (656,340) (1,236,986) (1,151,090) (1,925,762) ---------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 395,448 (267,728) (367,743) (925,398) ---------- ----------- ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 1,307,078 1,247,084 1,722,366 4,148,789 ---------- ----------- ----------- ----------- NET ASSETS AT DECEMBER 31, 2009 4,537,418 6,471,128 5,993,548 14,630,234 Changes From Operations: - Net investment income (loss) 88,996 (64,189) (18,909) (12,911) - Net realized gain (loss) on investments (45,414) 5,227 (383,291) (69,717) - Net change in unrealized appreciation or depreciation on investments 490,859 1,701,416 1,172,959 1,823,793 ---------- ----------- ----------- ----------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS 534,441 1,642,454 770,759 1,741,165 Changes From Unit Transactions: - Contract purchases 888,949 828,037 562,234 641,710 - Contract withdrawals (759,093) (1,537,553) (1,276,180) (2,503,672) ---------- ----------- ----------- ----------- NET INCREASE (DECREASE) IN NET ASSETS RESULTING FROM UNIT TRANSACTIONS 129,856 (709,516) (713,946) (1,861,962) ---------- ----------- ----------- ----------- TOTAL INCREASE (DECREASE) IN NET ASSETS 664,297 932,938 56,813 (120,797) ---------- ----------- ----------- ----------- NET ASSETS AT DECEMBER 31, 2010 $5,201,715 $ 7,404,066 $ 6,050,361 $14,509,437 ========== =========== =========== ===========
See accompanying notes. L-14 LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT L NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2010 1. ACCOUNTING POLICIES AND VARIABLE ACCOUNT INFORMATION THE VARIABLE ACCOUNT: Lincoln National Variable Annuity Account L (the Variable Account) is a segregated investment account of The Lincoln National Life Insurance Company (the Company) and is registered as a unit investment trust with the Securities and Exchange Commission under the Investment Company Act of 1940, as amended. The operations of the Variable Account, which commenced on September 26, 1996, are part of the operations of the Company. The Variable Account offers only one product (Group Variable Annuity) at two fee rates. 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 support the annuity contracts and may not be used to satisfy liabilities arising from any other business of the Company. BASIS OF PRESENTATION: The accompanying financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for unit investment trusts. ACCOUNTING ESTIMATES: The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions affecting the reported amounts as of the date of the financial statements. Those estimates are inherently subject to change and actual results could differ from those estimates. Included among the material (or potentially material) reported amounts that require use of estimates is the fair value of certain assets. INVESTMENTS: The assets of the Variable Account are divided into variable subaccounts, each of which may be invested in shares of one of fifty-two mutual funds (the Funds) of twelve diversified, open-ended management investment companies, each Fund with its own investment objective. The Funds are: AllianceBernstein Variable Products Series Fund, Inc. (ABVPSF): ABVPSF Global Thematic Growth 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 Class I Portfolio American Century VP Inflation Protection Class I 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 BlackRock Variable Series Funds, Inc. (BlackRock): BlackRock Global Allocation V.I. Class I Fund Delaware VIP Trust (Delaware VIP): Delaware VIP Diversified Income Standard Class Series Delaware VIP High Yield Standard Class Series Delaware VIP REIT Service Class Series Delaware VIP Small Cap Value Service Class Series Delaware VIP Smid Cap Growth Service Class Series Dreyfus Variable Investment Fund (Dreyfus): Dreyfus Opportunistic Small Cap Initial Class Portfolio Dreyfus Stock Index Initial Class Fund DWS Scudder VIP Funds (DWS VIP): DWS VIP Alternative Asset Allocation Plus Class A Fund DWS VIP Equity 500 Index Class A Fund DWS VIP Small Cap Index Class A Fund Fidelity Variable Insurance Products Fund (Fidelity VIP): Fidelity VIP Asset Manager Initial Class Portfolio Fidelity VIP Contrafund Service Class 2 Portfolio Fidelity VIP Equity-Income Initial Class Portfolio Fidelity VIP Growth Initial Class Portfolio Fidelity VIP Money Market Initial Class Portfolio Janus Aspen Series: Janus Aspen Series Worldwide Institutional Class Portfolio Lincoln Variable Insurance Products Trust (LVIP)*: LVIP Baron Growth Opportunities Service Class Fund LVIP Cohen & Steers Global Real Estate Standard Class Fund LVIP Delaware Bond Standard Class Fund LVIP Delaware Foundation Aggressive Allocation Standard Class Fund LVIP Delaware Foundation Conservative Allocation Standard Class Fund LVIP Delaware Foundation Moderate Allocation Standard Class Fund LVIP Delaware Growth and Income Standard Class Fund LVIP Delaware Social Awareness Standard Class Fund LVIP Global Income Standard Class Fund LVIP Janus Capital Appreciation Standard Class Fund LVIP Mondrian International Value Standard Class Fund LVIP SSgA Bond Index Standard Class Fund LVIP SSgA Emerging Markets 100 Standard Class Fund LVIP SSgA Global Tactical Allocation Standard Class Fund LVIP SSgA International Index Standard Class Fund LVIP T. Rowe Price Structured Mid-Cap Growth Standard Class Fund LVIP Wilshire 2010 Profile Standard Class Fund LVIP Wilshire 2020 Profile Standard Class Fund LVIP Wilshire 2030 Profile Standard Class Fund LVIP Wilshire 2040 Profile Standard Class Fund L-15 LVIP Wilshire Conservative Profile Standard Class Fund LVIP Wilshire Moderate Profile Standard Class Fund LVIP Wilshire Moderately Aggressive Profile Standard Class Fund Neuberger Berman Advisors Management Trust (NB AMT): NB AMT Mid-Cap Growth I Class Fund NB AMT Partners I Class Fund T. Rowe Price International Series, Inc. (T. Rowe Price): T. Rowe Price International Stock Class I Portfolio * Denotes an affiliate of The Lincoln National Life Insurance Company. As of December 31, 2009, Delaware VIP Trust was an affiliate of the Company. On January 4, 2010, Lincoln National Corporation (the parent of the Company) sold Delaware Management Holdings Inc. and its subsidiaries, including Delaware Management Company, which is the investment advisor for the Delaware VIP Trust funds. 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 fair value as determined by the closing net asset value per share on December 31, 2010. The difference between cost and net asset value is reflected as unrealized appreciation or depreciation of investments. The Variable Account's investments in the Funds are valued in accordance with the Fair Value Measurements and Disclosure Topic of the Financial Accounting Standards Board Accounting Standards Codification (Topic). The Topic defines fair value as the price that the Variable Account would receive to sell an asset or pay to transfer a liability in an orderly transaction between market participants at the measurement date. The Topic also establishes a framework for measuring fair value and a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability. Inputs may be observable or unobservable and refer broadly to the assumptions that market participants would use in pricing the asset or liability. Observable inputs reflect the assumptions market participants would use in pricing the asset or liability based on market data obtained from sources independent of the reporting entity. Unobservable inputs reflect the reporting entity's own assessment regarding the assumptions market participants would use in pricing the asset or liability and are developed based on the best information available in the circumstances. The Variable Account's investments in the Funds are assigned a level based upon the observability of the inputs which are significant to the overall valuation. The three-tier hierarchy of inputs is summarized below. Level 1 - inputs to the valuation methodology are quoted prices in active markets Level 2 - inputs to the valuation methodology are observable, directly or indirectly Level 3 - inputs to the valuation methodology are unobservable and reflect assumptions on the part of the reporting entity The Variable Account's investments in the Funds are valued within the fair value hierarchy as Level 2. Net asset value is quoted by the Funds as derived by the fair value of the Funds' underlying investments. The Funds are not considered Level 1 as they are not traded in the open market; rather the Company sells and redeems shares at net asset value with the Funds. 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 or receivable with respect to the Variable Account's net investment income and the net realized gain (loss) on investments. INVESTMENT FUND CHANGES: During 2009, the American Century VP Inflation Protection Class I Portfolio, the BlackRock Global Allocation V.I. Class I Fund, the DWS VIP Alternative Asset Allocation Plus Class A Fund, the LVIP Delaware Foundation Moderate Allocation Standard Class Fund, the LVIP Global Income Standard Class Fund, the LVIP SSgA Bond Index Standard Class Fund, the SSgA Emerging Markets 100 Standard Class Fund and the LVIP SSgA International Index Standard Class Fund became available as investment options for account contract owners. Accordingly, the 2009 statements of changes in net assets and total return and investment income ratios in note 3 for these subaccounts L-16 are for the period from the commencement of operations to December 31, 2009. During 2009, the LVIP UBS Global Asset Allocation Standard Class Fund merged into the LVIP Delaware Foundation Aggressive Allocation Standard Class Fund and the LVIP Delaware Managed Standard Class Fund merged into the LVIP Delaware Foundation Conservative Allocation Standard Class Fund. During 2009, the ABVPSF Global Technology Class B Fund changed its name to the ABVPSF Global Thematic Growth Class B Fund and the Janus Aspen Series Worldwide Growth Institutional Class Portfolio changed its name to the Janus Aspen Series Worldwide Institutional Class Portfolio. During 2010, the Dreyfus Developing Leaders Institutional Class Portfolio changed its name to the Dreyfus Opportunistic Small Cap Initial Class Portfolio and the LVIP Wilshire Aggressive Profile Standard Class Fund changed its name to the LVIP SSgA Global Tactical Allocation Standard Class Fund. Also during 2010, the Delaware VIP Trend Service Class Series merged into the Delaware VIP Smid Cap Growth Service Class Series. 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. 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, 2010, 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 THEMATIC GROWTH CLASS B 2010 0.75% 1.00% $ 5.41 $ 5.55 514,709 $ 2,785,369 17.40% 17.70% 1.97% 2009 0.75% 1.00% 4.60 4.71 560,973 2,585,875 51.62% 52.00% 0.00% 2008 0.75% 1.00% 3.04 3.10 562,350 1,709,433 -47.99% -47.86% 0.00% 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% ABVPSF GROWTH CLASS B 2010 0.75% 1.00% 7.27 7.46 161,724 1,177,462 13.65% 13.94% 0.05% 2009 0.75% 1.00% 6.40 6.55 175,880 1,126,600 31.55% 31.87% 0.00% 2008 0.75% 1.00% 4.86 4.96 180,984 880,928 -43.17% -43.03% 0.00% 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% ABVPSF GROWTH AND INCOME CLASS B 2010 0.75% 1.00% 10.84 11.02 83,141 901,820 11.68% 11.96% 0.00% 2009 0.75% 1.00% 9.70 9.84 104,851 1,018,193 19.15% 19.45% 3.60% 2008 0.75% 1.00% 8.14 8.24 95,769 780,345 -41.25% -41.14% 1.77% 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% AMERICAN CENTURY VP BALANCED CLASS I 2010 0.75% 1.00% 28.66 29.49 606,823 17,425,978 10.53% 10.80% 1.88% 2009 0.75% 1.00% 25.93 26.62 675,956 17,565,553 14.33% 14.62% 5.35% 2008 0.75% 1.00% 22.68 23.22 761,745 17,309,845 -21.12% -20.93% 2.68% 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% AMERICAN CENTURY VP INFLATION PROTECTION CLASS I 2010 0.75% 1.00% 11.07 11.11 71,574 792,299 4.32% 4.58% 1.85% 2009 7/27/2009 0.75% 1.00% 10.61 10.63 42,292 448,778 1.33% 5.45% 1.26%
L-17
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) --------------------------------------------------------------------------------------------------------------------------------- AMERICAN FUNDS GLOBAL GROWTH CLASS 2 2010 0.75% 1.00% $16.46 $16.74 337,607 $ 5,565,771 10.63% 10.91% 1.50% 2009 0.75% 1.00% 14.88 15.09 356,289 5,308,480 40.89% 41.24% 1.45% 2008 0.75% 1.00% 10.56 10.69 375,792 3,972,915 -39.00% -38.85% 1.80% 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% AMERICAN FUNDS GROWTH CLASS 2 2010 0.75% 1.00% 10.33 10.59 2,391,020 24,737,180 17.50% 17.79% 0.70% 2009 0.75% 1.00% 8.79 8.99 2,719,762 23,965,826 38.02% 38.37% 0.67% 2008 0.75% 1.00% 6.37 6.50 2,778,102 17,724,499 -44.53% -44.39% 0.79% 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% AMERICAN FUNDS GROWTH-INCOME CLASS 2 2010 0.75% 1.00% 12.03 12.23 678,662 8,174,284 10.32% 10.59% 1.49% 2009 0.75% 1.00% 10.91 11.06 721,001 7,872,039 29.94% 30.26% 1.63% 2008 0.75% 1.00% 8.40 8.49 748,494 6,288,093 -38.47% -38.31% 1.68% 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% AMERICAN FUNDS INTERNATIONAL CLASS 2 2010 0.75% 1.00% 13.13 13.47 1,283,685 16,871,090 6.17% 6.43% 1.98% 2009 0.75% 1.00% 12.37 12.66 1,482,031 18,351,540 41.65% 42.00% 1.59% 2008 0.75% 1.00% 8.73 8.91 1,541,742 13,474,872 -42.70% -42.56% 1.88% 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% BLACKROCK GLOBAL ALLOCATION V.I. CLASS I 2010 0.75% 1.00% 12.42 12.47 71,179 884,156 8.96% 9.24% 1.74% 2009 7/20/2009 0.75% 1.00% 11.40 11.42 33,672 383,871 0.67% 11.50% 4.12% DELAWARE VIP DIVERSIFIED INCOME STANDARD CLASS 2010 0.75% 1.00% 15.60 15.85 471,338 7,355,730 6.98% 7.25% 4.69% 2009 0.75% 1.00% 14.58 14.78 505,506 7,376,772 25.70% 26.01% 5.96% 2008 0.75% 1.00% 11.60 11.73 500,660 5,810,708 -5.49% -5.26% 3.55% 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% DELAWARE VIP HIGH YIELD STANDARD CLASS 2010 0.75% 1.00% 14.71 14.92 208,040 3,063,324 14.17% 14.46% 7.66% 2009 0.75% 1.00% 12.89 13.04 206,221 2,661,007 47.49% 47.86% 6.59% 2008 0.75% 1.00% 8.74 8.82 149,172 1,304,781 -24.93% -24.74% 8.49% 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% DELAWARE VIP REIT SERVICE CLASS 2010 0.75% 1.00% 23.30 23.90 464,315 10,830,826 25.35% 25.66% 2.57% 2009 0.75% 1.00% 18.59 19.02 482,547 8,980,777 22.01% 22.32% 4.24% 2008 0.75% 1.00% 15.24 15.55 563,961 8,600,927 -35.93% -35.77% 2.06% 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% DELAWARE VIP SMALL CAP VALUE SERVICE CLASS 2010 0.75% 1.00% 16.32 16.59 540,575 8,829,991 30.60% 30.93% 0.46% 2009 0.75% 1.00% 12.50 12.67 555,313 6,945,896 30.25% 30.58% 0.66% 2008 0.75% 1.00% 9.59 9.70 569,271 5,464,975 -30.76% -30.59% 0.48% 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% DELAWARE VIP SMID CAP GROWTH SERVICE CLASS 2010 10/8/2010 0.75% 1.00% 10.11 10.38 266,490 2,702,240 13.45% 13.51% 0.00%
L-18
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 VIP TREND SERVICE CLASS 2009 0.75% 1.00% $ 7.47 $7.65 282,506 $ 2,119,971 52.84% 53.22% 0.00% 2008 0.75% 1.00% 4.89 4.99 273,105 1,339,330 -47.39% -47.26% 0.00% 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% DREYFUS OPPORTUNISTIC SMALL CAP INITIAL CLASS 2010 0.75% 1.00% 23.39 24.08 1,301,328 30,502,057 29.85% 30.17% 0.76% 2009 0.75% 1.00% 18.02 18.50 1,463,419 26,415,246 24.78% 25.10% 1.66% 2008 0.75% 1.00% 14.44 14.79 1,659,181 23,995,706 -38.21% -38.06% 0.92% 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% DREYFUS STOCK INDEX INITIAL CLASS 2010 0.75% 1.00% 41.29 42.50 1,378,411 57,034,613 13.70% 13.98% 1.80% 2009 0.75% 1.00% 36.32 37.28 1,553,211 56,524,261 25.08% 25.39% 2.08% 2008 0.75% 1.00% 29.04 29.73 1,755,524 51,067,523 -37.77% -37.61% 2.08% 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% DWS VIP ALTERNATIVE ASSET ALLOCATION PLUS CLASS A 2010 1.00% 1.00% 12.52 12.52 6,674 83,584 11.35% 11.35% 1.19% 2009 11/16/2009 1.00% 1.00% 11.25 11.25 143 1,607 -0.89% -0.89% 0.00% DWS VIP EQUITY 500 INDEX CLASS A 2010 0.75% 1.00% 12.12 12.32 199,957 2,424,596 13.56% 13.85% 1.91% 2009 0.75% 1.00% 10.67 10.82 233,308 2,491,222 25.07% 25.38% 2.84% 2008 0.75% 1.00% 8.53 8.63 231,326 1,974,628 -37.78% -37.62% 2.23% 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% DWS VIP SMALL CAP INDEX CLASS A 2010 0.75% 1.00% 14.06 14.29 147,905 2,082,615 25.14% 25.45% 0.92% 2009 0.75% 1.00% 11.24 11.39 161,946 1,822,036 25.31% 25.63% 1.83% 2008 0.75% 1.00% 8.97 9.07 173,355 1,555,651 -34.78% -34.62% 1.58% 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% FIDELITY VIP ASSET MANAGER INITIAL CLASS 2010 0.75% 1.00% 32.79 33.74 1,343,770 44,114,945 13.13% 13.41% 1.64% 2009 0.75% 1.00% 28.98 29.75 1,523,997 44,222,649 27.83% 28.15% 2.36% 2008 0.75% 1.00% 22.67 23.22 1,695,153 38,475,274 -29.43% -29.25% 2.54% 2007 0.75% 1.00% 32.13 32.82 1,878,514 60,409,613 14.35% 14.64% 6.09% 2006 0.75% 1.00% 28.09 28.62 2,143,508 60,256,845 6.25% 6.52% 2.74% FIDELITY VIP CONTRAFUND SERVICE CLASS 2 2010 0.75% 1.00% 13.77 14.13 1,402,304 19,333,235 15.76% 16.05% 1.02% 2009 0.75% 1.00% 11.89 12.17 1,486,546 17,706,512 34.12% 34.46% 1.21% 2008 0.75% 1.00% 8.87 9.05 1,486,186 13,197,378 -43.26% -43.12% 0.80% 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% FIDELITY VIP EQUITY-INCOME INITIAL CLASS 2010 0.75% 1.00% 28.78 29.62 1,503,500 43,377,161 14.00% 14.29% 1.77% 2009 0.75% 1.00% 25.25 25.92 1,699,575 43,015,866 28.91% 29.24% 2.28% 2008 0.75% 1.00% 19.59 20.06 1,917,427 37,627,702 -43.23% -43.08% 2.36% 2007 0.75% 1.00% 34.50 35.24 2,311,317 79,873,441 0.52% 0.77% 1.73% 2006 0.75% 1.00% 34.32 34.97 2,570,626 88,275,724 19.00% 19.30% 3.37% FIDELITY VIP GROWTH INITIAL CLASS 2010 0.75% 1.00% 40.54 41.72 1,774,948 72,062,172 22.94% 23.25% 0.27% 2009 0.75% 1.00% 32.97 33.85 2,011,962 66,445,466 27.01% 27.33% 0.44% 2008 0.75% 1.00% 25.96 26.58 2,259,073 58,726,912 -47.69% -47.56% 0.77% 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%
L-19
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 MONEY MARKET INITIAL CLASS 2010 0.00% 0.00% $17.96 $17.96 1,237 $ 22,220 0.24% 0.24% 0.18% 2009 0.00% 0.00% 17.92 17.92 771 13,820 0.72% 0.72% 0.96% 2008 0.00% 0.00% 17.79 17.82 3,284 58,416 3.02% 3.02% 3.49% 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% JANUS ASPEN SERIES WORLDWIDE INSTITUTIONAL CLASS 2010 0.75% 1.00% 14.00 14.41 819,249 11,492,633 14.68% 14.97% 0.61% 2009 0.75% 1.00% 12.21 12.53 918,814 11,242,040 36.33% 36.67% 1.42% 2008 0.75% 1.00% 8.95 9.17 1,004,075 9,009,222 -45.21% -45.08% 1.19% 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% LVIP BARON GROWTH OPPORTUNITIES SERVICE CLASS 2010 0.75% 1.00% 32.07 33.01 509,670 16,384,821 25.13% 25.44% 0.00% 2009 0.75% 1.00% 25.63 26.32 582,238 14,963,025 36.95% 37.29% 0.00% 2008 0.75% 1.00% 18.72 19.17 632,290 11,860,923 -39.74% -39.59% 0.00% 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% LVIP COHEN & STEERS GLOBAL REAL ESTATE STANDARD CLASS 2010 0.75% 1.00% 7.56 7.63 83,533 631,722 16.80% 17.10% 0.00% 2009 0.75% 1.00% 6.47 6.51 56,051 362,862 36.46% 36.80% 0.00% 2008 0.75% 1.00% 4.74 4.76 18,355 87,068 -42.61% -42.47% 2.01% 2007 6/4/2007 0.75% 1.00% 8.26 8.28 4,553 37,628 -18.10% -7.47% 1.28% LVIP DELAWARE BOND STANDARD CLASS 2010 0.75% 1.00% 14.10 14.34 570,500 8,051,380 7.41% 7.68% 3.56% 2009 0.75% 1.00% 13.13 13.31 566,723 7,446,362 17.72% 18.01% 4.44% 2008 0.75% 1.00% 11.15 11.28 525,501 5,865,412 -3.89% -3.65% 5.13% 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% LVIP DELAWARE FOUNDATION AGGRESSIVE ALLOCATION STANDARD CLASS 2010 0.75% 1.00% 13.35 13.40 6,233 83,270 11.36% 11.64% 3.52% 2009 7/14/2009 0.75% 1.00% 11.99 12.00 1,736 20,827 13.90% 21.57% 1.74% LVIP DELAWARE FOUNDATION CONSERVATIVE ALLOCATION STANDARD CLASS 2010 0.75% 1.00% 12.42 12.63 81,634 1,017,302 9.33% 9.61% 1.70% 2009 0.75% 1.00% 11.36 11.52 85,146 969,859 21.62% 21.93% 3.00% 2008 0.75% 1.00% 9.34 9.45 85,416 799,875 -27.68% -27.50% 2.39% 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% LVIP DELAWARE FOUNDATION MODERATE ALLOCATION STANDARD CLASS 2010 1.00% 1.00% 12.97 12.97 11,901 154,355 9.91% 9.91% 6.12% 2009 8/28/2009 1.00% 1.00% 11.80 11.80 4 48 8.15% 8.15% 0.00% LVIP DELAWARE GROWTH AND INCOME STANDARD CLASS 2010 0.75% 1.00% 9.37 9.61 453,326 4,254,556 11.81% 12.09% 0.91% 2009 0.75% 1.00% 8.38 8.58 520,227 4,366,120 23.44% 23.75% 1.12% 2008 0.75% 1.00% 6.79 6.93 589,773 4,008,978 -36.41% -36.25% 1.28% 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% LVIP DELAWARE SOCIAL AWARENESS STANDARD CLASS 2010 0.75% 1.00% 15.49 15.95 904,374 14,040,223 10.46% 10.74% 0.60% 2009 0.75% 1.00% 14.03 14.40 996,878 14,010,749 28.71% 29.03% 0.70% 2008 0.75% 1.00% 10.90 11.16 1,101,328 12,023,926 -35.06% -34.90% 0.88% 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% LVIP GLOBAL INCOME STANDARD CLASS 2010 1.00% 1.00% 11.73 11.73 12,568 147,459 8.59% 8.59% 2.85% 2009 7/15/2009 1.00% 1.00% 10.80 10.80 6,160 66,561 5.35% 5.35% 3.68%
L-20
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) --------------------------------------------------------------------------------------------------------------------------------- LVIP JANUS CAPITAL APPRECIATION STANDARD CLASS 2010 0.75% 1.00% $ 7.07 $ 7.26 224,617 $ 1,591,476 10.24% 10.51% 0.73% 2009 0.75% 1.00% 6.42 6.57 247,111 1,588,529 37.15% 37.49% 0.85% 2008 0.75% 1.00% 4.68 4.78 279,582 1,310,114 -41.41% -41.26% 0.66% 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% LVIP MONDRIAN INTERNATIONAL VALUE STANDARD CLASS 2010 0.75% 1.00% 14.81 15.06 341,663 5,069,710 1.44% 1.70% 3.11% 2009 0.75% 1.00% 14.60 14.81 425,403 6,223,680 20.03% 20.33% 3.27% 2008 0.75% 1.00% 12.17 12.31 503,462 6,132,921 -37.29% -37.13% 4.48% 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% LVIP SSgA BOND INDEX STANDARD CLASS 2010 0.75% 1.00% 10.89 10.94 44,556 485,640 4.91% 5.17% 2.71% 2009 7/6/2009 0.75% 1.00% 10.38 10.40 10,015 104,047 -0.52% 2.61% 3.50% LVIP SSgA EMERGING MARKETS 100 STANDARD CLASS 2010 0.75% 1.00% 17.25 17.32 77,860 1,343,516 26.50% 26.82% 1.71% 2009 6/29/2009 0.75% 1.00% 13.64 13.66 42,116 574,480 21.46% 35.70% 1.67% LVIP SSgA GLOBAL TACTICAL ALLOCATION STANDARD CLASS 2010 0.75% 1.00% 11.40 11.56 169,896 1,938,112 7.65% 7.92% 1.05% 2009 0.75% 1.00% 10.59 10.71 165,203 1,750,486 29.50% 29.82% 6.69% 2008 0.75% 1.00% 8.18 8.25 201,111 1,645,101 -41.05% -40.90% 0.64% 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% LVIP SSgA INTERNATIONAL INDEX STANDARD CLASS 2010 1.00% 1.00% 12.84 12.84 8,697 111,675 5.98% 5.98% 1.50% 2009 7/16/2009 1.00% 1.00% 12.12 12.12 4,951 59,991 19.49% 19.49% 2.53% LVIP T. ROWE PRICE STRUCTURED MID-CAP GROWTH STANDARD CLASS 2010 0.75% 1.00% 15.74 16.20 1,167,911 18,420,566 27.09% 27.41% 0.00% 2009 0.75% 1.00% 12.39 12.71 1,309,307 16,250,903 44.89% 45.25% 0.10% 2008 0.75% 1.00% 8.55 8.75 1,423,681 12,193,479 -43.35% -43.20% 0.00% 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% LVIP WILSHIRE 2010 PROFILE STANDARD CLASS 2010 0.75% 1.00% 10.74 10.84 77,423 832,709 10.36% 10.63% 1.15% 2009 0.75% 1.00% 9.74 9.80 73,801 719,040 23.16% 23.47% 2.10% 2008 0.75% 1.00% 7.90 7.94 55,025 435,193 -24.67% -24.48% 3.42% 2007 6/5/2007 0.75% 1.00% 10.49 10.51 4,819 50,563 0.46% 4.95% 0.45% LVIP WILSHIRE 2020 PROFILE STANDARD CLASS 2010 0.75% 1.00% 10.32 10.42 216,761 2,238,428 10.92% 11.19% 1.00% 2009 0.75% 1.00% 9.31 9.37 144,789 1,348,029 24.41% 24.72% 1.90% 2008 0.75% 1.00% 7.48 7.51 122,899 919,581 -27.62% -27.44% 1.87% 2007 6/5/2007 0.75% 1.00% 10.34 10.35 9,796 101,265 3.36% 4.32% 0.77% LVIP WILSHIRE 2030 PROFILE STANDARD CLASS 2010 0.75% 1.00% 10.10 10.20 226,525 2,288,763 11.43% 11.71% 0.91% 2009 0.75% 1.00% 9.07 9.13 178,202 1,615,827 26.68% 26.99% 2.09% 2008 0.75% 1.00% 7.16 7.19 70,442 504,196 -31.47% -31.30% 1.48% 2007 6/5/2007 0.75% 1.00% 10.44 10.46 8,819 92,110 1.15% 3.97% 0.60% LVIP WILSHIRE 2040 PROFILE STANDARD CLASS 2010 0.75% 1.00% 9.56 9.65 82,452 788,425 12.53% 12.82% 0.94% 2009 0.75% 1.00% 8.50 8.55 60,926 517,698 29.65% 29.97% 1.47% 2008 0.75% 1.00% 6.55 6.58 37,059 242,878 -36.19% -36.03% 0.87% 2007 6/5/2007 0.75% 1.00% 10.27 10.28 4,747 48,770 1.95% 3.74% 1.83%
L-21
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) --------------------------------------------------------------------------------------------------------------------------------- LVIP WILSHIRE CONSERVATIVE PROFILE STANDARD CLASS 2010 0.75% 1.00% $13.00 $13.18 286,321 $ 3,721,821 9.40% 9.68% 3.77% 2009 0.75% 1.00% 11.88 12.02 267,910 3,183,545 23.61% 23.92% 4.30% 2008 0.75% 1.00% 9.61 9.70 264,582 2,543,244 -19.25% -19.05% 1.96% 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% LVIP WILSHIRE MODERATE PROFILE STANDARD CLASS 2010 0.75% 1.00% 12.89 13.07 378,148 4,879,150 10.85% 11.12% 2.98% 2009 0.75% 1.00% 11.63 11.77 376,162 4,378,100 26.76% 27.08% 4.26% 2008 0.75% 1.00% 9.18 9.26 436,310 4,005,220 -27.35% -27.17% 2.12% 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% LVIP WILSHIRE MODERATELY AGGRESSIVE PROFILE STANDARD CLASS 2010 0.75% 1.00% 12.35 12.53 420,843 5,201,715 11.60% 11.88% 2.89% 2009 0.75% 1.00% 11.07 11.20 409,680 4,537,418 27.75% 28.07% 4.70% 2008 0.75% 1.00% 8.67 8.74 372,615 3,230,340 -34.08% -33.92% 1.09% 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% NB AMT MID-CAP GROWTH I CLASS 2010 0.75% 1.00% 8.47 8.69 873,255 7,404,066 27.81% 28.13% 0.00% 2009 0.75% 1.00% 6.63 6.78 975,025 6,471,128 30.29% 30.62% 0.00% 2008 0.75% 1.00% 5.09 5.19 1,026,161 5,224,044 -43.93% -43.79% 0.00% 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% NB AMT PARTNERS I CLASS 2010 0.75% 1.00% 16.78 17.27 359,925 6,050,361 14.52% 14.80% 0.66% 2009 0.75% 1.00% 14.65 15.04 408,049 5,993,548 54.52% 54.91% 2.64% 2008 0.75% 1.00% 9.48 9.71 449,518 4,271,182 -52.87% -52.75% 0.50% 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% T. ROWE PRICE INTERNATIONAL STOCK CLASS I 2010 0.75% 1.00% 18.38 18.91 788,274 14,509,437 13.32% 13.60% 0.89% 2009 0.75% 1.00% 16.22 16.65 900,546 14,630,234 50.87% 51.25% 2.71% 2008 0.75% 1.00% 10.75 11.01 973,595 10,481,445 -49.21% -49.09% 1.91% 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%
(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. (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. L-22 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 2010:
AGGREGATE AGGREGATE COST OF PROCEEDS SUBACCOUNT PURCHASES FROM SALES --------------------------------------------------------------------------------------- ABVPSF Global Thematic Growth Class B $ 177,657 $ 366,313 ABVPSF Growth Class B 78,287 185,058 ABVPSF Growth and Income Class B 148,803 365,773 American Century VP Balanced Class I 476,862 2,176,008 American Century VP Inflation Protection Class I 788,853 445,973 American Funds Global Growth Class 2 741,533 974,754 American Funds Growth Class 2 1,532,630 4,550,967 American Funds Growth-Income Class 2 860,250 1,284,273 American Funds International Class 2 1,103,905 3,281,511 BlackRock Global Allocation V.I. Class I 606,528 137,845 Delaware VIP Diversified Income Standard Class 1,268,776 1,484,532 Delaware VIP High Yield Standard Class 1,012,452 774,108 Delaware VIP REIT Service Class 1,188,292 1,334,711 Delaware VIP Small Cap Value Service Class 1,215,921 1,394,477 Delaware VIP Smid Cap Growth Service Class 2,544,867 121,540 Delaware VIP Trend Service Class 384,786 2,820,369 Dreyfus Opportunistic Small Cap Initial Class 498,465 3,685,860 Dreyfus Stock Index Initial Class 1,604,156 7,645,208 DWS VIP Alternative Asset Allocation Plus Class A 77,268 1,518 DWS VIP Equity 500 Index Class A 397,845 744,404 DWS VIP Small Cap Index Class A 254,430 418,536 Fidelity VIP Asset Manager Initial Class 1,350,362 6,299,497 Fidelity VIP Contrafund Service Class 2 1,409,334 2,402,152 Fidelity VIP Equity-Income Initial Class 1,579,808 6,295,464 Fidelity VIP Growth Initial Class 875,527 9,352,212 Fidelity VIP Money Market Initial Class 96,062 87,662 Janus Aspen Series Worldwide Institutional Class 239,543 1,507,633 LVIP Baron Growth Opportunities Service Class 531,323 2,646,730 LVIP Cohen & Steers Global Real Estate Standard Class 279,664 91,135 LVIP Delaware Bond Standard Class 2,429,006 2,013,451 LVIP Delaware Foundation Aggressive Allocation Standard Class 58,688 1,853 LVIP Delaware Foundation Conservative Allocation Standard Class 141,289 173,018 LVIP Delaware Foundation Moderate Allocation Standard Class 147,967 1,319 LVIP Delaware Growth and Income Standard Class 254,509 817,438 LVIP Delaware Social Awareness Standard Class 299,847 1,655,680 LVIP Global Income Standard Class 140,138 66,635 LVIP Janus Capital Appreciation Standard Class 193,928 328,548 LVIP Mondrian International Value Standard Class 396,592 1,467,986 LVIP SSgA Bond Index Standard Class 583,056 206,164 LVIP SSgA Emerging Markets 100 Standard Class 1,127,043 534,153 LVIP SSgA Global Tactical Allocation Standard Class 322,558 273,288 LVIP SSgA International Index Standard Class 88,909 47,757 LVIP T. Rowe Price Structured Mid-Cap Growth Standard Class 392,559 2,426,401 LVIP Wilshire 2010 Profile Standard Class 186,602 143,482 LVIP Wilshire 2020 Profile Standard Class 1,194,791 508,429 LVIP Wilshire 2030 Profile Standard Class 582,943 141,148 LVIP Wilshire 2040 Profile Standard Class 270,706 80,730 LVIP Wilshire Conservative Profile Standard Class 609,544 286,807 LVIP Wilshire Moderate Profile Standard Class 792,665 666,866 LVIP Wilshire Moderately Aggressive Profile Standard Class 876,262 656,562 NB AMT Mid-Cap Growth I Class 459,602 1,252,148 NB AMT Partners I Class 386,090 1,094,044 T. Rowe Price International Stock Class I 419,612 2,232,067
L-23 5. INVESTMENTS The following is a summary of investments owned at December 31, 2010:
NET SHARES ASSET FAIR VALUE OF SUBACCOUNT OWNED VALUE SHARES COST OF SHARES ----------------------------------------------------------------------------------------------------------------- ABVPSF Global Thematic Growth Class B 146,678 $18.99 $ 2,785,417 $ 2,252,991 ABVPSF Growth Class B 60,008 19.62 1,177,364 1,038,728 ABVPSF Growth and Income Class B 52,985 17.01 901,280 1,063,489 American Century VP Balanced Class I 2,771,219 6.30 17,458,678 18,838,802 American Century VP Inflation Protection Class I 72,591 11.11 806,481 784,003 American Funds Global Growth Class 2 259,212 21.48 5,567,866 5,399,854 American Funds Growth Class 2 455,108 54.34 24,730,596 23,375,237 American Funds Growth-Income Class 2 238,751 34.25 8,177,229 8,646,673 American Funds International Class 2 938,749 17.98 16,878,705 16,878,245 BlackRock Global Allocation V.I. Class I 54,734 16.15 883,955 833,382 Delaware VIP Diversified Income Standard Class 652,017 11.28 7,354,755 6,508,529 Delaware VIP High Yield Standard Class 513,423 6.04 3,101,077 2,783,888 Delaware VIP REIT Service Class 1,132,769 9.58 10,851,926 14,410,250 Delaware VIP Small Cap Value Service Class 276,922 31.89 8,831,055 7,657,929 Delaware VIP Smid Cap Growth Service Class 126,638 21.65 2,741,709 2,429,592 Dreyfus Opportunistic Small Cap Initial Class 997,868 30.59 30,524,786 41,441,955 Dreyfus Stock Index Initial Class 1,922,305 29.67 57,034,778 50,101,750 DWS VIP Alternative Asset Allocation Plus Class A 5,945 13.85 82,333 77,368 DWS VIP Equity 500 Index Class A 184,075 13.17 2,424,263 2,287,523 DWS VIP Small Cap Index Class A 167,224 12.41 2,075,252 2,116,419 Fidelity VIP Asset Manager Initial Class 3,034,212 14.54 44,117,440 46,438,073 Fidelity VIP Contrafund Service Class 2 823,641 23.49 19,347,328 21,473,347 Fidelity VIP Equity-Income Initial Class 2,282,037 19.02 43,404,352 50,625,807 Fidelity VIP Growth Initial Class 1,942,884 37.09 72,061,554 71,353,170 Fidelity VIP Money Market Initial Class 22,220 1.00 22,220 22,220 Janus Aspen Series Worldwide Institutional Class 381,694 30.13 11,500,448 13,980,264 LVIP Baron Growth Opportunities Service Class 541,216 30.27 16,382,621 11,967,000 LVIP Cohen & Steers Global Real Estate Standard Class 84,652 7.46 631,671 522,931 LVIP Delaware Bond Standard Class 587,494 13.70 8,045,731 7,615,269 LVIP Delaware Foundation Aggressive Allocation Standard Class 6,729 12.38 83,272 76,230 LVIP Delaware Foundation Conservative Allocation Standard Class 72,291 14.07 1,016,852 1,058,317 LVIP Delaware Foundation Moderate Allocation Standard Class 11,308 13.65 154,359 146,744 LVIP Delaware Growth and Income Standard Class 147,748 28.96 4,279,064 4,235,781 LVIP Delaware Social Awareness Standard Class 459,203 30.57 14,039,203 14,818,854 LVIP Global Income Standard Class 12,702 11.57 147,016 144,159 LVIP Janus Capital Appreciation Standard Class 74,004 21.50 1,591,312 1,339,482 LVIP Mondrian International Value Standard Class 328,600 15.45 5,075,887 6,511,526 LVIP SSgA Bond Index Standard Class 44,250 10.98 485,643 487,221 LVIP SSgA Emerging Markets 100 Standard Class 96,159 13.96 1,342,669 1,159,733 LVIP SSgA Global Tactical Allocation Standard Class 187,932 10.31 1,938,139 2,065,524 LVIP SSgA International Index Standard Class 14,076 7.93 111,647 103,020 LVIP T. Rowe Price Structured Mid-Cap Growth Standard Class 1,276,810 14.43 18,424,362 17,466,459 LVIP Wilshire 2010 Profile Standard Class 78,853 10.56 832,452 732,793 LVIP Wilshire 2020 Profile Standard Class 219,016 10.22 2,238,345 2,020,999 LVIP Wilshire 2030 Profile Standard Class 225,300 10.16 2,288,145 1,933,797 LVIP Wilshire 2040 Profile Standard Class 81,193 9.70 787,899 660,312 LVIP Wilshire Conservative Profile Standard Class 309,283 12.03 3,721,910 3,446,595 LVIP Wilshire Moderate Profile Standard Class 409,003 11.93 4,877,765 4,649,266 LVIP Wilshire Moderately Aggressive Profile Standard Class 455,355 11.42 5,201,067 5,150,257 NB AMT Mid-Cap Growth I Class 269,515 27.42 7,390,094 6,159,775 NB AMT Partners I Class 538,573 11.27 6,069,713 7,279,145 T. Rowe Price International Stock Class I 1,046,801 13.88 14,529,601 13,780,506
L-24 6. CHANGES IN UNITS OUTSTANDING The change in units outstanding for the year ended December 31, 2010, is as follows:
UNITS UNITS NET INCREASE SUBACCOUNT ISSUED REDEEMED (DECREASE) ------------------------------------------------------------------------------------------------- ABVPSF Global Thematic Growth Class B 47,527 (93,791) (46,264) ABVPSF Growth Class B 17,002 (31,158) (14,156) ABVPSF Growth and Income Class B 21,690 (43,400) (21,710) American Century VP Balanced Class I 32,252 (101,385) (69,133) American Century VP Inflation Protection Class I 74,746 (45,464) 29,282 American Funds Global Growth Class 2 74,065 (92,747) (18,682) American Funds Growth Class 2 407,927 (736,669) (328,742) American Funds Growth-Income Class 2 126,229 (168,568) (42,339) American Funds International Class 2 191,352 (389,698) (198,346) BlackRock Global Allocation V.I. Class I 51,159 (13,652) 37,507 Delaware VIP Diversified Income Standard Class 89,687 (123,855) (34,168) Delaware VIP High Yield Standard Class 74,498 (72,679) 1,819 Delaware VIP REIT Service Class 79,351 (97,583) (18,232) Delaware VIP Small Cap Value Service Class 136,306 (151,044) (14,738) Delaware VIP Smid Cap Growth Service Class 287,208 (20,718) 266,490 Delaware VIP Trend Service Class 51,342 (333,848) (282,506) Dreyfus Opportunistic Small Cap Initial Class 69,180 (231,271) (162,091) Dreyfus Stock Index Initial Class 67,589 (242,389) (174,800) DWS VIP Alternative Asset Allocation Plus Class A 7,045 (514) 6,531 DWS VIP Equity 500 Index Class A 50,688 (84,039) (33,351) DWS VIP Small Cap Index Class A 28,617 (42,658) (14,041) Fidelity VIP Asset Manager Initial Class 67,238 (247,465) (180,227) Fidelity VIP Contrafund Service Class 2 241,118 (325,360) (84,242) Fidelity VIP Equity-Income Initial Class 102,547 (298,622) (196,075) Fidelity VIP Growth Initial Class 81,715 (318,729) (237,014) Fidelity VIP Money Market Initial Class 22,237 (21,771) 466 Janus Aspen Series Worldwide Institutional Class 39,663 (139,228) (99,565) LVIP Baron Growth Opportunities Service Class 46,407 (118,975) (72,568) LVIP Cohen & Steers Global Real Estate Standard Class 43,647 (16,165) 27,482 LVIP Delaware Bond Standard Class 182,408 (178,631) 3,777 LVIP Delaware Foundation Aggressive Allocation Standard Class 4,756 (259) 4,497 LVIP Delaware Foundation Conservative Allocation Standard Class 14,373 (17,885) (3,512) LVIP Delaware Foundation Moderate Allocation Standard Class 12,026 (129) 11,897 LVIP Delaware Growth and Income Standard Class 48,305 (115,206) (66,901) LVIP Delaware Social Awareness Standard Class 52,922 (145,426) (92,504) LVIP Global Income Standard Class 12,820 (6,412) 6,408 LVIP Janus Capital Appreciation Standard Class 38,132 (60,626) (22,494) LVIP Mondrian International Value Standard Class 41,395 (125,135) (83,740) LVIP SSgA Bond Index Standard Class 58,252 (23,711) 34,541 LVIP SSgA Emerging Markets 100 Standard Class 80,344 (44,600) 35,744 LVIP SSgA Global Tactical Allocation Standard Class 36,066 (31,373) 4,693 LVIP SSgA International Index Standard Class 7,787 (4,041) 3,746 LVIP T. Rowe Price Structured Mid-Cap Growth Standard Class 83,548 (224,944) (141,396) LVIP Wilshire 2010 Profile Standard Class 19,689 (16,067) 3,622 LVIP Wilshire 2020 Profile Standard Class 131,693 (59,721) 71,972 LVIP Wilshire 2030 Profile Standard Class 67,726 (19,403) 48,323 LVIP Wilshire 2040 Profile Standard Class 35,757 (14,231) 21,526 LVIP Wilshire Conservative Profile Standard Class 44,409 (25,998) 18,411 LVIP Wilshire Moderate Profile Standard Class 71,568 (69,582) 1,986 LVIP Wilshire Moderately Aggressive Profile Standard Class 86,377 (75,214) 11,163 NB AMT Mid-Cap Growth I Class 124,721 (226,491) (101,770) NB AMT Partners I Class 41,032 (89,156) (48,124) T. Rowe Price International Stock Class I 44,940 (157,212) (112,272)
L-25 The change in units outstanding for the year ended December 31, 2009, is as follows:
UNITS UNITS NET INCREASE SUBACCOUNT ISSUED REDEEMED (DECREASE) ------------------------------------------------------------------------------------------------- ABVPSF Global Thematic Growth Class B 189,203 (190,580) (1,377) ABVPSF Growth Class B 29,413 (34,517) (5,104) ABVPSF Growth and Income Class B 30,959 (21,877) 9,082 American Century VP Balanced Class I 52,580 (138,369) (85,789) American Century VP Inflation Protection Class I 44,991 (2,699) 42,292 American Funds Global Growth Class 2 77,842 (97,345) (19,503) American Funds Growth Class 2 554,811 (613,151) (58,340) American Funds Growth-Income Class 2 153,421 (180,914) (27,493) American Funds International Class 2 305,797 (365,508) (59,711) BlackRock Global Allocation V.I. Class I 33,672 -- 33,672 Delaware VIP Diversified Income Standard Class 141,231 (136,385) 4,846 Delaware VIP High Yield Standard Class 112,193 (55,144) 57,049 Delaware VIP REIT Service Class 93,471 (174,885) (81,414) Delaware VIP Small Cap Value Service Class 126,208 (140,166) (13,958) Delaware VIP Trend Service Class 74,544 (65,143) 9,401 Dreyfus Opportunistic Small Cap Initial Class 76,310 (272,072) (195,762) Dreyfus Stock Index Initial Class 92,368 (294,681) (202,313) DWS VIP Alternative Asset Allocation Plus Class A 143 -- 143 DWS VIP Equity 500 Index Class A 68,176 (66,194) 1,982 DWS VIP Small Cap Index Class A 32,711 (44,120) (11,409) Fidelity VIP Asset Manager Initial Class 93,499 (264,655) (171,156) Fidelity VIP Contrafund Service Class 2 293,597 (293,237) 360 Fidelity VIP Equity-Income Initial Class 137,931 (355,783) (217,852) Fidelity VIP Growth Initial Class 99,057 (346,168) (247,111) Fidelity VIP Money Market Initial Class 11,519 (14,032) (2,513) Janus Aspen Series Worldwide Institutional Class 61,174 (146,435) (85,261) LVIP Baron Growth Opportunities Service Class 59,676 (109,728) (50,052) LVIP Cohen & Steers Global Real Estate Standard Class 61,412 (23,716) 37,696 LVIP Delaware Bond Standard Class 191,005 (149,783) 41,222 LVIP Delaware Foundation Aggressive Allocation Standard Class 1,741 (5) 1,736 LVIP Delaware Foundation Conservative Allocation Standard Class 22,100 (22,370) (270) LVIP Delaware Foundation Moderate Allocation Standard Class 4 -- 4 LVIP Delaware Growth and Income Standard Class 64,617 (134,163) (69,546) LVIP Delaware Social Awareness Standard Class 74,960 (179,410) (104,450) LVIP Global Income Standard Class 7,360 (1,200) 6,160 LVIP Janus Capital Appreciation Standard Class 57,446 (89,917) (32,471) LVIP Mondrian International Value Standard Class 74,066 (152,125) (78,059) LVIP SSgA Bond Index Standard Class 13,622 (3,607) 10,015 LVIP SSgA Emerging Markets 100 Standard Class 59,497 (17,381) 42,116 LVIP SSgA International Index Standard Class 4,978 (27) 4,951 LVIP T. Rowe Price Structured Mid-Cap Growth Standard Class 98,107 (212,481) (114,374) LVIP Wilshire 2010 Profile Standard Class 47,421 (28,645) 18,776 LVIP Wilshire 2020 Profile Standard Class 66,077 (44,187) 21,890 LVIP Wilshire 2030 Profile Standard Class 120,976 (13,216) 107,760 LVIP Wilshire 2040 Profile Standard Class 36,265 (12,398) 23,867 LVIP SSgA Global Tactical Allocation Standard Class 55,079 (90,987) (35,908) LVIP Wilshire Conservative Profile Standard Class 72,286 (68,958) 3,328 LVIP Wilshire Moderate Profile Standard Class 96,303 (156,451) (60,148) LVIP Wilshire Moderately Aggressive Profile Standard Class 121,801 (84,736) 37,065 NB AMT Mid-Cap Growth I Class 181,767 (232,903) (51,136) NB AMT Partners I Class 80,779 (122,248) (41,469) T. Rowe Price International Stock Class I 87,300 (160,349) (73,049)
L-26 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 statements 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, 2010, and the related statements of operations for the year then ended and changes in net assets for each of the two years in the period then ended, or for those sub-accounts operating for portions of such periods as disclosed in the financial statements. 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, 2010, by correspondence with the fund companies, or their transfer agents, as applicable. 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, 2010, and the results of their operations and the changes in their net assets for the periods described above, in conformity with U.S. generally accepted accounting principles. /s/ Ernst & Young LLP Philadelphia, Pennsylvania April 6, 2011 L-27 Lincoln National Variable Annuity Account L PART C - OTHER INFORMATION Item 24. Financial Statements and Exhibits (a) List of Financial Statements 1. Part A The Table of Condensed Financial Information is included in Part A of this Registration Statement. 2. Part B The following financial statements for the Variable Account are included in Part B of this Registration Statement: Statement of Assets and Liabilities - December 31, 2010 Statement of Operations - Year ended December 31, 2010 Statements of Changes in Net Assets - Years ended December 31, 2010 and 2009 Notes to Financial Statements - December 31, 2010 Report of Independent Registered Public Accounting Firm 3. Part B The following consolidated financial statements for The Lincoln National Life Insurance Company are included in Part B of this Registration Statement: Consolidated Balance Sheets - Years ended December 31, 2010 and 2009 Consolidated Statements of Income - Years ended December 31, 2010, 2009, and 2008 Consolidated Statements of Shareholder's Equity - Years ended December 31, 2010, 2009, and 2008 Consolidated Statements of Cash Flows - Years ended December 31, 2010, 2009, and 2008 Notes to Consolidated Financial Statements - December 31, 2010 Report of Independent Registered Public Accounting Firm (b) List of Exhibits (1)(a) Resolution of Board of Directors of The Lincoln National Life Insurance Company authorizing establishment of the Variable Account incorporated herein by reference to Pre-Effective Amendment No. 1 (File No. 333-04999) filed on September 26,1996. (b) Amendment dated December 2, 1996 to Resolution of Board of Directors of The Lincoln National Life Insurance Company authorizing establishment of the Variable Account incorporated herein by reference to Post-Effective Amendment No. 2 (File No. 333-04999) filed on April 30, 1998. (2) Not Applicable. (3) (a) Broker-Dealer Sales Agreement incorporated herein by reference to Pre-Effective Amendment No. 1 (File No. 333-04999) filed on September 26, 1996. (b) Amended and Restated Principal Underwriting Agreement dated May 1, 2007 between The Lincoln National Life Insurance Company and Lincoln Financial Distributors, Inc. incorporated herein by reference to Post-Effective Amendment No. 24 (File No. 333-61554) filed on December 18, 2007. (4)(a) Group Variable Annuity I Contract incorporated herein by reference to Post-Effective Amendment No. 7 (File No. 333-04999) filed on April 26, 2000. (b) Group Variable Annuity II Contract incorporated herein by reference to Post-Effective Amendment No. 7 (File No. 333-04999) filed on April 26, 2000. (c) Group Variable Annuity III Contract incorporated herein by reference to Post-Effective Amendment No. 7 (File No. 333-04999) filed on April 26, 2000. (d) Endorsement to Group Annuity Contracts incorporated herein by reference to Post-Effective Amendment No. 7 (File No. 333-04999) filed on April 26, 2000. (e) Group Annuity Amendment to Group Annuity Contracts incorporated herein by reference to Post-Effective Amendment No. 7 (File No. 333-04999) filed on April 26, 2000. (f) Endorsement to Certificate incorporated herein by reference to Post-Effective Amendment No. 7 (File No. 333-04999) filed on April 26, 2000. (g) Section 403(b) Annuity Amendment incorporated herein by reference to Post-Effective Amendment No. 10 (File No. 333-04999) filed on April 9, 2002. (h) Group Annuity Amendment incorporated herein by reference to Post-Effective Amendment No. 10 (File No. 333-04999) filed on April 9, 2002. (i) Qualified Individual Retirement Annuity Rider incorporated herein by reference to Post-Effective Amendment No. 12 (File No. 333-04999) filed on April 6, 2004. (j) Section 403(b) Annuity Endorsement (32481-G-12/08) incorporated herein by reference to Post-Effective Amendment No. 14 (File No. 333-43373) filed on April 7, 2009. (5)(a) Application for Group Annuity Contract incorporated herein by reference to Post-Effective Amendment No. 7 (File No. 333-05827) filed on April 26, 2000. (b) Participant Enrollment Form incorporated herein by reference to Post-Effective Amendment No. 7 (File No. 333-04999) filed on April 26, 2000. (6)(a) Articles of Incorporation of The Lincoln National Life Insurance Company incorporated herein by reference to Pre-Effective Amendment No. 1 (File No. 333-04999) filed on September 24, 1996. (b) By-Laws of The Lincoln National Life Insurance Company incorporated herein by reference to Post-Effective Amendment No. 3 on Form N-6 (File No. 333-118478) filed on April 5, 2007. (7) Not Applicable. (8) (a)Accounting and Financial Adminstration Services Agreement dated October 1, 2007 among Mellon Bank, N.A., The Lincoln National Life Insurance Company and Lincoln Life & Annuity Company of New York incorporated herein by reference to Registration Statement on Form N-4 (File No. 333-147673) filed on November 28, 2007. (b) Fund Participation Agreements and Amendments between The Lincoln National Life Insurance Company and: (i) American Century Variable Products incorporated herein by reference to Post-Effective Amendment No. 16 on Form N-6 (File No. 333-146507) filed on April 1, 2011. (ii) (a) Dreyfus Variable Investment Fund and Dreyfus Life and Annuity Index Fund, Inc. incorporated herein by reference to Pre-Effective Amendment No. 1 (File No. 333-04999) filed September 26, 1996. (Fund Participation Agreement) (b) Dreyfus Variable Investment Fund, Dreyfus Socially Responsible Growth Fund, Inc. and Dreyfus Life and Annuity Index Fund, Inc. incorporated herein by reference to Post-Effective Amendment No. 11 (File No. 333-04999) filed on April 3, 2003. (Amendment) (c) Dreyfus Variable Investment Fund, Dreyfus Socially Responsible Growth Fund, Inc. and Dreyfus Life and Annuity Index Fund, Inc. incorporated herein by reference to Post-Effective Amendment No. 11 (File No. 333-04999) filed on April 3, 2003. (Amendment) (d) Dreyfus Variable Investment Fund, Dreyfus Socially Responsible Growth Fund, Inc. and Dreyfus Life and Annuity Index Fund, Inc. incorporated herein by reference to Post-Effective Amendment No. 12 (File No. 333-04999) filed on April 6, 2004. (Amendment) (iii) Fidelity Variable Insurance Products incorporated herein by reference to Post-Effective Amendment No. 13 on Form N-6 (File No. 333-146507) filed on April 1, 2010. (iv) Janus Aspen Series incorporated herein by reference to Post-Effective Amendment No. 13 on Form N-6 (File No. 333-146507) filed on April 1, 2010. (v) Lincoln Variable Insurance Products Trust incorporated herein by reference to Post-Effective Amendment No. 16 on Form N-6 (File No. 333-146507) filed on April 1, 2011. (vi) Neuberger Berman Advisers Management Trust incorporated herein by reference to Post-Effective Amendment No. 1 on Form N-6 (File No. 333-139960) filed on April 1, 2008. (vii)(a) T. Rowe Price International Series, Inc and T. Rowe Price Investment Services, Inc. incorporated herein by reference to Pre-Effective Amendment No. 1 (File No. 333-04999) filed on September 26, 1996. (Fund Participation Agreement) (b) T. Rowe Price International Series, Inc, and T. Rowe Price Investment Services, Inc. incorporated herein by reference to Post-Effective Amendment No. 11 (File No. 333-04999) filed on April 3, 2003. (Amendment) B-2 (c) T. Rowe Price International Series, Inc. and T. Rowe Price Investment Services, Inc. (viii) Alliance Variable Products Series Fund incorporated herein by reference to Post-Effective Amendment No. 13 on Form N-6 (File No. 333-146507) filed on April 1, 2010. (ix) American Funds Insurance Series incorporated herein by reference to Post-Effective Amendment No. 16 on Form N-6 (File No. 333-146507) filed on April 1, 2011. (x) Delaware VIP Trust incorporated herein by reference to Post-Effective Amendment No. 13 on Form N-6 (File No. 333-146507) filed on April 1, 2010. (xi) DWS Investments VIT Funds Trust incorporated herein by reference to Post-Effective Amendment No. 13 on Form N-6 (File No. 333-146507) filed on April 1, 2010. (xii) DWS Variable Series II incorporated herein by reference to Post-Effective Amendment No. 13 on Form N-6 (File No. 333-146507) filed on April 1, 2010. (c) Rule 22c-2 Agreements between The Lincoln National Life Insurance Company and: (i) American Century Variable Products incorporated herein by reference to Post-Effective Amendment No. 29 (File No. 333-61554) filed on March 16, 2009. (ii) American Funds incorporated herein by reference to Post-Effective Amendment No. 30 (File No. 333-36304) filed on May 29, 2008. (iii) Delaware VIP Trust incorporated herein by reference to Post-Effective Amendment No. 29 (File No. 333-61554) filed on March 16, 2009. (iv) Fidelity Variable Insurance Products Fund incorporated herein by reference to Post-Effective Amendment No. 30 (File No. 333-36304) filed on May 29, 2008. (v) Janus Aspen Series incorporated herein by reference to Post-Effective Amendment No. 30 (File No. 333-36304) filed on May 29, 2008. (vi) Lincoln Variable Insurance Products Trust incorporated herein by reference to Post-Effective Amendment No. 30 (File No. 333-36304) filed on May 29, 2008. (vii) Neuberger Berman Advisers Management Trust incorporated herein by reference to Post-Effective Amendment No. 30 (File No. 333-36304) filed on May 29, 2008. (9) Opinion and Consent of Jeremy Sachs, Senior Counsel of The Lincoln National Life Insurance Company as to the legality of securities being issued incorporated herein by reference to Pre-Effective Amendment No. 1 (File No. 333-05827) filed on September 26, 1996. (10) (a) Consent of Ernst & Young LLP, Independent Registered Public Accounting Firm (b) Power of Attorney - Principal Officers and Directors of The Lincoln National Life Insurance Company (11) Not Applicable (12) Not Applicable (13) Organizational Chart of The Lincoln National Insurance Holding Company System incorporated herein by reference to Post-Effective Amendment No. 11 (File No. 333-145531) filed on August 26, 2010. Item 25. Directors and Officers of the Depositor The following list contains the officers and directors of The Lincoln National Life Insurance Company who are engaged directly or indirectly in activities relating to Lincoln National Variable Annuity Account L as well as the contracts. The list also shows The Lincoln National Life Insurance Company's executive officers. B-3
Name Positions and Offices with Depositor --------------------------- -------------------------------------------------------------------- Dennis R. Glass** President and Director Chuck C. Cornelio*** Executive Vice President, Chief Administrative Officer and Director Randal J. Freitag** Executive Vice President, Chief Financial Officer and Director Frederick J. Crawford** Executive Vice President and Director Mark E. Konen*** Senior Vice President and Director Keith J. Ryan* Vice President and Director Charles A. Brawley, III** Vice President and Secretary C. Phillip Elam, II*** Senior Vice President and Chief Investment Officer Rise' C.M. Taylor* Vice President and Treasurer
* Principal business address is 1300 South Clinton Street, Fort Wayne, Indiana 46802 ** Principal business address is Radnor Financial Center, 150 Radnor Chester Road, Radnor, PA 19087 *** Principal business address is 100 North Greene Street, Greensboro, NC 27401 Item 26. Persons Controlled by or Under Common Control with the Depositor or Registrant See Exhibit 13: Organizational Chart of the Lincoln National Insurance Holding Company System. Item 27. Number of Contractowners As of February 28, 2011 there were 54,614 participants in group contracts under Account L. Item 28. Indemnification (a) Brief description of indemnification provisions. In general, Article VII of the By-Laws of The Lincoln National Life Insurance Company (Lincoln Life) provides that Lincoln Life will indemnify certain persons against expenses, judgments and certain other specified costs incurred by any such person if he/she is made a party or is threatened to be made a party to a suit or proceeding because he/she was a director, officer, or employee of Lincoln Life, as long as he/she acted in good faith and in a manner he/she reasonably believed to be in the best interests of, or act opposed to the best interests of, Lincoln Life. Certain additional conditions apply to indemnification in criminal proceedings. In particular, separate conditions govern indemnification of directors, officers, and employees of Lincoln Life in connection with suits by, or in the right of, Lincoln Life. Please refer to Article VII of the By-Laws of Lincoln Life (Exhibit no. 6(b) hereto) for the full text of the indemnification provisions. Indemnification is permitted by, and is subject to the requirements of, Indiana law. (b) Undertaking pursuant to Rule 484 of Regulation C under the Securities Act of 1933: Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions described in Item 28(a) above or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in the successful defense of any such action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. Item 29. Principal Underwriter (a) Lincoln Financial Distributors, Inc. ("LFD") currently serves as Principal Underwriter for: Lincoln National Variable Annuity Fund A (Group & Individual); Lincoln National Variable Annuity Account C; Lincoln National Flexible Premium Variable Life Account D; Lincoln National Variable Annuity Account E; Lincoln National Flexible Premium Variable Life Account F; Lincoln National Flexible Premium Variable Life Account G; Lincoln National Variable Annuity Account H; Lincoln Life & Annuity Variable Annuity Account H; Lincoln Life Flexible Premium Variable Life Account J; Lincoln Life Flexible Premium Variable Life B-4 Account K; Lincoln National Variable Annuity Account L; Lincoln Life & Annuity Variable Annuity Account L; Lincoln Life Flexible Premium Variable Life Account M; Lincoln Life & Annuity Flexible Premium Variable Life Account M; Lincoln Life Variable Annuity Account N; Lincoln New York Account N for Variable Annuities; Lincoln Life Variable Annuity Account Q; Lincoln Life Flexible Premium Variable Life Account R; LLANY Separate Account R for Flexible Premium Variable Life Insurance; Lincoln Life Flexible Premium Variable Life Account S; LLANY Separate Account S for Flexible Premium Variable Life Insurance; Lincoln Life Variable Annuity Account T; Lincoln Life Variable Annuity Account W; and Lincoln Life Flexible Premium Variable Life Account Y and Lincoln Life & Annuity Flexible Premium Variable Life Account Y. (b) Officers and Directors of Lincoln Financial Distributors, Inc.:
Name Positions and Offices with Underwriter ------------------------ ------------------------------------------------ Wilford H. Fuller* President, Chief Executive Officer and Director David M. Kittredge* Senior Vice President Anant Bhalla* Vice President and Treasurer Patrick J. Caulfield** Vice President and Chief Compliance Officer Joel Schwartz* Vice President and Director Keith J. Ryan*** Vice President and Chief Financial Officer Patricia A. Insley* Director Thomas P. O'Neill* Vice President and Director Linda E. Woodward*** Secretary
* Principal Business address is Radnor Financial Center, 150 Radnor Chester Road, Radnor, PA 19087 ** Principal Business address is 350 Church Street, Hartford, CT 06103 *** Principal Business address is 1300 S. Clinton Street, Ft. Wayne, IN 46802 (c) N/A Item 30. Location of Accounts and Records All accounts, books, and other documents, except accounting records, required to be maintained by Section 31a of the 1940 Act and the Rules promulgated thereunder are maintained by The Lincoln National Life Insurance Company, 1300 South Clinton Street, Fort Wayne, Indiana 46802. The accounting records are maintained by The Bank of New York Mellon, One Mellon Bank Center, 500 Grant Street, Pittsburgh, PA 15258. Item 31. Management Services Not Applicable. Item 32. Undertakings (a) Registrant undertakes that it will file a post-effective amendment to this registration statement as frequently as necessary to ensure that the audited financial statements in the registration statement are never more than 16 months old for so long as payments under the variable annuity contracts may be accepted. (b) Registrant undertakes that it will include either (1) as part of any application to purchase a Certificate or an Individual Contract offered by the Prospectus, a space that an applicant can check to request a Statement of Additional Information, or (2) a post card or a similar written communication affixed to or included in the Prospectus that the applicant can remove to send for a Statement of Additional Information. (c) Registrant undertakes to deliver any Statement of Additional Information and any financial statements required to be made available under this Form promptly upon written or oral request to Lincoln Life at the address or phone number listed in the Prospectus. (d) Lincoln Life hereby represents that the fees and charges deducted under the contract, in the aggregate, are reasonable in relation to the services rendered, the expenses expected to be incurred, and the risks assumed by Lincoln Life. (e) Registrant hereby represents that it is relying on the American Council of Life Insurance (avail. Nov. 28, 1988) no-action letter with respect to Contracts used in connection with retirement plans meeting the requirements of Section 403(b) of the Internal Revenue Code, and represents further that it will comply with the provisions of paragraphs (1) through (4) set forth in that no-action letter. B-5 Item 33. For contracts sold in connection with the Texas Optional Retirement Program, Registrant is relying on Rule 6c-7 and represents that paragraphs (a) through (d) of that rule have been complied with. SIGNATURES a) As required by the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant certifies that it meets the requirements of Securities Act Rule 485(b) for effectiveness of this Registration Statement and has caused this Post-Effective Amendment No. 21 to the Registration Statement to be signed on its behalf, in the City of Fort Wayne, and State of Indiana on this 6th day of April, 2011. Lincoln National Variable Annuity Account L (Registrant) Group Variable Annuity I, II & III By: /s/ John D. Weber ------------------------------------ John D. Weber Second Vice President, The Lincoln National Life Insurance Company (Title) THE LINCOLN NATIONAL LIFE INSURANCE COMPANY (Depositor) By: /s/ Brian A. Kroll ------------------------------------ Brian A. Kroll (Signature-Officer of Depositor) Vice President, The Lincoln National Life Insurance Company (Title)
(b) As required by the Securities Act of 1933, this Amendment to the Registration Statement has been signed by the following persons in their capacities indicated on April 6, 2011. Signature Title * President and Director (Principal Executive Officer) ------------------------------ Dennis R. Glass * Executive Vice President, Chief Administrative Officer and Direc- ------------------------------ tor Charles C. Cornelio * Executive Vice President and Director ------------------------------ Frederick J. Crawford * Senior Vice President and Chief Investment Officer ------------------------------ C. Phillip Elam II * Executive Vice President, Chief Financial Officer and Director ------------------------------ (Principal Financial Officer) Randal J. Freitag * Senior Vice President and Director ------------------------------ Mark E. Konen * Vice President and Director ------------------------------ Keith J. Ryan *By:/s/ John D. Weber Pursuant to a Power of Attorney --------------------------- John D. Weber
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