report.) . Financial Statements ASSETS Investments: Available-for-sale securities, at fair value: Fixed maturity (amortized cost: 2008 – $56,211; 2007 – $56,069) Equity (cost: 2008 – $612; 2007 – $548) Trading securities Mortgage loans on real estate Real estate Policy loans Derivative investments Other investments Total investments Cash and invested cash Deferred acquisition costs and value of business acquired Premiums and fees receivable Accrued investment income Reinsurance recoverables Goodwill Other assets Separate account assets Total assets LIABILITIES AND STOCKHOLDERS’ EQUITY Liabilities Future contract benefits Other contract holder funds Short-term debt Long-term debt Reinsurance related derivative liability Funds withheld reinsurance liabilities Deferred gain on indemnity reinsurance Payables for collateral under securities loaned and derivatives Other liabilities Separate account liabilities Total liabilities Contingencies and Commitments (See Note 10) Stockholders’ Equity Series A preferred stock – 10,000,000 shares authorized Common stock – 800,000,000 shares authorized; 255,841,633 and 264,233,303 shares issued and outstanding as of September 30, 2008, and December 31, 2007, respectively Retained earnings Accumulated other comprehensive income (loss) Total stockholders’ equity Total liabilities and stockholders’ equity Revenues Insurance premiums Insurance fees Investment advisory fees Net investment income Realized loss Amortization of deferred gain on business sold through reinsurance Other revenues and fees Total revenues Benefits and Expenses Interest credited Benefits Underwriting, acquisition, insurance and other expenses Interest and debt expense Impairment of intangibles Total benefits and expenses Income from continuing operations before taxes Federal income taxes Income from continuing operations Income (loss) from discontinued operations, net of federal incomes taxes Net income Earnings Per Common Share – Basic Income from continuing operations Income (loss) from discontinued operations Net income Earnings Per Common Share – Diluted Income from continuing operations Income (loss) from discontinued operations Net income Series A Preferred Stock Balance at beginning-of-year Balance at end-of-period Common Stock Balance at beginning-of-year Issued for acquisition Stock compensation Deferred compensation payable in stock Retirement of common stock/cancellation of shares Balance at end-of-period Retained Earnings Balance at beginning-of-year Cumulative effect of adoption of SOP 05-1 Cumulative effect of adoption of FIN 48 Cumulative effect of adoption of EITF 06-10 Comprehensive income (loss) Less other comprehensive loss, net of tax Net income Retirement of common stock Dividends declared: Common (2008 – $1.245; 2007 – $1.185) Balance at end-of-period Net Unrealized Gain on Available-for-Sale Securities Balance at beginning-of-year Change during the period Balance at end-of-period Net Unrealized Gain on Derivative Instruments Balance at beginning-of-year Change during the period Balance at end-of-period Foreign Currency Translation Adjustment Balance at beginning-of-year Change during the period Balance at end-of-period Funded Status of Employee Benefit Plans Balance at beginning-of-year Change during the period Balance at end-of-period Total stockholders’ equity at end-of-period Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Deferred acquisition costs, value of business acquired, deferred sales inducements and deferred front end loads deferrals and interest, net of amortization Trading securities purchases, sales and maturities, net Change in premiums and fees receivable Change in accrued investment income Change in future contract benefits Change in other contract holder funds Change in funds withheld reinsurance liability and reinsurance recoverables Change in federal income tax accruals Realized loss Loss on disposal of discontinued operations Impairment of intangibles Amortization of deferred gain on business sold through reinsurance Stock-based compensation expense Other Net adjustments Net cash provided by operating activities Cash Flows from Investing Activities Purchases of available-for-sale securities Sales of available-for-sale securities Maturities of available-for-sale securities Purchases of other investments Sales or maturities of other investments Increase (decrease) in payables for collateral under securities loaned and derivatives Proceeds from sale of subsidiaries/businesses and disposal of discontinued operations Other Net cash used in investing activities Cash Flows from Financing Activities Payment of long-term debt, including current maturities Issuance of long-term debt Issuance (decrease) in commercial paper Deposits of fixed account values, including the fixed portion of variable Withdrawals of fixed account values, including the fixed portion of variable Transfers to and from separate accounts, net Payment of funding agreements Common stock issued for benefit plans and excess tax benefits Repurchase of common stock Dividends paid to stockholders Net cash used in financing activities Net increase (decrease) in cash and invested cash Cash and invested cash at beginning-of-year Cash and invested cash at end-of-period The detail of the reclassifications from what was previously reported in Realized loss, as previously reported Effect of reclassifications to: Insurance fees Net investment income Interest credited Benefits Underwriting, acquisition, insurance and other expenses Realized loss, as adjusted Business Combinations Assets DAC VOBA Other assets – DSI Total assets Liabilities Future Contract Benefits: Remaining guaranteed interest and similar contracts Embedded derivative instruments – living benefits liabilities DFEL Other liabilities – income tax liabilities Total liabilities Revenues Realized loss Federal income tax benefit Loss from continuing operations The adoption did not have a material impact on our consolidated financial condition or results of operations. statements, primarily in Note 6. Postretirement Benefit Plan Assets We will statements beginning with the interim period ending June 30, 2009. Goodwill Specifically identifiable intangible assets Other Total assets held-for-sale Liabilities held-for-sale Discontinued Operations Before Disposal Media revenues, net of agency commissions Income from discontinued operations before disposal, before federal income taxes Federal income taxes Income from discontinued operations before disposal Disposal Loss on disposal, before federal income taxes Federal income tax expense (benefit) Loss on disposal Income (loss) from discontinued operations Corporate bonds U.S. Government bonds Foreign government bonds Mortgage-backed securities: Mortgage pass-through securities Collateralized mortgage obligations Commercial mortgage-backed securities State and municipal bonds Redeemable preferred stocks Total fixed maturity securities Equity securities Total available-for-sale securities Corporate bonds U.S. Government bonds Foreign government bonds Mortgage-backed securities: Mortgage pass-through securities Collateralized mortgage obligations Commercial mortgage-backed securities State and municipal bonds Redeemable preferred stocks Total fixed maturity securities Equity securities Total available-for-sale securities Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Subtotal Mortgage-backed securities Total fixed maturity available-for-sale securities Corporate bonds U.S. Government bonds Foreign government bonds Mortgage-backed securities: Mortgage pass-through securities Collateralized mortgage obligations Commercial mortgage-backed securities State and municipal bonds Redeemable preferred stocks Total fixed maturity securities Equity securities Total available-for-sale securities Total number of securities in an unrealized loss position Corporate bonds U.S. Government bonds Foreign government bonds Mortgage-backed securities: Mortgage pass-through securities Collateralized mortgage obligations Commercial mortgage-backed securities State and municipal bonds Redeemable preferred stocks Total fixed maturity securities Equity securities Total available-for-sale securities Total number of securities in an unrealized loss position Less than six months Six months or greater, but less than nine months Nine months or greater, but less than twelve months Twelve months or greater Total available-for-sale securities Less than six months Six months or greater, but less than nine months Nine months or greater, but less than twelve months Twelve months or greater Total available-for-sale securities Corporate bonds U.S. Government bonds Foreign government bonds Mortgage-backed securities: Mortgage pass-through securities Collateralized mortgage obligations Commercial mortgage-backed securities State and municipal bonds Redeemable preferred stocks Total fixed maturity securities Equity securities Total trading securities Fixed maturity available-for-sale securities Equity available-for-sale securities Trading securities Mortgage loans on real estate Real estate Policy loans Invested cash Alternative investments Other investments Investment income Investment expense Net investment income Fixed maturity available-for-sale securities: Gross gains Gross losses Equity available-for-sale securities: Gross gains Gross losses Gain (loss) on other investments Associated amortization expense of DAC, VOBA, DSI and DFEL and changes in other contract holder funds and funds withheld reinsurance liabilities Total realized loss on investments, excluding trading securities Loss on certain derivative instruments Associated amortization expense of DAC, VOBA, DSI and DFEL and changes in other contract holder funds Total realized loss on investments and certain derivative instruments, excluding trading securities Write-downs for other-than-temporary impairments included in realized loss on available-for-sale securities above The carrying value and fair value of the collateral payable held for derivatives is $1.6 billion and $2.8 billion as of March 31, 2009 and December 31, 2008, respectively. protection on a new issuer, selected by Delaware Investments. The cost to substitute the corporate names is based on market conditions and the liquidity of the corporate names. This new issuer will replace the issuer Delaware Investments has identified to remove from the pool of issuers. The substitution of corporate issuers does not revise the CLN agreement. The subordination and the participation in credit losses may change as a result of the substitution. The amount of the change is dependant upon the relative risk of the issuers removed and replaced in the pool of issuers. March 31, 2009. 2008. The following summarizes the fair value to amortized cost ratio (dollars in millions) of the CLNs: Amount of subordination (1) Maturity Current rating of tranche (1) Number of entities (1) Number of countries (1) (1) Balance at beginning-of-year Cumulative effect of adoption of Statement of Position (“SOP”) 05-1 (“SOP 05-1”) Deferrals DAC and VOBA amortization, net of interest: Prospective unlocking – assumption changes Prospective unlocking – model refinements Retrospective unlocking Other amortization, net of interest Adjustment related to realized gains on available-for-sale securities and derivatives Adjustment related to unrealized losses on available-for-sale securities and derivatives Foreign currency translation adjustment Balance at end-of-period Balance at beginning-of-year Cumulative effect of adoption of SOP 05-1 Business acquired Deferrals DAC and VOBA amortization, net of interest: Prospective unlocking – assumption changes Prospective unlocking – model refinements Retrospective unlocking Other amortization, net of interest Accretion of interest Adjustment related to realized (gains) losses on available-for-sale securities and derivatives Adjustment related to unrealized losses on available-for-sale securities and derivatives Foreign currency translation adjustment Balance at end-of-period Balance at beginning-of-year Cumulative effect of adoption of SOP 05-1 Deferrals DAC and VOBA amortization, net of interest: Prospective unlocking – assumption changes Prospective unlocking – model refinements Retrospective unlocking Other amortization, net of interest Adjustment related to realized gains on available-for-sale securities and derivatives Balance at end-of-period Balance at beginning-of-year Cumulative effect of adoption of SOP 05-1 Deferrals DAC and VOBA amortization, net of interest: Prospective unlocking – assumption changes Prospective unlocking – model refinements Retrospective unlocking Other amortization, net of interest Adjustment related to realized (gains) losses on available-for-sale securities and derivatives Foreign currency translation adjustment Balance at end-of-period non-U.S. income tax authorities. The changes in the carrying amount of goodwill (in millions) by reportable segment were as follows: Retirement Solutions: Annuities Defined Contribution Insurance Solutions: Life Insurance Group Protection Investment Management Lincoln UK Other Operations Total goodwill Insurance Solutions – Life Insurance: Sales force Retirement Solutions – Defined Contribution: Mutual fund contract rights(1) Investment Management: Client lists Other(1) Other Operations: FCC licenses(1) (2) Other Total on our Consolidated Statements of Income. Return of Net Deposits Variable annuity account value Net amount at risk(1) Average attained age of contract holders Minimum Return Variable annuity account value Net amount at risk(1) Average attained age of contract holders Guaranteed minimum return Anniversary Contract Value Variable annuity account value Net amount at risk(1) Average attained age of contract holders (1) Represents the amount of death benefit in excess of the Balance at beginning-of-year Cumulative effect of adoption of SOP 05-1 Changes in reserves Benefits paid Balance at end-of-period Asset Type Domestic equity International equity Bonds Money market Total Percent of total variable annuity separate account values Account values and other contract holder funds Deferred front-end loads Contract holder dividends payable Premium deposit funds Undistributed earnings on participating business Total other contract holder funds regulatory authorities as they review these issues. Series A Preferred Stock Balance at beginning-of-period Conversion into common stock Balance at end-of-period Common Stock Balance at beginning-of-period Conversion of Series A preferred stock Stock compensation(1) Deferred compensation payable in stock Retirement of common stock by repurchase/cancellation of shares Balance at end-of-period Common stock at end-of-period: Assuming conversion of preferred stock Diluted basis Weighted-average shares, as used in basic calculation Shares to cover conversion of preferred stock Shares to cover non-vested stock Average stock options outstanding during the period Assumed acquisition of shares with assumed proceeds and benefits from exercising stock options (at average market price for the year) Shares repurchasable from measured but unrecognized stock option expense Average deferred compensation shares Weighted-average shares, as used in diluted calculation Total realized loss on investments and certain derivative instruments, excluding trading securities(1) Gain (loss) on certain reinsurance derivative/trading securities(2) Indexed annuity net derivative results(3): Gross Associated amortization expense of DAC, VOBA, DSI and DFEL Guaranteed living benefits(4): Gross Associated amortization expense of DAC, VOBA, DSI and DFEL Guaranteed death benefits(5): Gross Associated amortization expense of DAC, VOBA, DSI and DFEL Gain on sale of subsidiaries/businesses Total realized loss (1) See (2) Represents changes in the fair value of total return swaps (embedded derivatives) related to various modified coinsurance and coinsurance with funds withheld reinsurance arrangements that have contractual returns related to various assets and liabilities associated with these arrangements. Changes in the fair value of these derivatives are offset by the change in fair value of trading securities in the portfolios that support these arrangements. (3) Represents the net difference between the change in the fair value of the (4) Represents the net difference in the change in fair value of the embedded derivative liabilities of our GLB products and the change in the fair value of the derivative instruments we own to hedge, including the cost of purchasing the hedging instruments. The (5) Represents the change in the fair value of the derivatives used to hedge our GDB riders. Commissions General and administrative expenses DAC and VOBA deferrals and interest, net of amortization Other intangibles amortization Media expenses Taxes, licenses and fees Merger-related expenses Total Pension and Other Postretirement Benefit Plans U.S. Plans Service cost Interest cost Expected return on plan assets Amortization of prior service cost Recognized net actuarial gain Net periodic benefit expense (recovery) Non-U.S. Plans Service cost Interest cost Expected return on plan assets Recognized net actuarial loss Net periodic benefit expense U.S. Plans Service cost Interest cost Expected return on plan assets Amortization of prior service cost Recognized net actuarial gain Net periodic benefit expense (recovery) Non-U.S. Plans Service cost Interest cost Expected return on plan assets Recognized net actuarial loss Net periodic benefit expense Awards 10-year LNC stock options Non-employee director stock options Non-employee agent stock options Restricted stock Stock appreciation rights valuation methodologies between these periods. Assets Investments: Available-for-sale securities: Fixed maturities Equity Trading securities Derivative instruments Cash and invested cash Separate account assets Total assets Liabilities Future Contract Benefits: Remaining guaranteed interest and similar contracts Embedded derivative instruments – living benefits liabilities Reinsurance related derivative liability Total liabilities Investments: Available-for-sale securities: Fixed maturities Equity Trading securities Derivative instruments Future Contract Benefits: Remaining guaranteed interest and similar contracts Embedded derivative instruments – living benefits liabilities Total, net Investments: Available-for-sale securities: Fixed maturities Equity Trading securities Derivative instruments Future Contract Benefits: Remaining guaranteed interest and similar contracts Embedded derivative instruments – living benefits liabilities Total, net Investments: Available-for-sale securities: Fixed maturities(1) Equity Trading securities(1) Derivative instruments(2) Future Contract Benefits: Remaining guaranteed interest and similar contracts (2) Embedded derivative instruments – living benefits liabilities(2) Total, net Investments: Available-for-sale securities: Fixed maturities(1) Equity Trading securities(1) Derivative instruments(2) Future Contract Benefits: Remaining guaranteed interest and similar contracts (2) Embedded derivative instruments – living benefits liabilities(2) Total, net our derivative instruments. The fair value of Corporate bonds Asset-backed securities Commercial mortgage-backed securities Collateralized mortgage obligations Mortgage pass-through securities Municipals Government and government agencies Redeemable preferred stock Total available-for-sale fixed maturity securities Corporate bonds Asset-backed securities Commercial mortgage-backed securities Collateralized mortgage obligations Mortgage pass-through securities Municipals Government and government agencies Redeemable preferred stock Total available-for-sale fixed maturity securities non-performance risk. business segments. We also have Other Operations, which includes the financial data for operations that are not directly related to the business segments. Our reporting segments reflect the manner by which our chief operating decision makers view and manage the business. The following is a brief description of these segments and Other Operations. run-off. Revenues Operating revenues: Retirement Solutions: Annuities Defined Contribution Total Retirement Solutions Insurance Solutions: Life Insurance Group Protection Total Insurance Solutions Investment Management(1) Lincoln UK(2) Other Operations Excluded realized loss, pre-tax Amortization of deferred gain arising from reserve changes on business sold through reinsurance, pre-tax Total revenues (1) Revenues for the Investment Management segment included inter-segment revenues for asset management services provided to our other segments. These inter-segment revenues totaled (2) Revenues from our Lincoln UK segment represent our revenues from a foreign country. Net Income Income (loss) from operations: Retirement Solutions: Annuities Defined Contribution Total Retirement Solutions Insurance Solutions: Life Insurance Group Protection Total Insurance Solutions Investment Management Lincoln UK Other Operations Excluded realized loss, after-tax Income (loss) from reserve changes (net of related amortization) on business sold through reinsurance, after-tax Impairment of intangibles, after-tax Income from continuing operations, after-tax Income (loss) from discontinued operations, after-tax Net income Significant non-cash investing and financing transactions: Business combinations: Fair value of assets acquired (includes cash and invested cash) Fair value of common stock issued and stock options recognized Cash paid for common shares Liabilities assumed Business dispositions: Assets disposed (includes cash and invested cash) Liabilities disposed Cash received Realized gain on disposal Estimated gain on net assets held-for-sale in prior periods Loss on discontinued operations in current period Sale of subsidiaries/businesses: Proceeds from sale of subsidiaries/businesses, reported as gain on sale of subsidiaries/businesses Short-term debt Long-term debt Financial Condition and Results of Operations Data.” economics of the underlying business and do not reflect the manner in which management evaluates the business. The items that are now excluded from our operating results that were previously included are as follows: GLB net derivatives results; indexed annuity forward-starting option; and GDB derivatives results. For more information regarding this change, see our current report on Form 8-K dated July 16, 2008. details. Business Corresponding Segments These operating businesses and their segments are described in “Part I – Item 1. Business” of our 2008 Form 10-K. expectations or prior periods. OTTI. participate if available. Critical Accounting Policies and Estimates Priced by third party pricing services Priced by independent broker quotations Priced by matrices Priced by other methods (1) Cash and invested cash(2) Total Percent of total Assets Liabilities Insurance fees: Retirement Solutions – Annuities Insurance Solutions – Life Insurance Lincoln UK Total insurance fees Realized gain (loss): Indexed annuity forward-starting option GLB Total realized gain (loss) Total revenues Interest credited: Retirement Solutions – Annuities Total interest credited Benefits: Retirement Solutions – Annuities Insurance Solutions – Life Insurance Total benefits Underwriting, acquisition, insurance and other expenses: Retirement Solutions – Annuities Retirement Solutions – Defined Contribution Insurance Solutions – Life Insurance Lincoln UK Total underwriting, acquisition, insurance and other expenses Total benefits and expenses Income from continuing operations before taxes Federal income taxes Income from continuing operations However, when factors indicate that an impairment could be present, we reassess our conclusions related to goodwill recoverability through completion of an interim test. Subsequent reviews of goodwill could result in impairment of goodwill during 2009. Due to volatile capital markets and their unfavorable impact to our liquidity, earnings and discount rate assumptions and the execution of a reinsurance transaction on our life business, we completed an interim test of goodwill impairment as of March 31, 2009. re-evaluate this conclusion, as needed, based on market conditions. To protect us from a variety of equity market and interest rate risks that are inherent in many of our life insurance and annuity products, we use various derivative instruments. Assessing the effectiveness of these hedging programs and evaluating the carrying values of the related derivatives often involve a variety of assumptions and estimates. We use derivatives to hedge equity market risks, interest rate risk and foreign currency exposures that are embedded in our annuity and life insurance product liabilities or investment portfolios. Derivatives held as of income statement volatility, the hedge program is also focused on a long-term and return trade-off. This hedging strategy is managed on a combined basis with the hedge for our GDB features. Discontinued Operations Before Disposal Media revenues, net of agency commissions Income from discontinued operations before disposal, before federal income taxes Federal income taxes Income from discontinued operations before disposal Disposal Loss on disposal, before federal income taxes Federal income tax benefit Loss on disposal Income (loss) from discontinued operations Dispositions (Loss) Revenues Insurance premiums Insurance fees Investment advisory fees Net investment income Realized loss Amortization of deferred gain on business sold through reinsurance Other revenues and fees Total revenues Benefits and Expenses Interest credited Benefits Underwriting, acquisition, insurance and other expenses Interest and debt expense Impairment of intangibles Total benefits and expenses Income from continuing operations before taxes Federal income taxes Income from continuing operations Income (loss) from discontinued operations, net of federal incomes taxes Net income Revenues Operating revenues: Retirement Solutions: Annuities Defined Contribution Total Retirement Solutions Insurance Solutions: Life Insurance Group Protection Total Insurance Solutions Investment Management Lincoln UK Other Operations Excluded realized loss, pre-tax Amortization of deferred gain arising from reserve changes on business sold through reinsurance, pre-tax Total revenues Net Income Income (loss) from operations: Retirement Solutions: Annuities Defined Contribution Total Retirement Solutions Insurance Solutions: Life Insurance Group Protection Total Insurance Solutions Investment Management Lincoln UK Other Operations Excluded realized loss, after-tax Income (loss) from reserve changes (net of related amortization) on business sold through reinsurance, after-tax Impairment of intangibles, after-tax Income from continuing operations Income (loss) from discontinued operations Net income Deposits Retirement Solutions: Annuities Defined Contribution Insurance Solutions – Life Insurance Investment Management Consolidating adjustments (1) Total deposits Net Flows Retirement Solutions: Annuities Defined Contribution Insurance Solutions – Life Insurance Investment Management Consolidating adjustments (1) Total net flows (1) Consolidating adjustments represents the elimination of deposits and net flows on products affecting more than one segment. Assets Under Management by Advisor Investment Management: External assets Inter-segment assets Lincoln UK Policy loans Assets administered through unaffiliated third parties Total assets under management Operating Revenues Insurance premiums Insurance fees Net investment income Operating realized gain Other revenues and fees Total operating revenues Operating Expenses Interest credited Benefits Underwriting, acquisition, insurance and other expenses Total operating expenses Income from operations before taxes Federal income taxes Income from operations Account Values Variable portion of variable annuities Fixed portion of variable annuities Total variable annuities Fixed annuities, including indexed Fixed annuities ceded to reinsurers Total fixed annuities Total annuities Mutual funds Total annuities and mutual funds Average daily variable account values Average fixed account values, including the fixed portion of variable Operating Revenues Insurance premiums Insurance fees Net investment income Operating realized gain Other revenues and fees(1) Total operating revenues Operating Expenses Interest credited Benefits Underwriting, acquisition, insurance and other expenses Total operating expenses Income from operations before taxes Federal income taxes Income from operations (1) Other revenues and fees consists primarily of broker-dealer earnings that are subject to market volatility. Insurance Fees Mortality, expense and other assessments Surrender charges DFEL: Deferrals Amortization, net of interest: Prospective unlocking – assumption changes Retrospective unlocking Other amortization, net of interest Total insurance fees Account Values Variable portion of variable annuities Fixed portion of variable annuities Total variable annuities Fixed annuities, including indexed Fixed annuities ceded to reinsurers Total fixed annuities Total account values Averages Daily variable account values Daily S&P 500 Index® Net Flows Variable portion of variable annuity deposits Variable portion of variable annuity withdrawals Variable portion of variable annuity net flows Fixed portion of variable annuity deposits Fixed portion of variable annuity withdrawals Fixed portion of variable annuity net flows Total variable annuity deposits Total variable annuity withdrawals Total variable annuity net flows Fixed indexed annuity deposits Fixed indexed annuity withdrawals Fixed indexed annuity net flows Other fixed annuity deposits Other fixed annuity withdrawals Other fixed annuity net flows Total annuity deposits Total annuity withdrawals Total annuity net flows Net Investment Income Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses Commercial mortgage loan prepayment and bond makewhole premiums (1) Alternative investments (2) Surplus investments(3) Broker-dealer Total net investment income Interest Credited Amount provided to contract holders Opening balance sheet adjustment(4) DSI deferrals Interest credited before DSI amortization DSI amortization: Prospective unlocking – assumption changes Prospective unlocking – model refinements Retrospective unlocking Other amortization Total interest credited (1) See “Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond Makewhole Premiums” below for additional information. (2) See “Consolidated Investments – Alternative Investments” below for additional information. (3) Represents net investment income on the required statutory surplus for this segment. Interest Rate Spread Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses Commercial mortgage loan prepayment and bond make whole premiums Alternative investments Net investment income yield on reserves Interest rate credited to contract holders Interest rate spread Average invested assets on reserves Average fixed account values, including the fixed portion of variable Net flows for fixed annuities, including the fixed portion of variable Underwriting, Acquisition, Insurance and Other Expenses Commissions General and administrative expenses Taxes, licenses and fees Total expenses incurred, excluding broker-dealer DAC and VOBA deferrals Total pre-broker-dealer expenses incurred, excluding amortization, net of interest DAC and VOBA amortization, net of interest: Prospective unlocking – assumption changes Prospective unlocking – model refinements Retrospective unlocking Other amortization, net of interest Broker-dealer expenses incurred: Commissions General and administrative expenses Taxes, licenses and fees Total underwriting, acquisition, insurance and other expenses DAC and VOBA deferrals As a percentage of sales/deposits Operating Revenues Insurance fees Net investment income Other revenues and fees Total operating revenues Operating Expenses Interest credited Underwriting, acquisition, insurance and other expenses Total operating expenses Income from operations before taxes Federal income taxes Income from operations For factors that could cause actual results to differ materially from those set forth in this section, see “Part I – Item 1A. Risk Factors” in our Insurance Fees Annuity expense assessments Mutual fund fees Total expense assessments Surrender charges Total insurance fees Average Daily Variable Account Values Average Daily S&P 500 Index® Account Values Variable portion of variable annuities Fixed portion of variable annuities Total variable annuities Fixed annuities Total annuities Mutual funds Total annuities and mutual funds Account Value Roll Forward – By Product Total Micro – Small Segment: Balance at beginning-of-period Gross deposits Withdrawals and deaths Net flows Transfers between fixed and variable accounts Inter-product transfer(1) Investment increase and change in market value Balance at end-of-period Total Mid – Large Segment: Balance at beginning-of-period Gross deposits Withdrawals and deaths Net flows Transfers between fixed and variable accounts Inter-product transfer(1) Investment increase and change in market value Balance at end-of-period TotalMulti-Fund® and Other Variable Annuities: Balance at beginning-of-period Gross deposits Withdrawals and deaths Net flows Transfers between fixed and variable accounts Inter-segment transfer Investment increase and change in market value Balance at end-of-period Total Annuities and Mutual Funds: Balance at beginning-of-period Gross deposits Withdrawals and deaths Net flows Transfers between fixed and variable accounts Inter-segment transfer Investment increase and change in market value Balance at end-of-period(2) (1) (2) Includes mutual fund account values. Mutual funds are not included in the separate accounts reported on our Consolidated Balance Net Flows Variable portion of variable annuity deposits Variable portion of variable annuity withdrawals Variable portion of variable annuity net flows Fixed portion of variable annuity deposits Fixed portion of variable annuity withdrawals Fixed portion of variable annuity net flows Total variable annuity deposits Total variable annuity withdrawals Total variable annuity net flows Fixed annuity deposits Fixed annuity withdrawals Fixed annuity net flows Total annuity deposits Total annuity withdrawals Total annuity net flows Mutual fund deposits Mutual fund withdrawals Mutual fund net flows Total annuity and mutual fund deposits Total annuity and mutual fund withdrawals Total annuity and mutual fund net flows Net Investment Income Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses Commercial mortgage loan prepayment and bond makewhole premiums(1) Alternative investments(2) Surplus investments(3) Total net investment income Interest Credited (1) See “Consolidated Investments – Alternative Investments” below for additional information. Represents net investment income on the required statutory surplus for this segment. Interest Rate Spread Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses Commercial mortgage loan prepayment and bond makewhole premiums Alternative investments Net investment income yield on reserves Interest rate credited to contract holders Interest rate spread Average invested assets on reserves Average fixed account values, including the fixed portion of variable Net flows for fixed annuities, including the fixed portion of variable additional information. Underwriting, Acquisition, Insurance and Other Expenses Commissions General and administrative expenses Taxes, licenses and fees Total expenses incurred DAC deferrals Total expenses recognized before amortization DAC and VOBA amortization, net of interest: Prospective unlocking – assumption changes Retrospective unlocking Other amortization, net of interest Total underwriting, acquisition, insurance and other expenses DAC deferrals As a percentage of sales/deposits amortized. employers. Operating Revenues Insurance premiums Insurance fees Net investment income Other revenues and fees Total operating revenues Operating Expenses Interest credited Benefits Underwriting, acquisition, insurance and other expenses Total operating expenses Income from operations before taxes Federal income taxes Income from operations Insurance Fees Mortality assessments Expense assessments Surrender charges DFEL: Deferrals Amortization, net of interest: Prospective unlocking – assumption changes Prospective unlocking – model refinements Retrospective unlocking Other amortization, net of interest Total insurance fees Sales by Product UL: ExcludingMoneyGuard® MoneyGuard® Total UL VUL COLI and BOLI Term/whole life Total sales Net Flows Deposits Withdrawals and deaths Net flows Contract holder assessments Account Values UL VUL Interest-sensitive whole life Total account values In-Force Face Amount UL and other Term insurance Total in-force face amount · Net Investment Income Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses Commercial mortgage loan prepayment and bond makewhole premiums (1) Alternative investments(2) Surplus investments(3) Total net investment income Interest Credited (1) See “Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond Makewhole Premiums” below for additional information. (2) See “Consolidated Investments – Alternative Investments” below for additional information. (3) Represents net investment income on the required statutory surplus for this segment and includes the impact of investment income on alternative investments for such assets that are held in the surplus portfolios versus the product portfolios. Interest Rate Yields and Spread Attributable to interest sensitive products: Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses Commercial mortgage loan prepayment and bond makewhole premiums Alternative investments Net investment income yield on reserves Interest rate credited to contract holders Interest rate spread Attributable to traditional products: Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses Commercial mortgage loan prepayment and bond makewhole premiums Alternative investments Net investment income yield on reserves Averages Attributable to interest-sensitive products: Invested assets on reserves Account values – universal and whole life Attributable to traditional products: Invested assets on reserves 2009 as a result of the coinsurance agreement with Commonwealth, which reduced these balances by $927 million and $938 million, respectively, on March 31, 2009. Details underlying benefits (dollars in millions) were as follows: Benefits Death claims direct and assumed Death claims ceded Reserves released on death Net death benefits Change in reserves for products with secondary guarantees: Prospective unlocking – assumption changes Prospective unlocking – model refinements Other Other benefits(1) Total benefits Death claims per $1,000 of inforce (1) Other benefits includes primarily traditional product changes in reserves and dividends. our expectations. Underwriting, Acquisition, Insurance and Other Expenses Commissions General and administrative expenses Taxes, licenses and fees Total expenses incurred DAC and VOBA deferrals Total expenses recognized before amortization DAC and VOBA amortization, net of interest: Prospective unlocking – assumption changes Prospective unlocking – model refinements Retrospective unlocking Other amortization, net of interest Other intangible amortization Total underwriting, acquisition, insurance and other expenses DAC and VOBA deferrals As a percentage of sales Insurance Solutions–Group Protection Operating Revenues Insurance premiums Net investment income Other revenues and fees Total operating revenues Operating Expenses Interest credited Benefits Underwriting, acquisition, insurance and other expenses Total operating expenses Income from operations before taxes Federal income taxes Income from operations Income from Operations by Product Line Life Disability Dental Total non-medical Medical Total income from operations Insurance Premiums by Product Line Life Disability Dental Total non-medical Medical Total insurance premiums Sales Benefits and Interest Credited by Product Line Life Disability Dental Total non-medical Medical Total benefits and interest credited Loss Ratios by Product Line Life Disability Dental Total non-medical Medical executives for non-covered health plan costs. This product produces significant revenues and benefits expenses for this segment but only a limited amount of income. Discontinuance of this product would significantly impact segment revenues, but not income from operations. millions. Underwriting, Acquisition, Insurance and Other Expenses Commissions General and administrative expenses Taxes, licenses and fees Total expenses incurred DAC and VOBA deferrals Total expenses recognized before amortization DAC and VOBA amortization, net of interest Total underwriting, acquisition, insurance and other expenses DAC and VOBA Deferrals As a percentage of insurance premiums affiliates. Operating Revenues Investment advisory fees – external Investment advisory fees – inter-segment Other revenues and fees Total operating revenues Operating Expenses Underwriting, acquisition, insurance and other expenses Income from operations before taxes Federal income taxes Income from operations Pre-tax operating margin(1) (1) The pre-tax operating margin is determined by dividing pre-tax income from operations by operating revenues. expenses, due to the assets under management erosion from unfavorable equity market returns and negative net flows experienced during 2008. Assets Under Management Retail – equity Retail – fixed Total retail Institutional – equity Institutional – fixed Total institutional Inter-segment assets – retail and institutional Inter-segment assets – general account Total inter-segment assets Total assets under management Total Sub-Advised Assets, Included Above Retail Institutional Total sub-advised assets Net Flows – External(1) (2) Retail equity sales Retail equity redemptions and transfers Retail equity net flows Retail fixed income sales Retail fixed income redemptions and transfers Retail fixed income net flows Total retail sales Total retail redemptions and transfers Total retail net flows Institutional equity inflows Institutional equity withdrawals and transfers Institutional equity net flows Institutional fixed income inflows Institutional fixed income withdrawals and transfers Institutional fixed income net flows Total institutional inflows Total institutional redemptions and transfers Total institutional net flows Total sales/inflows Total redemptions and transfers Total net flows (1) Includes Delaware Variable Insurance Product Includes net flows from retail and institutional. Excludes Net Flows – Inter-Segment(1) Total sales/inflows (2) Total redemptions and transfers(3) Total net flows Includes contributions, dividend reinvestments and transfers in kind. (3) Includes dividends and capital gains distributions. Average daily S&P 500 Index® Operating Revenues Insurance premiums Insurance fees Net investment income Total operating revenues Operating Expenses Benefits Underwriting, acquisition, insurance and other expenses Total operating expenses Income from operations before taxes Federal income taxes Income from operations Exchange Rate Ratio-U.S. Dollars to Pounds Sterling Average for the period End-of-period line items and their associated drivers below. Insurance Fees Mortality assessments Expense assessments DFEL: Deferrals Amortization, net of interest: Prospective unlocking – assumption changes Prospective unlocking – model refinements Retrospective unlocking Other amortization, net of interest Total insurance fees Individual life insurance in force Unit-Linked Assets Balance at beginning-of-period Deposits Withdrawals and deaths Net flows Investment income and change in market value Foreign currency adjustment Balance at end-of-period Underwriting, Acquisition, Insurance and Other Expenses Commissions General and administrative expenses Total expenses incurred DAC and VOBA deferrals Total expenses recognized before amortization DAC and VOBA amortization, net of interest: Prospective unlocking – assumption changes Prospective unlocking – model refinements Retrospective unlocking Other amortization, net of interest Total underwriting, acquisition, insurance and other expenses Operating Revenues Insurance premiums Net investment income Amortization of deferred gain on business sold through reinsurance Media revenues (net) Other revenues and fees Inter-segment elimination of investment advisory fees Total operating revenues Operating Expenses Interest credited Benefits Media expenses Other expenses Interest and debt expenses Inter-segment elimination of investment advisory fees Total operating expenses Loss from operations before taxes Federal income taxes Loss from operations Loss from operations for this segment increased due primarily to the following: disability income business. Other Expenses Merger-related expenses Branding Retirement Income Security Ventures Taxes, licenses and fees Other Total other expenses the current economic downturn and sustained market volatility, which focused on reducing expenses. The expenses associated with this initiative are reported in restructuring charges for expense initiatives above. During the fourth quarter of 2008, we recorded a pre-tax charge of $8 million and expect our cumulative pre-tax charges to amount to approximately $40 million for severance, benefits and related costs associated with the plan for workforce reduction and other restructuring actions. Operating realized gain: Indexed annuity net derivatives results GLB GDB hedge cost Total operating realized gain Realized loss related to certain investments Gain (loss) on certain reinsurance derivative/trading securities GLB net derivatives results GDB derivatives results Indexed annuity forward-starting option Gain on sale of subsidiaries/businesses Total excluded realized loss Total realized loss Operating realized gain: Indexed annuity net derivatives results GLB GDB hedge cost Total operating realized gain Realized loss related to certain investments Gain (loss) on certain reinsurance derivative/trading securities GLB net derivatives results GDB derivative results Indexed annuity forward-starting option Gain on sale of subsidiaries/businesses Total excluded realized loss Total realized loss (1) DAC refers to the associated amortization Indexed Annuity Net Derivatives Results Change in fair value of S&P 500 Index® call options Change in fair value of embedded derivatives Associated amortization expense of DAC, VOBA, DSI and DFEL Total indexed annuity net derivatives results GLB Attributed fee in excess of the net valuation premium Associated amortization expense of DAC, VOBA, DSI and DFEL: Retrospective unlocking(2) Other amortization Total GLB GDB hedge cost Pre-DAC(1) amount Associated amortization expense of DAC, VOBA, DSI and DFEL: Retrospective unlocking(2) Other amortization Total GDB hedge cost Total Operating Realized Gain (1) DAC refers to the associated amortization of (2) Related primarily to the emergence of gross profits. GLB GLB Net Derivatives Results Net valuation premium, net of reinsurance Change in reserves hedged : Prospective unlocking – assumption changes Prospective unlocking – model refinements Other Change in market value of derivative assets Hedge program ineffectiveness Change in reserves not hedged (NPR Component) Associated amortization expense of DAC, VOBA, DSI and DFEL: Prospective unlocking – assumption changes Retrospective unlocking(2) Other amortization Loss from the initial impact of adopting SFAS 157, after-DAC(1) Total GLB net derivatives results GDB Derivatives Results Benefit ratio unlocking of SOP 03-1 reserves Change in fair value of derivatives, excluding expected cost of hedging instruments Associated amortization expense of DAC, VOBA, DSI and DFEL: Retrospective unlocking(2) Other amortization Total GDB derivatives results Related primarily to the emergence of gross profits. hedging instruments. The GDB. See additional information. Indexed Annuity Forward-Starting Option Pre-DAC(1) amounts: Prospective unlocking – assumption changes Other Associated amortization expense of DAC, VOBA, DSI and DFEL Gain from the initial impact of adopting SFAS 157, after-DAC(1) Total (1) DAC refers to the associated amortization of expense of DAC, VOBA, DSI and DFEL. Investments Available-for-sale securities: Fixed maturity Equity Trading securities Mortgage loans on real estate Real estate Policy loans Derivative instruments Alternative investments Other investments Total investments 5. Fixed Maturity Available-For-Sale Securities Corporate bonds: Financial services Basic industry Capital goods Communications Consumer cyclical Consumer non-cyclical Energy Technology Transportation Industrial other Utilities Asset-backed securities: Collateralized debt obligations and credit-linked notes Commercial real estate collateralized debt obligations Credit card Home equity Manufactured housing Auto loan Other Commercial mortgage-backed securities: Non-agency backed Collateralized mortgage obligations: Agency backed Non-agency backed Mortgage pass-throughs: Agency backed Non-agency backed Municipals: Taxable Tax-exempt Government and government agencies: United States Foreign Redeemable preferred stock Total available-for-sale – fixed maturity Equity Available-For-Sale Securities Total available-for-sale securities Trading Securities(1) Total available-for-sale and trading securities Fixed Maturity Available-For-Sale Securities Corporate bonds: Financial services Basic industry Capital goods Communications Consumer cyclical Consumer non-cyclical Energy Technology Transportation Industrial other Utilities Asset-backed securities: Collateralized debt obligations and credit-linked notes Commercial real estate collateralized debt obligations Mortgage-backed securities collateralized debt obligations Credit card Home equity Manufactured housing Auto loan Other Commercial mortgage-backed securities: Non-agency backed Collateralized mortgage obligations: Agency backed Non-agency backed Mortgage pass-throughs: Agency backed Non-agency backed Municipals: Taxable Tax-exempt Government and government agencies: United States Foreign Redeemable preferred stock Total available-for-sale – fixed maturity Equity Available-For-Sale Securities Total available-for-sale securities Trading Securities(1) Total available-for-sale and trading securities (1) Our trading securities support our modified coinsurance arrangements (“Modco”) and the investment results are passed directly to the reinsurers. Refer NAIC Designation Rating Agency Equivalent Designation Investment Grade Securities Below Investment Grade Securities Total securities Securities below investment grade as a % of total fixed maturity available-for-sale securities 2008. Type Collateralized mortgage obligations and pass-throughs Asset-backed securities home equity Total(1) Rating AAA AA A BBB BB and below Total(1) Origination Year 2004 and prior 2005 2006 2007 Total(1) (1) Type Collateralized mortgage obligations and pass throughs Asset-backed securities home equity Total(1) Rating AAA AA A BBB BB and below Total(1) Origination Year 2004 and prior 2005 2006 2007 Total(1) (2) Rating AAA AA BBB Total(2) (1) (2) Type Commercial mortgage-backed securities Commercial real estate collateralized debt obligations Total(1) Rating AAA AA A BBB BB and below Total(1) Origination Year 2004 and prior 2005 2006 2007 Total(1) (1) Does not include the fair value of trading securities totaling Monoline Name AMBAC ASSURED GUARANTY LTD FGIC FSA MBIA MGIC PMI GROUP INC RADIAN GROUP INC SECURITY CAPITAL ASSURANCE LTD XL CAPITAL LTD Total(2) (1) Additional direct exposure through credit default swaps with a notional totaling $50 million is excluded from this table. Does not include the fair value of trading securities totaling Fair value Amortized cost Fair value to amortized cost ratio Industry Telecommunications Financial intermediaries Oil and gas Insurance Utilities Chemicals and plastics Retailers, except food and drug Industrial equipment Sovereigns Other industry < 4% (32 industries) Total 5. Non-captive diversified Banking Gaming Property and casualty Non-captive consumer Food and beverage Financial – other Real estate investment trusts Consumer cyclical services Entertainment Building materials Brokerage Collateralized mortgage obligations Media – non-cable ABS Total Property and casualty Collateralized mortgage obligations Commercial mortgage-backed securities ABS Non-captive consumer Banking Consumer cyclical services Total ABS Banking Collateralized mortgage obligations Commercial mortgage-backed securities Electric Non-captive diversified Pipelines Property and casualty insurers Brokerage Non-captive consumer Food and beverage Real estate investment trusts Distributors Retailers Wirelines Financial – other Paper Metals and mining Media – non-cable Gaming Independent Life Diversified manufacturing Home construction Integrated Entertainment Building materials Owned no guarantee Transportation services Chemicals Pharmaceuticals Technology Automotive Refining Health insurance Sovereigns Wireless (Continued from Above) Industrial other Non agency Oil field services Railroads Consumer products Healthcare Airlines Utility – other Media – cable Unassigned Packaging Industries with unrealized losses less than $10 Total ABS Banking Collateralized mortgage obligations Commercial mortgage-backed securities Electric Property and casualty insurers Non-captive diversified Home construction Media – non-cable Retailers Non-captive consumer Pipelines Real estate investment trusts Paper Financial – other Brokerage Gaming Distributors Food and beverage Metals and mining Building materials Automotive Industries with unrealized losses less than $10 Total March 31, 2009. Aging Category Ratio of < or = 90 days < or = 90 days total >90 days but < or = 180 days >90 days but < or = 180 days total >180 days but < or = 270 days >180 days but < or = 270 days total >270 days but < or = 1 year >270 days but < or = 1 year total >1 year >1 year total Total below-investment-grade Aging Category Ratio of < or = 90 days < or = 90 days total >90 days but < or = 180 days >90 days but < or = 180 days total >180 days but < or = 270 days >180 days but < or = 270 days total >270 days but < or = 1 year >270 days but < or = 1 year total >1 year >1 year total Total below-investment-grade Average Length of Time in Loss Position Investment Grade Credit-linked notes Credit-linked notes Domestic bank and finance Domestic bank and finance Domestic brokerage UK bank and finance Domestic bank and finance Domestic finance Domestic brokerage Domestic bank and finance Domestic bank and finance International technology and services Domestic finance Mortgage related ABS Domestic bank and finance Domestic bank and finance Domestic bank and finance Domestic brokerage Domestic finance Mortgage related MBS UK bank and finance International communications International aircraft leasing Domestic bank and finance Domestic bank and finance UK bank and finance International beverage Mortgage related MBS Mortgage related MBS Domestic bank and finance Mortgage related ABS Property and casualty insurance International bank and finance International forestry Mortgage related MBS International real estate Domestic bank and finance UK bank and finance Property and casualty insurance Domestic retailer International finance Mortgage related MBS Domestic energy International energy Mortgage related MBS Length of Time in Loss Position (Continued from Above) Investment Grade Total investment grade Length of Time in Loss Position Non Investment Grade Domestic bank and finance Domestic entertainment Mortgage related MBS Domestic homebuilding Domestic homebuilding Mortgage related MBS Mortgage related MBS Mortgage related MBS Mortgage related ABS International communications Mortgage related MBS International forestry Mortgage related ABS Total non investment grade Property Type Office Building Industrial Retail Apartment Hotel/Motel Mixed Use Other Commercial Geographic Region New England Middle Atlantic East North Central West North Central South Atlantic East South Central West South Central Mountain Pacific Retirement Solutions: Annuities Defined Contribution Products Insurance Solutions: Life Insurance Group Protection Other Operations Total alternative investments Retirement Solutions: Annuities Defined Contribution Products Insurance Solutions: Life Insurance Group Protection Other Operations Total alternative investments (1) (1) Includes net investment income on the alternative investments supporting the required statutory surplus of our insurance businesses. energy limited partnership holdings. Net Investment Income Fixed maturity available-for-sale securities Equity available-for-sale securities Trading securities Mortgage loans on real estate Real estate Standby real estate equity commitments Policy loans Invested cash Commercial mortgage loan prepayment and bond makewhole premiums (1) Alternative investments (2) Consent fees Other investments Investment income Investment expense Net investment income (1) See “Commercial Mortgage Loan Prepayment and Bond Makewhole Premiums” below for additional information. (2) See “Alternative Investments” above for additional information. Interest Rate Yield Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses Commercial mortgage loan prepayment and bond makewhole premiums Alternative investments Consent fees Standby real estate equity commitments Net investment income yield on invested assets Average invested assets at amortized cost $3 million and the fair value of the associated real estate is included on our Consolidated Balance Sheets. We did not fund any commitments during the three months ended March 31, 2008. Fixed maturity available-for-sale securities: Gross gains Gross losses Equity available-for-sale securities: Gross gains Gross losses Gain on other investments Associated amortization expense of DAC, VOBA, DSI and DFEL and changes in other contract holder funds Total realized gain (loss) on investments, excluding trading securities Gain (loss) on certain derivative instruments Associated amortization expense of DAC, VOBA, DSI and DFEL and changes in other contract holder funds Total realized gain (loss) on investments and certain derivative instruments, excluding trading securities Write-downs for other-than-temporary impairments included in realized loss on available-for-sale securities above are considered temporary until such losses are recovered, the dynamic nature of portfolio management may result in a subsequent decision to sell. These subsequent decisions are consistent with the classification of our investment portfolio as Other-Than-Temporary Impairments Corporate bonds Redeemable Preferred Stock Mortgage-backed securities Total fixed maturity securities Equity securities Total other-than-temporary impairments sell. rescission. equity markets, interest rates and volatility associated with the guaranteed benefit features of these variable annuity Dividends from Subsidiaries LNL First Penn-Pacific Lincoln Financial Media(1) Delaware Investments Other non-regulated companies(2) Lincoln UK Loan Repayments and Interest from Subsidiary LNL interest on intercompany notes(3) Other Cash Flow and Liquidity Items Net capital received from stock option exercises (1) For (2) We anticipate that the dividend capacity of our insurance subsidiaries will be substantially constrained for the remainder of 2009. The market value of our separate account assets increased in the first quarter of 2009, resulting in an $18 million increase in statutory surplus. The separate accounts include the impact of our variable annuities and also our credit-linked notes. However, our separate account assets remained less than the guaranteed liabilities that they support as of March 31, 2009. Future declines in the market values of our separate account assets could cause future reductions in the surplus of LNL, which may impact its RBC ratio and dividend capacity. until June 2008. These reinsurance arrangements serve to reduce LNL’s exposure to changes in the statutory reserves associated with changes in the equity 2009. Short-Term Debt Commercial paper Current maturities of long-term debt Total short-term debt Long-Term Debt Senior notes Junior subordinated debentures issued to affiliated trusts Capital securities Total long-term debt (1) Expiration Revolving Credit Facilities Credit facility with Federal Home Loan Bank of Indianapolis(1) Five-year revolving credit facility Five-year revolving credit facility Five-year revolving credit facility U.K. revolving credit facility Total Letters of credit issued (1) Our borrowing capacity under this credit facility does not have an expiration date and continues while our investment in the Federal Home Loan Bank of Indianapolis (“FHLBI”) common stock remains outstanding. The maturity dates of the borrowings are discussed below. clients of the business sold through reinsurance. investment products. pay interest on our capital securities with proceeds from the issuance of qualifying securities if we fail to achieve capital adequacy or net income and shareholders’ equity levels” and Note 13 in our 2008 Form 10-K. its most recent year end. The balance as of March 31, 2009, was $392 million. differ materially from those set forth in this section, see “Part I – Item 1A. Risk Factors” in our 2008 Form 10-K, as updated in “Part II – Item 1A. Risk Factors” below, and “Forward-Looking Statements – Cautionary Language” in this report. Note 3. For the Year Ended Dividends to stockholders Repurchase of common stock Total cash returned to stockholders Number of shares repurchased Average price per share millions. prospectively in light of the recent market volatility and extraordinary events and developments affecting financial markets. below. Excess of Crediting Rates over Contract Minimums CD and on-benefit type annuities Discretionary rate setting products(1) No difference up to .10% 0.11% to .20% 0.21% to .30% 0.31% to .40% 0.41% to .50% 0.51% to .60% 0.61% to .70% 0.71% to .80% 0.81% to .90% 0.91% to 1.0% 1.01% to 1.50% 1.51% to 2.00% 2.01% to 2.50% 2.51% to 3.00% 3.01% and above Total discretionary rate setting products Total account values Segment Relevant Measure (1) contract holders. Credit default swaps are derivatives that can be used by companies to hedge against a drop in bond prices due to credit concerns of certain bond issuers. A credit default swap allows an investor to put the bond back to the counterparty at par upon a credit event by the bond issuer. A credit event can include, among other items, bankruptcy, failure to pay or obligation acceleration. Wecan use various credit-related derivatives to minimize exposure to various credit-related risks. As of to us. December 31, 2008, our fair value of counterparty exposure (in millions) was as follows: . Legal Proceedings The risk cause us to lean more heavily on our inter-company borrowing facility and to access our bank credit lines. In the event that current resources do not satisfy our current needs, we may have to seek additional Period 7/1/08 - 7/31/08 8/1/08 - 8/31/08 9/1/08 - 9/30/08 (1) Of the total number of shares purchased, no shares were received in connection with the exercise of stock options and related taxes and (2) On February 23, 2007, our Board approved a $2 billion increase to our securities repurchase authorization, bringing the total authorization at that time to $2.6 billion. As of (3) As of the last day of the applicable month. Exhibits Exhibit 12.1 31.1 31.2 32.1 32.2x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 September 30, 2008.March 31, 2009¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 . Indiana 35-1140070 (I.R.S. EmployerIdentification No.)150 N. Radnor Chester Road, Radnor, Pennsylvania 19087 (Address of principal executive offices) (Zip Code) report)registrant:registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨non- acceleratednon-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check (Check one):November 3, 2008,May 4, 2009, there were 255,881,396256,087,959 shares of the registrant’s common stock outstanding.Item 1.Financial Statements As of
September 30,
2008 As of
December 31,
2007 (Unaudited) $ 51,931 $ 56,276 493 518 2,393 2,730 7,688 7,423 127 258 2,870 2,885 1,262 807 1,193 1,075 67,957 71,972 2,160 1,665 11,652 9,580 463 401 921 843 8,222 8,187 4,041 4,144 2,884 3,530 74,971 91,113 $ 173,271 $ 191,435 $ 16,281 $ 16,007 60,678 59,640 635 550 4,569 4,618 (9 ) 220 2,062 2,117 639 696 1,668 1,135 2,277 3,621 74,971 91,113 163,771 179,717 — — 7,006 7,200 4,304 4,293 (1,810 ) 225 9,500 11,718 $ 173,271 $ 191,435 As of As of March 31, December 31, 2009 2008 (Unaudited) ASSETS Investments: Available-for-sale securities, at fair value: Fixed maturity (amortized cost: 2009 - $55,876; 2008 - $55,194) $ 49,349 $ 48,935 Equity (cost: 2009 - $464; 2008 - $466) 205 288 Trading securities 2,246 2,333 Mortgage loans on real estate 7,616 7,715 Real estate 129 125 Policy loans 2,908 2,924 Derivative investments 2,226 3,397 Other investments 1,476 1,624 Total investments 66,155 67,341 Cash and invested cash 5,613 5,926 Deferred acquisition costs and value of business acquired 11,922 11,936 Premiums and fees receivable 489 481 Accrued investment income 881 832 Reinsurance recoverables 8,033 8,450 Reinsurance related derivative assets 107 31 Goodwill 3,344 3,944 Other assets 3,396 3,562 Separate account assets 57,487 60,633 Total assets $ 157,427 $ 163,136 LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Future contract benefits $ 18,836 $ 19,260 Other contract holder funds 61,525 60,847 Short-term debt 1,436 815 Long-term debt 4,345 4,731 Funds withheld reinsurance liabilities 1,215 2,042 Deferred gain on business sold through reinsurance 548 619 Payables for collateral under securities loaned and derivatives 2,386 3,706 Other liabilities 2,326 2,506 Separate account liabilities 57,487 60,633 Total liabilities 150,104 155,159 Contingencies and Commitments (See Note 11) Stockholders' Equity Series A preferred stock - 10,000,000 shares authorized - - Common stock - 800,000,000 shares authorized; 256,046,103 and 255,869,859 shares issued and outstanding as of March 31, 2009, and December 31, 2008, respectively 7,033 7,035 Retained earnings 3,265 3,745 Accumulated other comprehensive loss (2,975 ) (2,803 ) Total stockholders' equity 7,323 7,977 Total liabilities and stockholders' equity $ 157,427 $ 163,136 1 For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 2008 2007 (Unaudited) $ 533 $ 491 $ 1,572 $ 1,439 791 836 2,446 2,342 68 89 220 272 1,089 1,062 3,231 3,285 (204 ) (65 ) (347 ) (24 ) 19 19 57 65 140 169 431 514 2,436 2,601 7,610 7,893 625 611 1,849 1,817 836 623 2,199 1,866 754 850 2,408 2,475 69 69 209 204 — — 175 — 2,284 2,153 6,840 6,362 152 448 770 1,531 3 125 203 450 149 323 567 1,081 (1 ) 7 (5 ) 21 $ 148 $ 330 $ 562 $ 1,102 $ 0.58 $ 1.20 $ 2.20 $ 3.98 — 0.02 (0.02 ) 0.08 $ 0.58 $ 1.22 $ 2.18 $ 4.06 $ 0.58 $ 1.19 $ 2.18 $ 3.93 — 0.02 (0.02 ) 0.07 $ 0.58 $ 1.21 $ 2.16 $ 4.00 For the Three Months Ended March 31, 2009 2008 (Unaudited) Revenues Insurance premiums $ 518 $ 509 Insurance fees 728 814 Investment advisory fees 44 76 Net investment income 1,027 1,065 Realized loss: Total other-than-temporary impairment losses on securities (214 ) (57 ) Portion of loss recognized in other comprehensive income 89 - Net other-than-temporary impairment losses on securities recognized in earnings (125 ) (57 ) Realized gain (loss), excluding other-than-temporary impairment losses on securities (68 ) 22 Total realized loss (193 ) (35 ) Amortization of deferred gain on business sold through reinsurance 19 19 Other revenues and fees 102 146 Total revenues 2,245 2,594 Benefits and Expenses Interest credited 627 612 Benefits 939 679 Underwriting, acquisition, insurance and other expenses 725 809 Interest and debt expense - 76 Impairment of intangibles 603 - Total benefits and expenses 2,894 2,176 Income (loss) from continuing operations before taxes (649 ) 418 Federal income tax expense (benefit) (70 ) 125 Income (loss) from continuing operations (579 ) 293 Loss from discontinued operations, net of federal incomes taxes - (4 ) Net income (loss) $ (579 ) $ 289 Earnings Per Common Share - Basic Income (loss) from continuing operations $ (2.27 ) $ 1.13 Loss from discontinued operations - (0.02 ) Net income (loss) $ (2.27 ) $ 1.11 Earnings Per Common Share - Diluted Income (loss) from continuing operations $ (2.27 ) $ 1.12 Loss from discontinued operations - (0.02 ) Net income (loss) $ (2.27 ) $ 1.10 2 For the Nine
Months Ended
September 30, 2008 2007 (Unaudited) $ — $ 1 — 1 7,200 7,449 — 20 51 113 4 5 (249 ) (278 ) 7,006 7,309 4,293 4,138 — (41 ) — (15 ) (4 ) — (1,473 ) 686 (2,035 ) (416 ) 562 1,102 (227 ) (408 ) (320 ) (320 ) 4,304 4,456 86 493 (1,990 ) (437 ) (1,904 ) 56 53 39 1 (7 ) 54 32 175 165 (54 ) 29 121 194 (89 ) (84 ) 8 (1 ) (81 ) (85 ) $ 9,500 $ 11,963 For the Three Months Ended March 31, 2009 2008 (Unaudited) Common Stock Balance at beginning-of-year $ 7,035 $ 7,200 Stock compensation/issued for benefit plans (5 ) 21 Deferred compensation payable in stock 3 3 Retirement of common stock/cancellation of shares - (149 ) Balance at end-of-period 7,033 7,075 Retained Earnings Balance at beginning-of-year 3,745 4,293 Cumulative effect of adoption of EITF 06-10 - (4 ) Cumulative effect of adoption of FSP 115-2 102 - Comprehensive loss (649 ) (258 ) Less other comprehensive loss, net of tax (70 ) (547 ) Net income (loss) (579 ) 289 Retirement of common stock - (137 ) Dividends declared: Common (2009 - $0.010; 2008 - $0.415) (3 ) (108 ) Balance at end-of-period 3,265 4,333 Net Unrealized Loss on Available-for-Sale Securities Balance at beginning-of-year (2,654 ) 86 Cumulative effect of adoption of FSP 115-2 (84 ) Change during the period 39 (538 ) Balance at end-of-period (2,699 ) (452 ) Balance at beginning-of-year - - Cumulative effect of adoption of FSP 115-2 (18 ) - Change during the period (58 ) - Balance at end-of-period (76 ) - Net Unrealized Gain on Derivative Instruments Balance at beginning-of-year 127 53 Change during the period (69 ) (9 ) Balance at end-of-period 58 44 Foreign Currency Translation Adjustment Balance at beginning-of-year 6 175 Change during the period 17 (1 ) Balance at end-of-period 23 174 Funded Status of Employee Benefit Plans Balance at beginning-of-year (282 ) (89 ) Change during the period 1 1 Balance at end-of-period (281 ) (88 ) Total stockholders' equity at end-of-period $ 7,323 $ 11,086 3 For the Nine
Months Ended
September 30, 2008 2007 (Unaudited) $ 562 $ 1,102 (838 ) (907 ) 141 319 47 1 (78 ) (50 ) 159 113 548 1,033 (57 ) (125 ) (228 ) 358 347 24 13 — 175 — (57 ) (65 ) 23 39 54 288 249 1,028 811 2,130 (5,578 ) (10,740 ) 1,803 6,456 2,978 3,162 (1,848 ) (1,849 ) 1,383 1,617 533 (184 ) 645 — (90 ) (75 ) (174 ) (1,613 ) (285 ) (653 ) 450 1,050 (145 ) 226 7,366 7,030 (4,373 ) (5,805 ) (1,838 ) (1,732 ) (550 ) — 32 81 (476 ) (686 ) (323 ) (323 ) (142 ) (812 ) 495 (295 ) 1,665 1,621 $ 2,160 $ 1,326 For the Three Months Ended March 31, 2009 2008 Cash Flows from Operating Activities (Unaudited) Net income (loss) $ (579 ) $ 289 Adjustments to reconcile net income to net cash provided by operating activities: Deferred acquisition costs, value of business acquired, deferred sales inducements and deferred front end loads deferrals and interest, net of amortization (100 ) (169 ) Trading securities purchases, sales and maturities, net 37 12 Change in premiums and fees receivable 37 (34 ) Change in accrued investment income (49 ) (74 ) Change in future contract benefits (233 ) 299 Change in other contract holder funds (2 ) 24 Change in funds withheld reinsurance liability and reinsurance recoverables (170 ) (170 ) Change in federal income tax accruals 36 (74 ) Realized loss 193 35 Loss on disposal of discontinued operations - 12 Impairment of intangibles 603 - Amortization of deferred gain on business sold through reinsurance (19 ) (19 ) Stock-based compensation expense 6 12 Other (39 ) (45 ) Net cash provided by (used in) operating activities (279 ) 98 Cash Flows from Investing Activities Purchases of available-for-sale securities (2,719 ) (1,599 ) Sales of available-for-sale securities 1,242 300 Maturities of available-for-sale securities 731 888 Purchases of other investments (1,201 ) (713 ) Sales or maturities of other investments 2,411 596 Increase (decrease) in payables for collateral under securities loaned and derivatives (1,320 ) 661 Proceeds from sale of subsidiaries/businesses and disposal of discontinued operations 2 642 Other (16 ) (13 ) Net cash provided by (used in) investing activities (870 ) 762 Cash Flows from Financing Activities Payment of long-term debt, including current maturities (87 ) (100 ) Increase (decrease) in commercial paper, net 371 (54 ) Deposits of fixed account values, including the fixed portion of variable 2,612 2,403 Withdrawals of fixed account values, including the fixed portion of variable (1,590 ) (1,434 ) Transfers to and from separate accounts, net (408 ) (509 ) Common stock issued for benefit plans and excess tax benefits (8 ) 12 Repurchase of common stock - (286 ) Dividends paid to stockholders (54 ) (110 ) Net cash provided by (used in) financing activities 836 (78 ) Net increase (decrease) in cash and invested cash (313 ) 782 Cash and invested cash at beginning-of-year 5,926 1,665 Cash and invested cash at end-of-period $ 5,613 $ 2,447 417.16. The collective group of businesses uses “Lincoln Financial Group” as its marketing identity. Through our business segments, we sell a wide range of wealth protection, accumulation and retirement income products. These products include institutional and/or retail fixed and indexed annuities, variable annuities, universal life (“UL”) insurance, variable universal life (“VUL”) insurance, term life insurance, mutual funds and managed accounts.20072008 (“20072008 Form 10-K”), should be read in connection with the reading of these interim unaudited consolidated financial statements.and nine month periodsperiod ended September 30, 2008,March 31, 2009, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2008.2009. All material intercompany accounts and transactions have been eliminated in consolidation.future contract benefitsholder funds (previously reported within benefits) have also been reclassified to realized loss.prior periodMarch 31, 2008, financial statements (in millions) was as follows: For the
Three Months
Ended
September 30,
2007 For the
Nine Months
Ended
September 30,
2007 $ (37 ) $ (15 ) 16 47 5 41 (15 ) (44 ) (55 ) (57 ) 21 4 $ (65 ) $ (24 ) 5 For the Three Months Ended March 31, 2008 Realized loss, as previously reported $ (38 ) Effect of reclassifications to: Insurance fees 32 Net investment income (97 ) Interest credited 102 Benefits (13 ) Underwriting, acquisition, insurance and other expenses (21 ) Realized loss, as adjusted $ (35 ) 157141(R) – Fair Value MeasurementsSeptember 2006,December 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value under current accounting pronouncements that require or permit fair value measurement and enhances disclosures about fair value instruments. SFAS 157 retains the exchange price notion, but clarifies that exchange price is the price in an orderly transaction between market participants to sell the asset or transfer the liability (exit price) in the principal market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the price that would be paid to acquire the asset or receive a liability (entry price). Fair value measurement is based on assumptions used by market participants in pricing the asset or liability, which may include inherent risk, restrictions on the sale or use of an asset or non-performance risk, which would include the reporting entity’s own credit risk. SFAS 157 establishes a three-level fair value hierarchy, which prioritizes the inputs to valuation techniques used to measure fair value. The three-level hierarchy for fair value measurement is defined as follows:Level 1 – inputs to the valuation methodology are quoted prices available in active markets for identical investments as of the reporting date. “Blockage discounts” for large holdings of unrestricted financial instruments where quoted prices are readily and regularly available for an identical asset or liability in an active market are prohibited;Level 2 – inputs to the valuation methodology are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value can be determined through the use of models or other valuation methodologies; andLevel 3 – inputs to the valuation methodology are unobservable inputs in situations where there is little or no market activity for the asset or liability and the reporting entity makes estimates and assumptions related to the pricing of the asset or liability, including assumptions regarding risk.In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the investment.We have certain guaranteed benefit features within our annuity products that, prior to January 1, 2008, were recorded using fair value pricing. These benefits will continue to be measured on a fair value basis with the adoption of SFAS 157, utilizing Level 3 inputs and some Level 2 inputs, which are reflective of the hypothetical market participant perspective for fair value measurement, including liquidity assumptions and assumptions regarding the Company’s own credit or non-performance risk. In addition, SFAS 157 expands the disclosure requirements for annual and interim reporting to focus on the inputs used to measure fair value, including those measurements using significant unobservable inputs and the effects of the measurements on earnings. See Note 16 for additional information.6We adopted SFAS 157 effective January 1, 2008, by recording increases (decreases) to the following categories (in millions) on our consolidated financial statements: $ 13 (8 ) 2 $ 7 $ (20 ) 48 3 (8 ) $ 23 $ (24 ) (8 ) $ (16 ) The impact for the first quarter adoption of SFAS 157 to basic and diluted per share amounts was a decrease of $0.06.FASB Staff Position No. FAS 157-2– Effective Date of FASB Statement No. 157In February 2008, the FASB issued FASB Staff Position (“FSP”) No. FAS 157-2, “Effective Date of FASB Statement No. 157” (“FSP 157-2”). FSP 157-2 delays the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Accordingly, we did not apply the provisions of SFAS 157 to nonfinancial assets and nonfinancial liabilities within the scope of FSP 157-2. Examples of items to which the deferral is applicable include, but are not limited to:Nonfinancial assets and nonfinancial liabilities initially measured at fair value in a business combination or other new basis event, but not measured at fair value in subsequent periods;Reporting units measured at fair value in the goodwill impairment test under SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), and indefinite-lived intangible assets measured at fair value for impairment assessment under SFAS 142;Nonfinancial long-lived assets measured at fair value for an impairment assessment under SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”;Asset retirement obligations initially measured at fair value under SFAS No. 143, “Accounting for Asset Retirement Obligations”; andNonfinancial liabilities for exit or disposal activities initially measured at fair value under SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.”FASB Staff Position No. FAS 157-3 – Determining the Fair Value of a Financial Asset When the Market for That Asset is Not ActiveIn October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active” (“FSP 157-3”). FSP 157-3 clarifies the application of SFAS 157 in a market that is not active and provides an illustrative example of key considerations to analyze in determining fair value of a financial asset when the market for the asset is not active. During times when there is little market activity for a financial asset, the objective of fair value measurement remains the same, that is, to value the asset at the price that would be received by the holder of the financial asset in an orderly transaction (exit price) that is not a forced liquidation or distressed sale at the measurement date. Determining fair value of a financial asset during a period of market inactivity may require the use of significant judgment and an evaluation of the facts and circumstances to determine if transactions for a financial asset represent a forced liquidation or distressed sale. An entity’s own assumptions regarding future cash flows and risk-adjusted discount rates for financial assets are acceptable when relevant observable inputs are not available. FSP 157-3 was effective on October 10, 2008, and for all prior periods for which financial statements have not been issued. Any changes in valuation techniques resulting from the adoption of FSP 157-3 shall be accounted for as a change in accounting estimated in accordance with SFAS No. 154, “Accounting Changes and Error Corrections.” We adopted the guidance7in FSP 157-3 in our financial statements for the reporting period ending September 30, 2008. The adoption did not have a material impact on our consolidated financial condition or results of operations.SFAS No. 159 – The Fair Value Option for Financial Assets and Financial LiabilitiesIn February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”), which allows an entity to make an irrevocable election, on specific election dates, to measure eligible items at fair value. The election to measure an item at fair value may be determined on an instrument by instrument basis, with certain exceptions. If the fair value option is elected, unrealized gains and losses will be recognized in earnings at each subsequent reporting date, and any upfront costs and fees related to the item will be recognized in earnings as incurred. In addition, the presentation and disclosure requirements of SFAS 159 are designed to assist in the comparison between entities that select different measurement attributes for similar types of assets and liabilities. SFAS 159 applies to fiscal years beginning after November 15, 2007, with early adoption permitted for an entity that has also elected to apply the provisions of SFAS 157. At the effective date, the fair value option may be elected for eligible items that exist on that date. Effective January 1, 2008, we elected not to adopt the fair value option for any financial assets or liabilities that existed as of that date.Emerging Issues Task Force Issue No. 06-10 – Accounting for Collateral Assignment Split-Dollar Life Insurance ArrangementsIn March 2007, the FASB Board ratified the consensus reached by the Emerging Issues Task Force (“EITF”) in EITF Issue No. 06-10, “Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements” (“EITF 06-10”). EITF 06-10 requires an employer to recognize a liability related to a collateral assignment split-dollar life insurance arrangement in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” if the employer has agreed to maintain a life insurance policy during the employee’s retirement. In addition, based on the split-dollar arrangement, an asset should be recognized by the employer for the estimated future cash flows to which the employer is entitled. The adoption of EITF 06-10 can be recognized either as a change in accounting principle through a cumulative-effect adjustment to retained earnings or through retrospective application to all prior periods. The consensus is effective for fiscal years beginning after December 15, 2007, including interim periods within those fiscal years.We maintain collateral assignment split-dollar life insurance arrangements related to frozen policies that are within the scope of EITF 06-10. Effective January 1, 2008, we adopted EITF 06-10 by recording a $4 million cumulative effect adjustment to the opening balance of retained earnings, offset by an increase to our liability for postretirement benefits. We also recorded notes receivable for the amounts due to us from participants under the split-dollar arrangements. The recording of the notes receivable did not have a material effect on our consolidated financial condition or results of operations.Derivative Implementation Group Statement 133 Implementation Issue No. E23 – Issues Involving the Application of the Shortcut Method Under Paragraph 68In December 2007, the FASB issued Derivative Implementation Group (“DIG”) Statement 133 Implementation Issue No. E23, “Issues Involving the Application of the Shortcut Method under Paragraph 68” (“DIG E23”), which gives clarification to the application of the shortcut method of accounting for qualifying fair value hedging relationships involving an interest-bearing financial instrument and/or an interest rate swap, originally outlined in paragraph 68 in SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). We adopted DIG E23 effective January 1, 2008, for hedging relationships designated on or after that date. The adoption did not have a material impact on our consolidated financial condition or results of operations.Future Adoption of New Accounting StandardsSFAS No. 141(R) – Business CombinationsIn December 2007, the FASB issued SFAS No. 141(revised 2007), “Business Combinations” (“SFAS 141(R)”), which is a revision of SFAS No. 141 “Business Combinations” (“SFAS 141”). SFAS 141(R) retains the fundamental requirements of SFAS 141, but establishes principles and requirements for the acquirer in a business combination to recognize and measure the identifiable assets acquired, liabilities assumed and any noncontrolling interests in the acquiree and the goodwill acquired or the gain from a bargain purchase. The revised statement requires, among other things, that assets acquired, liabilities assumed and any noncontrolling interest in the acquiree shall be measured at their acquisition-date fair values. For business combinations completed upon adoptiona more detailed description of SFAS 141(R), goodwill will be measured as the excesssee Note 2 of the consideration transferred, plus the fair value of any noncontrolling interest in the acquiree, in excess of the fair values of the identifiable net assets acquired. Any contingent consideration shall be recognized at the acquisition-date fair value, which improves the accuracy of the goodwill measurement. Under SFAS 141(R), contractual pre-acquisition contingencies will be recognized at their acquisition-date fair values and non-contractual pre-acquisition contingencies will be recognized at their acquisition date fair values if it is more likely than not that the contingency gives rise to an asset or liability. Deferred recognition of pre-acquisition contingencies will no longer be permitted. Acquisition costs will be expensed in the period the costs are incurred, rather than included in the cost of the acquiree, and disclosure requirements will be8enhanced to provide users with information to evaluate the nature and financial effects of the business combination. SFAS 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period on or after December 15,our 2008 with earlier adoption prohibited.Form 10-K. We will adoptadopted SFAS 141(R) for acquisitions occurring after January 1, 2009.–- an amendment of Accounting Research Bulletin (“ARB”) No. 51” (“SFAS 160”), which aims to improve the relevance, comparability and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishingestablishes accounting and reporting standards surrounding noncontrolling interests, or minority interests, which are the portions of equity in a subsidiary not attributable, directly or indirectly, to a parent. The ownership interests in subsidiaries held by parties other than the parent shall be clearly identified, labeled and presented in the consolidated statementFor a more detailed description of financial position within equity, but separate from the parent’s equity. The amount of consolidated net income attributable to the parent and to the noncontrolling interest must be clearly identified and presented on the face of the Consolidated Statements of Income. Changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary must be accounted for consistently as equity transactions. A parent’s ownership interest in a subsidiary changes if the parent purchases additional ownership interests in its subsidiary, sells some of its ownership interests in its subsidiary, the subsidiary reacquires some of its ownership interests or the subsidiary issues additional ownership interests. When a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary must be initially measured at fair value. The gain or loss on the deconsolidation of the subsidiary is measured using the fair value of any noncontrolling equity investment rather than the carrying amount of that retained investment. Entities must provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160, is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008.see Note 2 of our 2008 Form 10-K. We will adoptadopted SFAS 160 effective January 1, 2009, and do2009. The adoption did not expect the adoption will have a material impact on our consolidated financial condition and results of operations. No. 140-3 – Accounting for Transfers of Financial Assets and Repurchase Financing Transactions No. 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions” (“FSP 140-3”), regarding the criteria for a repurchase financing to be considered a linked transaction under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and ExtinguishmentExtinguishments of Liabilities.Liabilities – a replacement of FASB Statement No. 125.” A repurchase financing isFor a transaction where the buyer (“transferee”)more detailed description of a financial asset obtains financing from the seller (“transferor”) and transfers the financial asset back to the seller as collateral until the financing is repaid. Under FSP 140-3, the transferor and the transferee shall not separately account for the transfersee Note 2 of a financial asset and a related repurchase financing unless the two transactions have a valid and distinct business or economic purpose for being entered into separately and the repurchase financing does not result in the initial transferor regaining control over the financial asset. In addition, an initial transfer of a financial asset and a repurchase financing entered into contemporaneously with, or in contemplation of, one another, must meet the criteria identified inour 2008 Form 10-K. We adopted FSP 140-3 in order to receive separate accounting treatment. FSP 140-3 is effective for financial statements issued for fiscal years beginning after November 15, 2008,January 1, 2009, and interim periods within those fiscal years. FSP 140-3 will be applied the guidance prospectively to initial transfers and repurchase financings executed on or after the beginning of the fiscal year in which FSP 140-3 is initially applied. Early application isthat date. The adoption did not permitted. We will adopt FSP 140-3 effective January 1, 2009, and do not expect the adoption will have a material impact on our consolidated financial condition and results of operations.currentthe qualitative and quantitative disclosure requirements for derivative instruments and hedging activities. Enhanced disclosures will include: how and why we use derivative instruments; how derivative instruments and related hedged items are accounted for under SFAS 133; and how derivative instruments and related hedged items affect our financial position, financial performance and cash flows. Quantitative disclosures will be enhanced by requiringFor a tabular format by primary underlying risk and accounting designation for the fair value amount and location of derivative instruments in the financial statements and the amount and location of gains and losses in the financial statements for derivative instruments and related hedged items. The tabular disclosures should improve transparency of derivative positions existing at the endmore detailed description of the reporting period and the effectnew disclosure requirements, see Note 2 of using derivatives during the reporting period. SFAS 161 also requires the disclosure of credit-risk-related contingent features in derivative instruments and cross-referencing within the notes to the consolidated financial statements to assist users in locating information about derivative instruments.our 2008 Form 10-K. The amended and expanded disclosure requirements apply to all derivative instruments within the scope of SFAS 133, non-derivativenonderivative hedging instruments and all hedged items designated and qualifying as hedges under SFAS 133. No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 161 is effective prospectively for financial statements issued for fiscal years and interim periods beginning after November 15, 2008.133”). We will adoptadopted SFAS 161 effective January 1, 2009, at which time we will include these requiredand have prospectively included the enhanced disclosures related to derivative instruments and hedging activities in our financial statements.9 No. 142-3 – Determination of the Useful Life of Intangible Assets No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”), which applies to recognized intangible assets accounted for under the guidance in SFAS 142. When developing renewal or extension assumptions in determiningFor a more detailed description of FSP 142-3, see Note 2 of our 2008 Form 10-K. We adopted FSP 142-3 effective January 1, 2009, and applied the useful life ofguidance prospectively to recognized intangible assets FSP 142-3 requires an entity to consider its own historical experience in renewing or extending similar arrangements. Absent the historical experience, an entity should use the assumptions a market participant would make when renewing and extending the intangible asset consistent with the highest and best use of the asset by market participants. In addition, FSP 142-3 requires financial statement disclosure regarding the extent to which expected future cash flows associated with the asset are affected by an entity’s intent and/or ability to renew or extend an arrangement. FSP 142-3 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008, with early adoption prohibited. FSP 142-3 should be applied prospectively to determine the useful life of a recognized intangible asset acquired after the effective date. In addition, FSP 142-3 requires prospective application ofdate and applied the disclosure requirements to all intangible assets recognized as of, and subsequent to, the effective date. We will adopt FSP 142-3 on January 1, 2009, and doThe adoption did not expect the adoption will have a material impact on our consolidated financial condition and results of operations.changes current accounting practice related to the recognition and measurementsee Note 2 of premium revenue and claim liabilities such that premium revenue recognition is linked to the amount of insurance protection and the period in which it is provided, and a claim liability is recognized when it is expected that a claim loss will exceed the unearned premium revenue. In addition, SFAS 163 expands disclosure requirements to include information related to the premium revenue and claim liabilities, as well as information related to the risk-management activities used to evaluate credit deterioration in insured financial obligations. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15,our 2008 and all interim periods within those fiscal years; early application is not permitted. However, the disclosure requirements related to risk-management activities are effective in the first period (including interim periods) beginning after May 2008. Since weForm 10-K. We do not hold a significant amount of financial guarantee insurance and reinsurance contracts, no additional disclosures have been made and we expectas such, the adoption of SFAS 163 willon January 1, 2009 did not behave a material toimpact on our consolidated financial condition orand results of operations.EITFEITFEmerging Issues Task Force (“EITF”) No. 07-5, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5 provides guidance to determine whether an instrument (or an embedded feature) is indexed to an entity’s own stock when evaluating the instrument as a derivative under SFAS 133. An instrument that is both indexed to an entity’s own stock and classified in stockholders’ equity in the entity’s statement of financial position is not considered a derivative for the purposes of applying the guidance in SFAS 133. EITF 07-5 provides a two-step process to determine whether an equity-linked instrument (or embedded feature) is indexed to itsan entity’s own stock first by evaluating the instrument’s contingent exercise provisions, if any, and second, by evaluating the instrument’s settlement provisions. EITF 07-5 is applicable to outstanding instruments as of the beginning of the fiscal year in which the issue isWe adopted and is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. We will adopt EITF 07-5 on January 1, 2009, and dofor all outstanding instruments as of that date. The adoption did not expect the adoption will behave a material toimpact on our consolidated financial condition and results of operations.133-1FAS 115-2 and FIN 45-4FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (“FSP 115-2”), which replaces the requirement in FSP No. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” for management to assert that it has the intent and ability to hold an impaired debt security until recovery with the requirement that management 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. If management intends to sell the debt security or it is more likely than not the entity will be required to sell the debt security before recovery of its amortized cost basis, an other-than-temporary impairment (“OTTI”) shall be recognized in earnings equal to the entire difference between the debt security’s amortized cost basis and its fair value at the balance sheet date. After the recognition of an OTTI, the debt security is accounted for as if it had been purchased on the measurement date of the OTTI, with an amortized cost basis equal to the previous amortized cost basis less the OTTI recognized in earnings. Unrealized Net OTTI Unrealized on Loss AFS on AFS Securities Securities Total Increase in amortized cost of fixed maturity available-for-sale ("AFS") securities $ 34 $ 165 $ 199 Change in DAC, VOBA, DSI, and DFEL (7 ) (35 ) (42 ) Income tax (9 ) (46 ) (55 ) Net cumulative effect adjustment $ 18 $ 84 $ 102
The cumulative effect adjustment was calculated for all debt securities held as of January 1, 2009, for which an OTTI was previously recognized, but as of January 1, 2009, 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.Corporate bonds $ 131 Residential collateralized mortgage obligations ("CMOs") 65 Collateralized debt obligations ("CDOs") 3 Total fixed maturity AFS securities $ 199 Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161SeptemberDecember 2008, the FASB issued FSP No. FAS No. 133-1 and FIN 45-4, “Disclosures132(R)-1, “Employers’ Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and ClarificationPostretirement Benefit Plan Assets” (“FSP 132(R)-1”), which requires enhanced disclosures of the Effective Dateplan assets of an employer’s defined benefit pension or other postretirement benefit plans. The disclosures required under FSP 132(R)-1 will include information regarding the investment allocation decisions made for plan assets, the fair value of each major category of plan assets disclosed separately for pension plans and other postretirement benefit plans and the inputs and valuation techniques used to measure the fair value of plan assets, including the level within the fair value hierarchy as defined by SFAS 157. FSP 132(R)-1 requires the additional disclosure in SFAS 157 for Level 3 fair value measurements must also be provided for the fair value measurements of plan assets using Level 3 inputs. The disclosures in FSP 132(R)-1 are effective for fiscal years ending after December 15, 2009, and are not required for earlier periods presented for comparative purposes. We will include the disclosures required in FSP 132(R)-1 in the notes to our consolidated financial statements for the year ending December 31, 2009.Statementissued FSP No. 161”FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP 133-1”107-1”). FSP 133-1 amends, which extends the disclosure requirements of SFAS 133No. 107, “Disclosures about Fair Value of Financial Instruments,” to requireinterim financial statements. FSP 107-1 also requires entities to disclose the sellermethod(s) and significant assumptions used to estimate the fair value of credit derivatives, including hybrid financial instruments with embedded credit derivatives,in the financial statements on an interim basis and to disclose additional information regarding, among other things, the naturehighlight any changes of the credit derivative, information regarding the factsmethod(s) and circumstances that may require performance or payment under the credit derivative, and the nature of any recourse provisions the seller can use for recovery of payments made under the credit derivative. In addition,significant assumptions from prior periods. The disclosures in FSP 133-1 amends the disclosure requirements in FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (“FIN 45”) to require additional disclosure about the payment/performance risk of a guarantee. Finally, FSP 133-1 clarifies the intent of the FASB regarding the effective date of SFAS 161. The provisions of FSP 133-1 related to SFAS 133 and FIN 45107-1 are effective for annual and interim reporting periods ending after NovemberJune 15, 2008, with2009, and are not required for earlier periods that are presented for comparative purposes at initial adoption. In periods after initial adoption, FSP 107-1 requires comparative disclosures required only for those periods ending subsequent toafter initial adoption. The clarification of the effective date of SFAS 161 was effective upon the issuance of FSP 133-1, and will not impact the effective date of SFAS 161 in our financial statements.10adoptinclude the disclosures required in FSP 133-1 on December 31, 2008, at which time we will include these required enhanced disclosures related to credit derivatives and guarantees107-1 in the notes to theour consolidated financial statements. Accordingly, in the periods prior to the closings, the assets and liabilities of these businesses were reclassified as held-for-sale and were reported within other assets and other liabilities on our Consolidated Balance Sheets. The major classes of assets and liabilities held-for-sale (in millions) were as follows: As of
September 30,
2008 As of
December 31,
2007 $ — $ 340 — 266 — 146 $ — $ 752 $ — $ 354 For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 2008 2007 $ — $ 33 $ 22 $ 104 $ — $ 10 $ 8 $ 32 — 3 3 11 — 7 5 21 — — (13 ) — 1 — (3 ) — (1 ) — (10 ) — $ (1 ) $ 7 $ (5 ) $ 21 Fixed Income Investment Management BusinessDuring For the Three Months Ended March 31, 2008 Discontinued Operations Before Disposal Media revenues, net of agency commissions $ 22 Income from discontinued operations before disposal, before federal income taxes $ 8 Federal income taxes 3 Income from discontinued operations before disposal 5 Disposal Loss on disposal, before federal income taxes (12 ) Federal income tax benefit (3 ) Loss on disposal (9 ) Loss from discontinued operations $ (4 ) fourth quarter of 2007, we sold certain institutional taxable fixed income business to an unaffiliated investment management company. Investment Management transferred $12.3 billion of assets under management as part of this transaction.primary beneficiary. Based upon the assets transferred as of October 31, 2007, the purchase price is expected to be no more than $49 million.During the fourth quarter of 2007, we received $25 millionon our analysis of the purchase price, with additional scheduled payments overexpected losses and residual returns of the next three years. During 2007,VIEs in which we recorded an after-tax losshave a variable interest, we have concluded that there are no VIEs for which we are the primary beneficiary, and, as such, we have not consolidated the VIEs in our consolidated financial statements. However, for those VIEs in which we are not the primary beneficiary, but hold a variable interest, we recognize the fair value of $2 millionour variable interest in our consolidated financial statements.StatementsBalance Sheets for those VIEs where we had significant variable interest and where we were a sponsor that held a variable interest was as follows: As of March 31, 2009 As of December 31, 2008 Maximum Maximum Total Total Loss Total Total Loss Assets Liabilities Exposure Assets Liabilities Exposure Affiliated trust $ 5 $ - $ - $ 5 $ - $ - Credit-linked notes 82 - 600 50 - 600 Income asan affiliated trust, Lincoln National Capital Trust VI, which was formed solely for the purpose of issuing trust preferred securities and lending the proceeds to us. We own the common securities of this trust, approximately a result3% ownership, and the only assets of the goodwill we attributed totrust are the junior subordinated debentures issued by us. Our common stock investment in this business. Duringtrust was financed by the threetrust and nine months ended September 30, 2008, we recorded an after-tax gain of $1 million and $4 million, respectively,is reported in other investments on our Consolidated StatementsBalance Sheets. Distributions are paid by the trust to the preferred security holders on a quarterly basis and the principal obligations of Incomethe trust are irrevocably guaranteed by us. Upon liquidation of the trust, the holders of the preferred securities are entitled to a fixed amount per share plus accumulated and unpaid distributions. We reserve the right to redeem the preferred securities at a fixed price plus accumulated and unpaid distributions and defer the interest payments due on the subordinated debentures for up to 20 consecutive quarters, but not beyond the maturity date of the subordinated debenture.realizedthe trust, as we do not receive any distributions or absorb any losses from the trust. In addition, our guarantee of the principal obligations of the trust does not represent a variable interest, as we are guaranteeing our own performance. Therefore, we are not the primary beneficiary and do not consolidate the trust. Since our investment in the common stock of the trust was financed directly by the trust, we do not have any equity investment at risk, and, therefore, do not have exposure to loss relatedfrom the trust.this transaction.114.make decisions about the entities’ activities that would have a significant effect on the success of the entities, we have determined that these entities are VIEs. We are not the primary beneficiary of the VIEs as the multi-tiered class structure of the CLNs requires the subordinated classes of the investment pool to absorb credit losses prior to our class of notes. As a result, we will not absorb the majority of the expected losses and the coupon we receive on the CLNs limits our participation in the residual returns. For information regarding our exposure to loss in our CLNs, see “Credit-Linked Notes” in Note 5.Available-for-SalelossesOTTI and fair value of available-for-sale securities (in millions) were as follows: As of September 30, 2008 Amortized
Cost Gross Unrealized Fair
Value Gains Losses $ 43,461 $ 425 $ 3,866 $ 40,020 200 17 — 217 784 30 28 786 2,021 25 27 2,019 6,896 46 618 6,324 2,588 10 279 2,319 130 2 2 130 131 1 16 116 56,211 556 4,836 51,931 612 9 128 493 $ 56,823 $ 565 $ 4,964 $ 52,424 As of December 31, 2007 Amortized
Cost Gross Unrealized Fair
Value Gains Losses $ 43,973 $ 1,120 $ 945 $ 44,148 205 17 — 222 979 67 9 1,037 1,226 24 4 1,246 6,721 78 130 6,669 2,711 49 70 2,690 151 2 — 153 103 9 1 111 56,069 1,366 1,159 56,276 548 13 43 518 $ 56,617 $ 1,379 $ 1,202 $ 56,794 As of March 31, 2009 Amortized Gross Unrealized Fair Cost Gains Losses Value Fixed Maturity Securities Corporate bonds $ 41,533 $ 553 $ 4,547 $ 34 $ 37,505 U.S. Government bonds 205 29 1 - 233 Foreign government bonds 779 40 54 - 765 Mortgage-backed securities ("MBS"): CMOs 6,684 281 666 109 6,190 1,616 73 32 - 1,657 Commercial MBS ("CMBS") 2,517 11 621 - 1,907 Asset-backed securities ("ABS"): CDOs 253 4 135 3 119 Credit-linked notes ("CLNs") 600 - 518 - 82 State and municipal bonds 125 3 2 - 126 Hybrid and redeemable preferred stocks 1,564 3 802 - 765 Total fixed maturity securities 55,876 997 7,378 146 49,349 Equity Securities Banking securities 280 - 213 - 67 Insurance securities 71 1 24 - 48 Other financial services securities 55 1 12 - 44 Other securities 58 2 14 - 46 Total equity securities 464 4 263 - 205 Total AFS securities $ 56,340 $ 1,001 $ 7,641 $ 146 $ 49,554 (1) This amount is comprised of the gross unrealized OTTI cumulative effect adjustment as discussed in Note 2 and the amount reflected in the Consolidated Statements of Income in the first three months of 2009. As of December 31, 2008 Amortized Gross Unrealized Fair Cost Gains Losses OTTI Value Fixed Maturity Securities Corporate bonds $ 40,363 $ 660 $ 4,521 $ - $ 36,502 U.S. Government bonds 204 42 - - 246 Foreign government bonds 755 56 51 - 760 MBS: CMOs 6,918 174 780 - 6,312 MPTS 1,875 62 38 - 1,899 CMBS 2,535 9 625 - 1,919 ABS: CDOs 256 7 103 - 160 CLNs 600 - 550 - 50 State and municipal bonds 125 2 2 - 125 Hybrid and redeemable preferred stocks 1,563 6 607 - 962 Total fixed maturity securities 55,194 1,018 7,277 - 48,935 Equity Securities Banking securities 280 - 147 - 133 Insurance securities 71 1 19 - 53 Other financial services securities 61 4 10 - 55 Other securities 54 4 11 - 47 Total equity securities 466 9 187 - 288 Total AFS securities $ 55,660 $ 1,027 $ 7,464 $ - $ 49,223 c available-for-saleAFS securities by contractual maturities (in millions) were as follows: As of September 30, 2008 Amortized
Cost Fair
Value $ 1,992 $ 1,984 12,940 12,632 15,018 13,593 14,756 13,060 44,706 41,269 11,505 10,662 $ 56,211 $ 51,931 As of March 31, 2009 Amortized Fair Cost Value Due in one year or less $ 1,817 $ 1,793 Due after one year through five years 13,230 12,656 Due after five years through ten years 14,383 13,122 Due after ten years 14,776 11,823 Subtotal 44,206 39,394 MBS 10,817 9,754 CDOs 253 119 CLNs 600 82 Total fixed maturity AFS securities $ 55,876 $ 49,349 12available-for-saleOTTI recognized in OCI, of AFS securities (in millions), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows: As of September 30, 2008 Less Than Or Equal
to Twelve Months Greater Than
Twelve Months Total Fair
Value Gross
Unrealized
Losses Fair
Value Gross
Unrealized
Losses Fair
Value Gross
Unrealized
Losses $ 22,046 $ 1,943 $ 6,384 $ 1,923 $ 28,430 $ 3,866 12 — — — 12 — 236 11 95 17 331 28 521 16 62 11 583 27 2,425 231 930 387 3,355 618 1,222 81 652 198 1,874 279 43 2 4 — 47 2 78 16 — — 78 16 26,583 2,300 8,127 2,536 34,710 4,836 420 126 12 2 432 128 $ 27,003 $ 2,426 $ 8,139 $ 2,538 $ 35,142 $ 4,964 3,911 As of December 31, 2007 Less Than Or Equal
to Twelve Months Greater Than
Twelve Months Total Fair
Value Gross
Unrealized
Losses Fair
Value Gross
Unrealized
Losses Fair
Value Gross
Unrealized
Losses $ 11,540 $ 679 $ 4,467 $ 266 $ 16,007 $ 945 — — 3 — 3 — 95 4 51 4 146 8 32 1 193 4 225 5 1,742 101 1,116 29 2,858 130 520 47 562 23 1,082 70 29 — 17 — 46 — 13 1 — — 13 1 13,971 833 6,409 326 20,380 1,159 402 42 8 1 410 43 $ 14,373 $ 875 $ 6,417 $ 327 $ 20,790 $ 1,202 2,441 We had perpetual preferred securities in unrealized loss positions as of September 30, 2008, and December 31, 2007, which are included in the corporate bonds and redeemable preferred stock line items above. As of September 30, 2008, and December 31, 2007, our amortized cost of perpetual preferred securities reported in corporate bonds was $1.3 billion and $1.4 billion, respectively, and the fair value was $1.1 billion and $1.3 billion, respectively.13 As of March 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 $ 16,651 $ 2,011 $ 7,320 $ 2,570 $ 23,971 $ 4,581 U.S. Government bonds 16 1 - - 16 1 Foreign government bonds 202 19 65 35 267 54 MBS: CMOs 676 397 645 378 1,321 775 MPTS 40 11 75 21 115 32 CMBS 692 121 877 500 1,569 621 ABS: CDOs 52 30 54 108 106 138 CLNs - - 82 518 82 518 State and municipal bonds 30 2 2 - 32 2 Hybrid and redeemable preferred stocks 385 357 328 445 713 802 Total fixed maturity securities 18,744 2,949 9,448 4,575 28,192 7,524 Equity Securities Banking securities 65 209 2 4 67 213 Insurance securities 27 24 - - 27 24 Other financial services securities 12 8 19 4 31 12 Other securities 1 3 22 11 23 14 Total equity securities 105 244 43 19 148 263 Total AFS securities $ 18,849 $ 3,193 $ 9,491 $ 4,594 $ 28,340 $ 7,787 Total number of securities in an unrealized loss position 3,467 As of December 31, 2008 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 $ 19,047 $ 2,378 $ 5,980 $ 2,143 $ 25,027 $ 4,521 U.S. Government bonds 3 - - - 3 - Foreign government bonds 159 17 64 34 223 51 MBS: CMOs 853 299 720 481 1,573 780 MPTS 96 26 52 12 148 38 CMBS 1,133 175 499 450 1,632 625 ABS: CDOs 76 20 68 83 144 103 CLNs - - 50 550 50 550 State and municipal bonds 29 2 2 - 31 2 Hybrid and redeemable preferred stocks 461 267 418 340 879 607 Total fixed maturity securities 21,857 3,184 7,853 4,093 29,710 7,277 Equity Securities Banking securities 131 146 2 1 133 147 Insurance securities 30 19 - - 30 19 Other financial services securities 32 9 5 1 37 10 Other securities 22 10 2 1 24 11 Total equity securities 215 184 9 3 224 187 Total AFS securities $ 22,072 $ 3,368 $ 7,862 $ 4,096 $ 29,934 $ 7,464 Total number of securities in an unrealized loss position 3,682 available-for-saleAFS securities where the fair value had declined and remained below amortized cost by greater than 20%, were as follows: As of September 30, 2008 Fair
Value Gross
Unrealized
Losses Number
of
Securities $ 640 $ 302 131 711 299 108 667 300 73 2,733 1,827 490 $ 4,751 $ 2,728 802 As of December 31, 2007 Fair
Value Gross
Unrealized
Losses Number
of
Securities $ 136 $ 49 22 427 138 32 364 110 17 183 81 60 $ 1,110 $ 378 131 As of March 31, 2009 Number Fair Gross Unrealized of Value Losses OTTI Securities Less than six months $ 5,306 $ 2,818 $ 144 840 Six months or greater, but less than nine months 1,370 1,095 - 253 Nine months or greater, but less than twelve months 628 856 - 148 Twelve months or greater 344 1,147 - 145 Total AFS securities $ 7,648 $ 5,916 $ 144 1,386 As of December 31, 2008 Number Fair Gross Unrealized of Value Losses OTTI Less than six months $ 6,794 $ 3,536 $ - 1,017 Six months or greater, but less than nine months 500 506 - 104 Nine months or greater, but less than twelve months 491 651 - 152 Twelve months or greater 173 869 - 91 Total AFS securities $ 7,958 $ 5,562 $ - 1,364 (1) We may reflect a security in more than one aging category based on various purchase dates. in Note 1 of our 2007 Form 10-K,below, we regularly review our investment holdings for other-than-temporary impairments.OTTIs. Based upon this review, the cause of the $3.8 billion$177 million increase in our gross available-for-saleAFS securities unrealized losses for the ninethree months ended September 30, 2008,March 31, 2009, was attributablerelated primarily to the combinationcumulative adjustment of reduced liquiditythe recognition of OTTI. See the $165 million increase in all market segments and deteriorationamortized cost in credit fundamentals.AFS securities as disclosed in Note 2. We believe that the securities in an unrealized loss position as of September 30, 2008,March 31, 2009, were not other-than-temporarily impaired dueas we do not intend to oursell these debt securities or it is not more likely than not that we will be required to sell the debt securities before recovery of their amortized cost basis, and we have the ability and intent to hold the equity securities for a period of time sufficient for recovery.14Trading SecuritiesTrading securities at fair value retainedconnection with modified coinsurance and coinsurance with funds withheld reinsurance arrangements (in millions) consistedthe amount of credit loss of OTTIs recognized in earnings where the following: As of
September 30,
2008 As of
December 31,
2007 $ 1,690 $ 1,999 383 367 39 46 32 22 129 160 92 107 17 19 9 8 2,391 2,728 2 2 $ 2,393 $ 2,730 The portion of trading losses that relaterelated to trading securities still held as of September 30, 2008,other factors was $187 million for the third quarter of 2008.Mortgage Loans on Real EstateMortgage loans on real estate principally involve commercial real estate. The commercial loans are geographically diversified throughout the United States with the largest concentrationsrecognized in California and Texas, which accounted for approximately 29% of mortgage loans as of September 30, 2008.Net Investment IncomeThe major categories of net investment incomeOCI (in millions) were as follows: For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 2008 2007 $ 856 $ 856 $ 2,569 $ 2,543 7 10 24 31 41 44 126 134 121 123 371 385 6 16 20 43 46 43 134 130 12 14 46 52 27 — 36 90 2 5 (1 ) 17 1,118 1,111 3,325 3,425 (29 ) (49 ) (94 ) (140 ) $ 1,089 $ 1,062 $ 3,231 $ 3,285 15 For the Three Months Ended March 31, 2009 Balance at beginning-of-period $ 31 Increases attributable to credit losses on securities for which an OTTI was not previously recognized 72 Balance at end-of-period $ 103 For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 2008 2007 $ 27 $ 26 $ 58 $ 108 (380 ) (44 ) (618 ) (97 ) 1 1 4 7 (26 ) — (33 ) — (1 ) 6 27 7 95 (14 ) 144 (36 ) (284 ) (25 ) (418 ) (11 ) (30 ) (11 ) (62 ) (7 ) — 1 — — $ (314 ) $ (35 ) $ (480 ) $ (18 ) $ (312 ) $ (34 ) $ (523 ) $ (68 ) See Note 12 For the Three Months Ended March 31, 2009 2008 Change Fixed maturity AFS securities: Gross gains $ 55 $ 9 NM Gross losses (244 ) (100 ) NM Equity AFS securities: Gross gains 3 3 0 % Gross losses (3 ) - NM Gain on other investments (2 ) 25 NM Associated amortization expense of DAC, VOBA, DSI and DFEL and changes in other contract holder funds and funds withheld reinsurance liabilities 55 25 120 % Total realized loss on investments, excluding trading securities (136 ) (38 ) NM Loss on certain derivative instruments (17 ) (3 ) NM Total realized loss on investments and certain derivative instruments, excluding trading securities $ (153 ) $ (41 ) NM Write-downs for OTTI included in realized loss on AFS securities above $ (170 ) $ (92 ) -85 %
Details underlying write-downs taken as a result of OTTIs (in millions) that were recognized in earnings and included in realized loss on AFS securities above were as follows: For the Three Months Ended March 31, 2009 2008 Fixed Maturity Securities Corporate bonds $ 85 $ 90 MBS: CMOs 81 1 ABS: CDOs - 1 Hybrid and redeemable preferred stock 1 - Total fixed maturity securities 167 92 Equity Securities Other financial services securities 3 - Total equity securities 3 - Total OTTI losses on AFS $ 170 $ 92 For the Three Months For the Three Months Ended March 31, 2009 Ended March 31, 2008 Total Portion Net OTTI Total Portion Net OTTI OTTI of Loss Losses OTTI of Loss Losses Losses on Recognized Recognized Losses on Recognized Recognized Securities in OCI in Earnings Securities in OCI in Earnings Gross $ 282 $ (112 ) $ 170 $ 92 $ - $ 92 DAC, VOBA, DSI and DFEL amortization (68 ) 23 (45 ) (35 ) - (35 ) Net $ 214 $ (89 ) $ 125 $ 57 $ - $ 57 comprehensive listingsufficient period of time to allow for a recovery in value, we conclude that an OTTI has occurred, and the amortized cost of the equity security is written down to the current fair value, with a corresponding change to realized gain (loss) on our Consolidated Statements of Income. 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 decline, a fundamental analysis of the liquidity, business prospects and overall financial condition of the issuer.· Historic and implied volatility of the security; · Length of time and extent to which the fair value has been less than amortized cost; · 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. · 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). · 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 and our expectations of sale of such a security; and · Susceptibility to variability of prepayments. $463$311 million and $655$427 million as of September 30, 2008,March 31, 2009 and December 31, 2007,2008, respectively. The fair values of these securities were $435$300 million and $634$410 million as of September 30, 2008,March 31, 2009 and December 31, 2007,2008, respectively.$280$460 million and $480$470 million as of September 30, 2008,March 31, 2009 and December 31, 2007,2008, respectively. The fair values of these securities were $293$485 million and $502$496 million as of September 30, 2008,March 31, 2009 and December 31, 2007,2008, respectively.September 30, 2008,March 31, 2009, our investment commitments for fixed maturity securities (primarily private placements), limited partnerships, real estate and mortgage loans on real estate were $1.1 billion,$782 million, which includes $314included $411 million of limited partnerships and $263 million of standby commitments to purchase real estate upon completion and leasing.Concentrations of Financial InstrumentsSeptember 30, 2008,March 31, 2009 and December 31, 2007, we did not have a significant concentration of financial instruments in a single investee, industry or geographic region of the U.S.16Credit-Linked NotesAs of September 30, 2008, and December 31, 2007, other contract holder funds on our Consolidated Balance Sheets included $600 million and $1.2 billion outstanding in funding agreements of the Lincoln National Life Insurance Company (“LNL”), respectively. LNL invested the proceeds of $850$600 million received for issuing threetwo funding agreements in 2006 and 2007 into threetwo separate credit-linked notesCLNs originated by third party companies. One of the credit linked notes totaling $250 million was paid off at parThe CLNs are included in September and as a result, the related structure, including the $250 million funding agreement, was terminated. The two remaining credit-linked notes are asset-backed securities, classified as corporate bonds in the tables above and are reported as fixed maturity AFS securities on our Consolidated Balance Sheets. An additional $300 million funding agreement was assumed as a result of the merger of Jefferson-Pilot, but was not invested into credit-linked notes. This $300 million funding agreement matured on June 2, 2008.credit-linked notesCLNs and the interest credited on the funding agreement. Our credit-linked notesCLNs were created using a special purpose trust that combines highly rated assets with credit default swaps to produce a multi-class structured security. The high quality asset in these transactions is a AAA-rated ABS secured by a pool of credit card receivables. Our affiliate, Delaware Investments, actively manages the credit default swaps in the underlying portfolios. The high quality assetAs permitted in these transactions is a AAA-rated asset-backed security secured by athe CLN agreements, Delaware Investments acts as the investment manager for the pool of underlying issuers in each of the transactions.card receivables.credit-linked notes,CLNs, which could result in principal losses to our investments. However, we have attempted to protect our investments from credit losses through the multi-tiered class structure of the credit-linked note,CLN, which requires the subordinated classes of the investment pool to absorb all of the initial credit losses. LNL owns the mezzanine tranche of these investments. Each tranche represents a 1% slice of the capital structure and each issuer is equally weighted in the underlying collateral pool.credit-linked noteCLN and two defaults in the underlying collateral pool of the $200 million credit-linked note.CLN. There has been no event of default on the credit-linked notes themselves, and we feelCLNs themselves. Based upon our analysis the remaining subordination isas represented by the attachment point should be sufficient to absorb future initial credit losses.losses, subject to changing market conditions. We do not anticipate any future payments under the CLNs, and as such, there are no recourse provisions or assets held as collateral for the recovery of any future payments. Similar to other debt market instruments, our maximum principal loss is limited to our original investment of $600 million as of September 30, 2008.$421$518 million on the $600 million in credit-linked notesCLNs as of September 30, 2008March 31, 2009 and $190$550 million on the $850$600 million in credit-linked notesCLNs as of December 31, 2007.2008. As described more fully in Note 1 of our 2007 Form 10-K,the realized loss related to investments section above, we regularly review our investment holdings for other-than-temporary impairments.OTTIs. Based upon this review, we believe that these securities were not other-than-temporarily impaired as of September 30, 2008,March 31, 2009 and December 31, 2007. As of As of As of April 30, March 31, December 31, 2009 2009 2008 Fair value to amortized cost ratio 22 % 14 % 8 % : Amount and Date of Issuance $400
December 2006 $200
April 2007 $ 1,944 $ 296 12/20/16 3/20/17 A+ Baa2 124 98 20 21 Amount and Date of Issuance $400 $200 December 2006 April 2007 Amortized cost $ 400 $ 200 Fair value 52 30 Original attachment point (subordination) 5.50 % 2.05 % Current attachment point (subordination) 4.77 % 1.48 % Maturity 12/20/2016 3/20/2017 Current rating of tranche BBB- Ba3 Current rating of underlying collateral pool Aaa-B3 Aaa-B1 Number of entities 124 98 Number of countries 19 23 Industry AAA AA A BBB BB CCC Total Financial intermediaries 0 % 3 % 8 % 1 % 0 % 0 % 12 % Telecommunications 0 % 0 % 5 % 5 % 1 % 0 % 11 % Oil and gas 0 % 1 % 2 % 4 % 0 % 0 % 7 % Insurance 0 % 0 % 3 % 2 % 0 % 1 % 6 % Utilities 0 % 0 % 2 % 2 % 0 % 0 % 4 % Chemicals and plastics 0 % 0 % 2 % 2 % 0 % 0 % 4 % Retailers, except food and drug 0 % 0 % 1 % 2 % 1 % 0 % 4 % Industrial equipment 0 % 0 % 3 % 0 % 0 % 0 % 3 % Sovereigns 0 % 0 % 2 % 1 % 0 % 0 % 3 % Drugs 0 % 2 % 1 % 0 % 0 % 0 % 3 % Forest products 0 % 0 % 0 % 2 % 1 % 0 % 3 % Other industry < 3% (28 industries) 1 % 3 % 15 % 16 % 5 % 0 % 40 % Total by industry 1 % 9 % 44 % 37 % 8 % 1 % 100 % As of March 31, 2009 Number Asset Carrying (Liability) Carrying of Notional or Fair Value or Fair Value Instruments Amounts Gain Loss Gain Loss Derivative Instruments Designated and Qualifying as Hedging Instruments Cash flow hedges: 103 $ 749 $ 53 $ (100 ) $ - $ - 14 367 66 (3 ) - - Total cash flow hedges 117 1,116 119 (103 ) - - Fair value hedges: 1 375 146 - - - 1 49 166 - - - Total fair value hedges 2 424 312 - - - Embedded derivatives: 7 - - - - (329 ) Remaining guaranteed interest 84,576 - - - - (253 ) GLBs accounted for under 225,448 - - - 714 (3,319 ) Reinsurance related - - 107 - - - Total embedded derivatives 310,031 - 107 - 714 (3,901 ) Total derivative instruments designated and qualifying as hedging instruments 310,150 1,540 538 (103 ) 714 (3,901 ) Derivative Instruments Not Designated and Not Qualifying as Hedging Instruments 43 2,150 - - - - 26,203 3,599 - - - - 54,903 3,480 - - - - 107 7,111 403 (455 ) - - 12 1,342 6 (2 ) - - 12 164 - - - (67 ) 1 126 - - - - 137 4,675 1,764 - - - 1 9 - - - - 554 2,986 37 - - - 36 26 142 (13 ) - - 3 - 16 - - - Total derivative instruments not designated and not qualifying as hedging instruments 82,012 25,668 2,368 (470 ) - (67 ) Total derivative instruments 392,162 $ 27,208 $ 2,906 $ (573 ) $ 714 $ (3,968 ) As of September 30, 200817(2) Reported in future contract benefits on our Consolidated Balance Sheets. (3) Reported in reinsurance related derivative assets on our Consolidated Balance Sheets. (4) Reported in other liabilities on our Consolidated Balance Sheets. 5. DAC, VOBA, DSI Remaining Life as of March 31, 2009 Less Than 1 - 5 5 - 10 10 - 30 1 Year Years Years Years Total Derivative Instruments Designated and Qualifying as Hedging Instruments Cash flow hedges: Interest rate swap agreements $ 140 $ 103 $ 240 $ 266 $ 749 Foreign currency swaps - 52 180 135 367 Total cash flow hedges 140 155 420 401 1,116 Fair value hedges: Interest rate swap agreements - - - 375 375 Equity collars - 49 - - 49 Total fair value hedges - 49 - 375 424 Total derivative instruments designated and qualifying as hedging instruments 140 204 420 776 1,540 Derivative Instruments Not Designated and Not Qualifying as Hedging Instruments Interest rate cap agreements 1,400 750 - - 2,150 Interest rate futures 3,599 - - - 3,599 Equity futures 3,480 - - - 3,480 Interest rate swap agreements - 1,900 1,706 3,505 7,111 Foreign currency forward contracts 1,342 - - - 1,342 Credit default swaps 10 50 104 - 164 Total return swaps 126 - - - 126 Put options - 1,800 2,700 175 4,675 Call options (based on LNC stock) 9 - - - 9 Call options (based on S&P 500) 2,250 736 - - 2,986 Variance swaps - 3 23 - 26 Total derivative instruments not designated and not qualifying as hedging instruments 12,216 5,239 4,533 3,680 25,668 Total derivative instruments with notional amounts $ 12,356 $ 5,443 $ 4,953 $ 4,456 $ 27,208 For the Three Months Ended March 31, 2009 Unrealized Gain on Derivative Instruments Balance at beginning-of-year $ 127 Other comprehensive income (loss): Unrealized holding losses arising during the period: Cash flow hedges: Interest rate swap agreements 3 Foreign currency swaps 2 Fair values hedges: Interest rate swap agreements (1 ) Net investment in foreign subsidiary (74 ) Change in DAC, VOBA, DSI and other contract holder funds 7 Income tax benefit (4 ) Less: Reclassification adjustment for gains included in net income: Cash flow hedges: 1 1 Fair values hedges: 1 Income tax expense (1 ) Balance at end-of-period $ 58 (1) The OCI offset is reported within net investment income on our Consolidated Statements of Income. (2) The OCI offset is reported within interest and debt expense on our Consolidated Statements of Income. DFELOnmark-to-market adjustments on derivative instruments (in millions) recorded on our Consolidated Statements of Income were as follows: For the Three Months Ended March 31, 2009 Derivative Instruments Designated and Qualifying as Hedging Instruments Cash flow hedges: $ 1 1 Total cash flow hedges 2 Fair value hedges: 4 Embedded derivatives: 7 11 178 76 Total embedded derivatives 272 Total derivative instruments designated and qualifying as hedging instruments 278 Derivative Instruments Not Designated and Not Qualifying as Hedging Instruments (328 ) 249 (311 ) 5 (9 ) 45 (18 ) (31 ) 1 Total derivative instruments not designated and not qualifying as hedging instruments (397 ) Total derivative instruments $ (119 ) (1) Reported in net investment income on our Consolidated Statements of Income. (2) Reported in interest and debt expense on our Consolidated Statements of Income. (3) Reported in net realized loss on our Consolidated Statements of Income. (4) Reported in underwriting, acquisition, insurance and other expenses on our Consolidated Statements of Income. quarterly basis,portion of our interest rate swap agreements to hedge the interest rate risk to our exposure to floating rate bond coupon payments, replicating a fixed rate bond. An interest rate swap is a contractual agreement to exchange payments at one or more times based on the actual or expected price level, performance or value of one or more underlying interest rates. We are required to pay the counterparty the stream of variable interest payments based on the coupon payments from the hedged bonds, and in turn, receive a fixed payment from the counterparty, at a predetermined interest rate. The net receipts/payments from these interest rate swaps are recorded in net investment income on our Consolidated Statements of Income. Gains or losses on interest rate swaps hedging our interest rate exposure on floating rate bond coupon payments are reclassified from accumulated OCI to net income as the related bond interest is accrued.may recorduse interest rate swap agreements to hedge our exposure to fixed rate bond coupon payments and the change in underlying asset values as interest rates fluctuate. The net receipts/payments from these interest rate swaps are recorded in net income on our Consolidated Statements of Income.includedare corresponding changes in the estimated fair value of trading securities in portfolios that support these arrangements. During the first three months of 2009, the portion of the embedded derivative liability related to the funds withheld nature of our disability income business was released due to the rescission of the underlying reinsurance agreement. See Note 11 for additional details.Balance SheetsStatements of Income.DAC, VOBA, DSIhedge accounting under SFAS 133; therefore, all gains or losses on the foreign currency forward contracts are recorded in net income on our Consolidated Statements of Income. Reason Nature Credit Maximum for of Rating of Fair Potential Maturity Entering Recourse Counterparty Payout 3/20/2010 (2) (4) A2/A $ - $ 10 6/20/2010 (2) (4) A1/A - 10 12/20/2012 (3) (4) Aa2/A+ - 10 12/20/2012 (3) (4) Aa2/A+ (1 ) 10 12/20/2012 (3) (4) A1/A - 10 12/20/2012 (3) (4) A1/A (1 ) 10 12/20/2016 (3) (4) A2/A (5) (10 ) 15 3/20/2017 (3) (4) A2/A (5) (13 ) 22 3/20/2017 (3) (4) A2/A (5) (11 ) 14 3/20/2017 (3) (4) A2/A (5) (10 ) 18 3/20/2017 (3) (4) A2/A (5) (13 ) 18 3/20/2017 (3) (4) A2/A (5) (8 ) 17 $ (67 ) $ 164 (1) Broker quotes are used to determine the market value of credit default swaps. (2) 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. (3) Credit default swap was entered into in order to generate income by providing default protection in return for a quarterly payment. (4) Seller does not have the right to demand indemnification/compensation from third parties in case of a loss (payment) on the contract. (5) These credit default swaps were sold to a counter party of the issuing special purpose trust as discussed in the “Credit-Linked Notes” section in Note 5. Maximum potential payout $ 164 Less: Collateral posted to date 47 Counterparty thresholds 30 Maximum collateral potentially required to post $ 87 DFELpay a floating rate of interest. Cash settlements on the change in market value of the total return swaps along with the resulting gains or losses are recorded in net income on our Consolidated Statements of Income.offsetting benefitinterest rate return or chargean equity market component, where interest credited to revenuethe contracts is linked to the performance of the S&P 500. Contract holders may elect to re-balance index options at renewal dates, either annually or expensebiannually. At each renewal date, we have the opportunity to re-price the indexed component by establishing participation rates, subject to minimum guarantees. We purchase call options that are highly correlated to the portfolio allocation decisions of our contract holders, such that we are economically hedged with respect to equity returns for the current reset period. The mark-to-market of the options held generally offsets the change in value of the embedded derivative within the indexed annuity, both of which are recorded in net income on our Consolidated Statements of Income. Collateral Collateral Posted by Posted by Credit Counterparty LNC Rating of (Held by (Held by Counterparty LNC) Counterparty) AAA $ 14 $ - AA+ 64 - AA 238 - AA- 553 - A+ 270 (10 ) A 772 (45 ) $ 1,911 $ (55 ) difference betweengoodwill impairment related to our Retirement Solutions – Annuities reporting unit, which did not have a corresponding tax effect.estimatesfirst three months of future gross profits used2009 included an increase of $56 million related to favorable adjustments from the 2008 tax return, filed in the priorfirst quarter of 2009, primarily relating to the separate account DRD, foreign tax credits and other tax preference items.emergenceuse of actualestimates are required in determining whether a valuation allowance is necessary, and updated estimatesif so, the amount of future gross profitssuch valuation allowance. In evaluating the need for a valuation allowance, we consider many factors, including 1) the nature and character of the deferred tax assets and liabilities; 2) taxable income in prior carryback years; 3) projected taxable earnings, including capital gains exclusive of reversing temporary differences and carryforwards; 4) the length of time carryovers can be utilized; 5) any tax planning strategies we would employ to avoid a tax benefit from expiring unused. Although realization is not assured, management believes it is more likely than not that the deferred tax assets, including our capital loss deferred tax asset, will be realized.current quarter (“retrospective unlocking”). range of none to $53 million.addition, in the third quarternormal course of each year,business we conduct our annual comprehensive review ofare subject to examination by taxing authorities throughout the assumptionsUnited States and the projection models used for our estimates of future gross profits underlying the amortization of DAC, VOBA, DSI and DFEL and the calculations of the embedded derivatives and reserves for annuity and life insurance products with living benefit and death benefit guarantees. These assumptions include investment margins, mortality, retention and rider utilization. Based on our review, the cumulative balances of DAC, VOBA, DSI and DFEL, included on our Consolidated Balance Sheets, are adjusted with an offsetting benefitUnited Kingdom. At any given time, we may be under examination by state, local or charge to revenue or amortization expense to reflect such change (“prospective unlocking – assumption changes”). We may also identify and implement actuarial modeling refinements (“prospective unlocking – model refinements”) that result in increases or decreases to the carrying values of DAC, VOBA, DSI, DFEL, embedded derivatives and reserves for annuity and life insurance products with living benefit and death benefit guarantees. The primary distinction between retrospective and prospective unlocking is that retrospective unlocking is driven by the emerging experience period-over-period, while prospective unlocking is driven by changes in assumptions or projection models related to estimated future gross profits.Changes in DAC (in millions) were as follows: For the Nine
Months Ended
September 30, 2008 2007 $ 6,510 $ 5,116 — (31 ) 1,354 1,469 24 35 44 (56 ) (69 ) 46 (585 ) (600 ) (16 ) (10 ) 715 184 (51 ) 23 $ 7,926 $ 6,176 18Changes in VOBA (in millions) were as follows: For the Nine
Months Ended
September 30, 2008 2007 $ 3,070 $ 3,304 — (35 ) — 14 32 35 26 14 (15 ) (7 ) (21 ) 16 (288 ) (348 ) 100 108 53 (6 ) 796 53 (27 ) 13 $ 3,726 $ 3,161 Changes in DSI (in millions) were as follows: For the Nine
Months Ended
September 30, 2008 2007 $ 279 $ 194 — (3 ) 77 81 — 2 — (1 ) (2 ) 2 (21 ) (25 ) (5 ) (1 ) $ 328 $ 249 19Changes in DFEL (in millions) were as follows: For the Nine
Months Ended
September 30, 2008 2007 $ 1,183 $ 977 — (2 ) 316 300 5 4 25 (34 ) (29 ) 10 (135 ) (144 ) (2 ) — (38 ) 17 $ 1,325 $ 1,128 6. Goodwill and Specifically Identifiable Intangibles For the Nine Months Ended September 30, 2008 Balance At
Beginning-
of-Year Purchase
Accounting
Adjustments Impairment Foreign
Currency
Translation
Adjustment Balance
At End-
of-Period $ 1,046 $ (6 ) $ — $ — $ 1,040 20 — — — 20 2,201 (11 ) — — 2,190 274 — — — 274 247 1 — — 248 17 — — (2 ) 15 339 (2 ) (83 ) — 254 $ 4,144 $ (18 ) $ (83 ) $ (2 ) $ 4,041 The purchase accounting adjustments above relate to income tax deductions recognized when stock options attributable to mergers were exercised or the release of unrecognized tax benefits acquired through mergers.As For the Three Months Ended March 31, 2009 Balance At Purchase Balance Beginning- Accounting At End- of-Year Adjustments Impairment of-Period Retirement Solutions: Annuities $ 1,040 $ - $ (600 ) $ 440 Defined Contribution 20 - - 20 Insurance Solutions: Life Insurance 2,188 - - 2,188 Group Protection 274 - - 274 Investment Management 248 - - 248 Lincoln UK - - - - Other Operations 174 3 (3 ) 174 Total goodwill $ 3,944 $ 3 $ (603 ) $ 3,344 result of declines in current and forecasted advertising revenue for the entire radio market, we updated our intangibleStep 1 goodwill impairment review in the second quarter of 2008, which was outsideanalysis on all of our annual process normally completedreporting units as of OctoberMarch 31, 2009. The Step 1 each year. This impairment test showedanalysis for Insurance Solutions – Life and Retirement Solutions – Annuities reporting units utilized primarily a discounted cash flow valuation technique. In determining the estimated fair value of these reporting units, we incorporated consideration of discounted cash flow calculations, the level of our own share price and assumptions that market participants would make in valuing these reporting units. Our fair value estimations were based primarily on an in-depth analysis of projected future cash flows and relevant discount rates, which considered market participant inputs (“income approach”). The discounted cash flow analysis required us to make judgments about revenues, earnings projections, capital market assumptions and discount rates. For our other reporting units, we used other available information including market data obtained through strategic reviews and other analysis to support our Step 1 conclusions.remaining radio properties were lower than their carrying amounts, thereforeStep 2 analysis, we recorded non-cash impairments of goodwill (set forth above) and specifically identifiable intangible (set forth below), based upon the guidance of SFAS 142. The impairment of goodwill did not have any offsetting tax benefit; therefore, our effective tax rate for the nine months ended September 30, 2008,Retirement Solutions – Annuities reporting unit, which was elevated overattributable primarily to higher discount rates driven by higher debt costs and equity market volatility, deterioration in sales and declines in equity markets.corresponding period in 2007.20The gross carrying amountsprocess of finalizing the fair value of the assets acquired and accumulated amortization (in millions) for each major specifically identifiable intangible asset class by reportable segment wereliabilities assumed as follows: As of
September 30, 2008 As of
December 31, 2007 Gross
Carrying
Amount Accumulated
Amortization Gross
Carrying
Amount Accumulated
Amortization $ 100 $ 10 $ 100 $ 7 3 — 3 — 92 92 92 90 5 — 3 — 292 — 384 — 4 3 4 3 $ 496 $ 105 $ 586 $ 100 (1)No amortization recorded as the intangible asset has indefinite life.(2)We recorded FCC licenses impairment of $90 million during the second quarter of 2008, as discussed above.See Note 3 forof the acquisition date. As such, these values are subject to change. During the first quarter of 2009, we impaired the estimated goodwill that arose from the acquisition after giving consideration to the expected financial performance and specifically identifiable intangibles included within discontinued operations.7.other relevant factors of this business.These157. Effective January 1, 2008, we adopted SFAS 157 which affected(see Note 15 for details). Other guarantees that are not considered embedded derivatives meet the criteria as insurance benefits and are accounted for under the valuation techniques included in SOP 03-1. Still other guarantees contain characteristics of ourboth an embedded derivatives. See Note 2 of this reportderivative and an insurance benefit and are accounted for detailsunder an approach that weights these features and their associated reserves accordingly based on the adoption of SFAS 157.their hybrid nature. We use derivative instruments to hedge our exposure to the risks and earnings volatility that result from the embedded derivatives for living benefits in certain of our variable annuity products. The change in fair value of these instruments tends to move in the opposite direction of the change in fair value of the embedded derivatives. The net impact of these changes is reported as guaranteed living benefitbenefits (“GLB”), which is reported as a component of realized loss discussed in Note 12.21 As of
September 30,
2008 As of
December 31,
2007 $ 39,646 $ 44,833 2,503 93 56 years 55 years $ 256 $ 355 72 25 68 years 68 years 5 % 5 % $ 20,794 $ 25,537 4,821 359 65 years 64 years As of As of March 31, December 31, 2009 2008 Return of Net Deposits Total account value $ 32,736 $ 33,907 7,524 6,337 Average attained age of contract holders 56 years 56 years Minimum Return Total account value $ 182 $ 191 116 109 Average attained age of contract holders 69 years 68 years Guaranteed minimum return 5 % 5 % Anniversary Contract Value Total account value $ 16,008 $ 16,950 9,156 8,402 Average attained age of contract holders 65 years 65 years current account balance at the end-of-period.balance. The increase in net amount ofat risk when comparing September 30, 2008,March 31, 2009, to December 31, 2007,2008, was attributedattributable primarily to the decline in equity markets and associated reduction in the account values. For the Nine
Months Ended
September 30, 2008 2007 $ 38 $ 23 — (4 ) 87 17 (22 ) (4 ) $ 103 $ 32 The changes to the benefit reserves amounts above are reflected in benefits on our Consolidated Statements of Income. For the Three Months Ended March 31, 2009 2008 Balance at beginning-of-year $ 277 $ 38 Changes in reserves 132 14 Benefits paid (65 ) (7 ) Balance at end-of-period $ 344 $ 45 As of
September 30,
2008 As of
December 31,
2007 $ 32,578 $ 44,982 9,974 8,076 9,559 8,034 4,849 6,545 $ 56,960 $ 67,637 98 % 97 % 22 As of As of March 31, December 31, 2009 2008 Asset Type Domestic equity $ 22,876 $ 24,878 International equity 8,431 9,204 Bonds 6,959 6,701 Money market 5,756 5,802 Total $ 44,022 $ 46,585 Percent of total variable annuity separate account values 98 % 99 % 8. Other Contract Holder FundsDetailsother contract holder fundspermanent life insurance in force as of March 31, 2009 and approximately 73% of sales for these products in 2009. As of
September 30,
2008 As of
December 31,
2007 $ 58,632 $ 57,698 1,325 1,183 499 524 129 140 93 95 $ 60,678 $ 59,640 For the Three Months Ended March 31, 2009 Balance at beginning-of-period $ 4,731 Early extinguishment of the following capital securities: (78 ) (9 ) Reclassification to short-term debt (250 ) Change in fair value hedge (50 ) Accretion (amortization) of discounts (premiums), net 1 Balance at end-of-period $ 4,345 (1) The results of the extinguishment of debt were favorable by a ratio of 25 cents to one dollar. (2) The results of the extinguishment of debt were favorable by a ratio of 23 cents to one dollar. 9. Federal Income TaxesThe effective tax rate was 2% and 28% forDetails underlying the three months ended September 30, 2008 and 2007, respectively. The effective tax rate for the nine months ended September 30, 2008 and 2007 was 26% and 29%, respectively. Differences in the effective rates and the U.S. statutory raterecognition of 35% in 2008 were the result of certain tax preferred investment income, separate account dividends-received deduction (“DRD”), foreign tax credits and other tax preference items. For information about the unfavorable impact to our effective tax rate for the nine months ended September 30, 2008, due from impairment of goodwill, see Note 6.Federal income tax expense for the third quarter and first nine months of 2008 included a reduction of $34 million related to favorable adjustments from the 2007 tax return, filed in the third quarter of 2008, primarily relating to the separate account DRD, foreign tax credits and other tax preference items. Federal income tax expense for the third quarter and first nine months of 2007 included a reduction of $13 million related to favorable adjustments from the 2006 tax return, filed in the third quarter of 2007, relating to the separate account DRD, foreign tax credits and other tax preference items.Changes to the Internal Revenue Code, administrative rulings or court decisions could increase our effective tax rate. In this regard, on August 16, 2007, the Internal Revenue Service (“IRS”) issued a revenue ruling that purports, among other things, to modify the calculation of the separate account DRD received by life insurance companies. Subsequently, the IRS issued another revenue ruling that suspended the August 16, 2007, ruling and announced a new regulation projectgain on the issue. The current separate account DRD lowered the effective tax rate by approximately 15% and 5% for the three months ended September 30, 2008 and 2007, respectively, and 9% and 4% for the nine months ended September 30, 2008 and 2007, respectively. The separate account deduction for dividends was relatively flat compared to prior quarters; however, its impact to the effective tax rate was the resultextinguishment (in millions) reported within interest expense on our Consolidated Statements of lower pre-tax income for the three months ended September 30, 2008.We are required to establish a valuation allowance for any gross deferred tax assets that are unlikely to reduce taxes payable in future years’ tax returns. As of September 30, 2008, we believed that it was more likely than not that all gross deferred tax assets will reduce taxes payable in future years.As of September 30, 2008, there have been no material changes to the balance of unrecognized tax benefits reported at December 31, 2007. We anticipate a change to our unrecognized tax benefits within the next 12 months in the range of none to $12 million.We recognize interest and penalties, if any, accrued related to unrecognized tax benefitsIncome were as a component of tax expense.In the normal course of business, we are subject to examination by taxing authorities throughout the U.S. and the U.K. At any given time, we may be under examination by state, local or non-U.S. income tax authorities. During the third quarter of 2008, the IRS completed its examination for the tax years 2003 and 2004 resulting in a proposed assessment. We believe a portion of the assessment is inconsistent with existing law and are protesting it through the established IRS appeals process. We do not anticipate that any adjustments that might result from such appeals would be material to our consolidated results of operations or financial condition.2310.follows:Principal balance outstanding prior to payoff $ 87 Unamortized debt issuance costs and discounts prior to payoff (1 ) Amount paid to retire (22 ) Gain on extinguishment, pre-tax $ 64 See “Contingencies and Commitments” in Note 13 to the consolidated financial statements in our 2007 Form 10-K for a discussion of commitments and contingencies, which information is incorporated herein by reference.Like others in the industry, we have received inquiries including requests for information regarding sales to seniors from the Financial Industry Regulatory Authority, and we have responded to these inquiries. We continue to cooperate fully with such authority.11. Stockholders’ EquityStockholders’ Equity For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 2008 2007 11,662 12,361 11,960 12,706 (100 ) (155 ) (398 ) (500 ) 11,562 12,206 11,562 12,206 256,801,622 271,441,613 264,233,303 275,752,668 1,600 2,480 6,368 8,000 96,454 774,931 775,676 3,610,276 18,465 35,149 85,544 104,310 (1,076,508 ) (3,096,069 ) (9,259,258 ) (10,317,150 ) 255,841,633 269,158,104 255,841,633 269,158,104 256,026,625 269,353,400 256,026,625 269,353,400 256,908,832 271,722,491 256,908,832 271,722,491 (1)Amount includes non stock option awards issued, including issuances for benefit plans and stock options exercised.24Earnings Per ShareThe income used in the calculation of our diluted earnings per share (“EPS”) is our income from continuing operations For the Three Months Ended March 31, 2009 2008 Series A Preferred Stock Balance at beginning-of-year 11,565 11,960 Conversion into common stock - (298 ) Balance at end-of-period 11,565 11,662 Common Stock Balance at beginning-of-year 255,869,859 264,233,303 Conversion of Series A preferred stock - 4,768 Stock compensation/issued for benefit plans 196,159 417,962 Retirement of common stock/cancellation of shares (19,915 ) (5,450,000 ) Balance at end-of-period 256,046,103 259,206,033 Common stock at end-of-period: Assuming conversion of preferred stock 256,231,143 259,392,625 Diluted basis 258,058,158 260,490,490 net income, reduced by minority interest adjustments related to outstanding stock options under the Delaware Investments U.S., Inc. (“DIUS”) stock option incentive plan of $1 million for the nine months ended September 30, 2008 and 2007 and less than $1 million for the three months ended September 30, 2008 and 2007. Series A preferred stocks are without par value.discontinued operations per share was as follows: For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 2008 2007 255,865,067 269,395,799 258,192,178 271,597,197 185,672 196,509 187,101 198,811 315,939 361,084 276,132 621,802 6,241,386 12,182,185 8,478,357 13,270,967 (6,240,810 ) (10,811,052 ) (8,392,562 ) (11,352,163 ) (2,279 ) (168,157 ) (57,531 ) (227,169 ) 1,280,279 1,331,319 1,278,454 1,328,341 257,645,254 272,487,687 259,962,129 275,437,786 For the Three Months Ended March 31, 2009 2008 Weighted-average shares, as used in basic calculation 255,558,961 260,951,566 Shares to cover conversion of preferred stock 185,040 189,056 Shares to cover non-vested stock 505,610 239,923 Average stock options outstanding during the period 14,853 9,994,302 Assumed acquisition of shares with assumed proceeds and benefits from exercising stock options (at average market price for the year) (11,612 ) (9,824,263 ) Shares repurchaseable from measured but unrecognized stock option expense (2,466 ) (69,606 ) Average deferred compensation shares 1,538,997 1,283,671 257,789,383 262,764,649 (1) As a result of the net loss in the first quarter of 2009, shares used in the earnings (loss) per share calculation represent basic shares, since using diluted shares would have been anti-dilutive to the calculation. EPSearnings per share (“EPS”) and will be shown in the table above. Participants in our deferred compensation plans that select LNC stock for measuring the investment return attributable to their deferral amounts will be paid out in LNC stock. The obligation to satisfy these deferred compensation plan liabilities is dilutive and is shown in the table above.2512. For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 2008 2007 $ (314 ) $ (35 ) $ (480 ) $ (18 ) (2 ) (1 ) — 3 8 (13 ) 19 (2 ) (5 ) 7 (10 ) 1 159 (37 ) 196 (6 ) (59 ) 15 (85 ) — 8 (2 ) 10 (3 ) (1 ) 1 (3 ) 1 2 — 6 — $ (204 ) $ (65 ) $ (347 ) $ (24 ) For the Three Months Ended March 31, 2009 2008 Total realized loss on investments and certain $ (153 ) $ (41 ) Gain on certain reinsurance derivative/ 22 - Gross gain 1 7 Associated amortization expense of DAC, VOBA, DSI and DFEL - (4 ) Gross gain (loss) (94 ) 17 Associated amortization expense of DAC, VOBA, DSI and DFEL (20 ) (18 ) Gross gain 57 1 Associated amortization expense of DAC, VOBA, DSI and DFEL (8 ) - Gain on sale of subsidiaries/businesses 2 3 Total realized loss $ (193 ) $ (35 ) Note 4 “Realized Loss Related to Investments” for detail.Standard & Poor’s (“S&P”)&P 500 Index® call options that we hold and the change in the fair value of the embedded derivative liabilities of our indexed annuity products along with changes in the fair value of embedded derivative liabilities related to index call options we may purchase in the future to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products as required under SFAS 133, amended by SFAS 161 and 157. The ninethree months ended September 30,March 31, 2008, includes a $10 million gain from the initial impact of adopting SFAS 157.ninethree months ended September 30,March 31, 2008, includes a $34$33 million loss from the initial impact of adopting SFAS 157.2613. Underwriting, Acquisition, Insurance and Other ExpensesDetails underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows: For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 2008 2007 $ 495 $ 542 $ 1,486 $ 1,592 416 438 1,260 1,300 (245 ) (228 ) (602 ) (712 ) 1 3 5 8 14 13 45 43 60 52 170 169 13 30 44 75 $ 754 $ 850 $ 2,408 $ 2,475 27Employee Benefit Plans For the Three Months Ended September 30, Pension Benefits Other
Postretirement Benefits 2008 2007 2008 2007 $ — $ 9 $ 1 $ — 15 14 2 2 (19 ) (19 ) — (1 ) — 1 — — 1 — — — $ (3 ) $ 5 $ 3 $ 1 $ — $ — 5 5 (5 ) (5 ) 1 1 $ 1 $ 1 For the Nine Months Ended September 30, Pension Benefits Other
Postretirement Benefits 2008 2007 2008 2007 $ 1 $ 25 $ 2 $ 2 46 44 6 6 (58 ) (59 ) (1 ) (2 ) — — — — 3 — (1 ) (1 ) $ (8 ) $ 10 $ 6 $ 5 $ 2 $ 1 15 14 (16 ) (15 ) 2 3 $ 3 $ 3 On May 1, 2007, simultaneous with our announcement of the freeze of our primary defined benefit pension plans, we announced a number of enhancements to our employees’ 401(k) plan effective January 1, 2008. Consequently, we are no longer accruing service costs in our U.S. pension plans.For any additional disclosures and other general information regarding our benefit plans, see Note 16 in our 2007 Form 10-K.28 Three Months Ended March 31, Pension Benefits 2009 2008 2009 2008 U.S. Plans Service cost $ 1 $ - $ 1 $ 1 Interest cost 16 15 2 2 Expected return on plan assets (14 ) (20 ) (1 ) (1 ) Recognized net actuarial (gain) loss 7 - - - Net periodic benefit expense (recovery) $ 10 $ (5 ) $ 2 $ 2 Non-U.S. Plans Interest cost $ 4 $ 5 Expected return on plan assets (3 ) (5 ) Recognized net actuarial loss - 1 Net periodic benefit expense $ 1 $ 1 Stock-Based Incentive Compensation PlansWe sponsor various incentive plans for our employees, agents and directors and our subsidiaries that provide for the issuance of stock options, stock incentive awards, stock appreciation rights, restricted stock awards, restricted stock units (“performance shares”), and deferred stock units. Delaware Investments U.S., Inc. (“DIUS”) has a separate stock-based incentive compensation plan, which has DIUS stock underlying the awards.In the first quarter of 2008, a performance period from 2008-2010 was approved for our executive officers by the Compensation Committee. Executive officers participating in this performance period received one-half of their award in 10-year LNC or DIUS restricted stock units, with the remainder of the award in a combination of either: 100% performance shares or 75% performance shares and 25% cash. LNC stock options granted for this performance period vest ratably over the three-year period, based solely on a service condition. DIUS restricted stock units granted for this performance period vest ratably over a four-year period, based solely on a service condition and were granted only to employees of DIUS. Depending on the performance, the actual amount of performance shares could range from zero to 200% of the granted amount. Under the 2008-2010 plan, a total of 1,564,800 LNC stock options were granted; 2,726 DIUS restricted stock units were granted; and 218,308 LNC performance shares were granted during the nine months ended September 30, 2008.In addition to the stock-based grants noted above, various other LNC stock-based awards were granted in the three and nine months ended September 30, 2008, and were as follows: For the Three
Months Ended
September 30, 2008 For the Nine
Months Ended
September 30, 2008 — 14,326 — 60,489 210 197,323 1,732 165,129 — 234,800 2916. Financial Instruments Carried at Fair ValueSee “Fair ValueFinancial Instruments”fair value is based on assumptions used by market participants in Note 19pricing 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 market, or the most advantageous market in the absence of a principal market, for that asset or liability, as opposed to the consolidatedprice that would be paid to acquire the asset or receive a liability (“entry price”). Pursuant to SFAS 157, we categorize our financial statements in our 2007 Form 10-K andSFAS No. 157 – Fair Value Measurements in Note 2 aboveinstruments 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 discussionsfair 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 as “blockage discounts” for large holdings of unrestricted financial instruments where quoted prices are readily and regularly available for an identical asset or liability in an active market are prohibited; · Level 2 – inputs to the valuation methodology are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value can be determined through the use of models or other valuation methodologies; and · Level 3 – inputs to the valuation methodology are unobservable inputs in situations where there is little or no market activity for the asset or liability and the reporting entity makes estimates and assumptions related to the pricing of the asset or liability, including assumptions regarding risk. methodologies and assumptionsinputs used to determinemeasure 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.financial instruments. table summarizes our financial instruments carried at fair value (in millions) on a recurring basis by the SFAS 157 fair value hierarchy levels described in Note 2. We did not have any assets or liabilities measuredabove: As of March 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 $ 51 $ 35,353 $ 2,101 $ 37,505 U.S. Government bonds 198 32 3 233 Foreign government bonds - 707 58 765 MBS: CMOs - 6,057 133 6,190 MPTS - 1,649 8 1,657 CMBS - 1,661 246 1,907 ABS: CDOs - 6 113 119 CLNs - - 82 82 State and municipal bonds - - 126 126 Hybrid and redeemable preferred stocks 5 672 88 765 Equity AFS securities: Banking securities 9 58 - 67 Insurance securities 2 - 46 48 Other financial services securities - 32 12 44 Other securities 23 - 23 46 Trading securities 2 2,166 78 2,246 Derivative investments - 81 2,145 2,226 Cash and invested cash - 5,613 - 5,613 Reinsurance related derivative assets - 107 - 107 Separate account assets - 57,487 - 57,487 Total assets $ 290 $ 111,681 $ 5,262 $ 117,233 Liabilities Future contract benefits: Remaining guaranteed interest and similar contracts $ - $ - $ (253 ) $ (253 ) GLBs accounted for under SFAS 157/SFAS 133 - - (2,605 ) (2,605 ) Total liabilities $ - $ - $ (2,858 ) $ (2,858 ) For the Three Months Ended March 31, 2009 Sales, Transfers Items Issuances, In or Included Gains Maturities, Out Beginning in (Losses) Settlements, of Ending Fair Net in Calls, Level 3, Fair Value Income OCI Net Value Investments: Fixed maturity AFS securities: Corporate bonds $ 2,356 $ (17 ) $ (40 ) $ 81 $ (279 ) $ 2,101 U.S. Government bonds 3 - - - - 3 Foreign government bonds 60 - (1 ) (1 ) - 58 MBS: CMOs 161 (3 ) (4 ) - (21 ) 133 MPTS 18 - - - (10 ) 8 CMBS 244 - 4 (2 ) - 246 ABS: CDOs 152 1 (39 ) (1 ) - 113 CLNs 50 - 32 - - 82 State and municipal bonds 126 - - - - 126 Hybrid and redeemable preferred stocks 96 - (16 ) 3 5 88 Equity AFS securities: Insurance securities 50 - (4 ) - - 46 Other financial services securities 21 (3 ) (3 ) (3 ) - 12 Other securities 23 3 (2 ) (1 ) - 23 Trading securities 81 (4 ) - - 1 78 Derivative investments 2,148 24 - (27 ) - 2,145 Future contract benefits: Remaining guaranteed interest and similar contracts (252 ) 11 - (12 ) - (253 ) GLBs accounted for under SFAS 157/SFAS 133 (2,904 ) 336 - (37 ) - (2,605 ) Total, net $ 2,433 $ 348 $ (73 ) $ - $ (304 ) $ 2,404 (1) Transfers in or out of Level 3 for AFS and trading securities are displayed at amortized cost at the beginning of the period. For AFS and trading securities, the difference between beginning of period amortized cost and beginning of period fair value was included in OCI and earnings, respectively, in prior periods. For the Three Months Ended March 31, 2009 Gains (Losses) from Sales, Unrealized (Amortization) Maturities, Holding Accretion, Settlements, Gains Net OTTI Calls Total Investments: Fixed maturity AFS securities: Corporate bonds $ 1 $ (15 ) $ (3 ) $ - $ (17 ) MBS: CMOs - (3 ) - - (3 ) ABS: CDOs - - 1 - 1 Equity AFS securities: Other financial services securities - (3 ) - - (3 ) Other securities - - 3 - 3 1 - - (5 ) (4 ) - - (28 ) 52 24 Future contract benefits: Remaining guaranteed interest and similar - - 10 1 11 GLBs accounted for under - - 16 320 336 Total, net $ 2 $ (21 ) $ (1 ) $ 368 $ 348 (1) Amortization and accretion, net and unrealized holding losses are included in net investment income on our Consolidated Statements of Income. All other amounts are included in realized loss on our Consolidated Statements of Income. (2) All amounts are included in realized loss on our Consolidated Statements of Income. (3) This change in unrealized gains or losses relates to assets and liabilities that we still held as of March 31, 2009. non-recurring basis duringmarket approach, which utilizes prices and other relevant information generated by market transactions involving identical or comparable securities. Sources of inputs to the third quarter of 2008market approach include third-party pricing services, independent broker quotations or as of September 30, 2008. As of September 30, 2008 Quoted
Prices
in Active
Markets for
Identical
Assets
(Level 1) Significant
Observable
Inputs
(Level 2) Significant
Unobservable
Inputs
(Level 3) Total
Fair
Value $ 238 $ 47,877 $ 3,816 $ 51,931 52 337 104 493 3 2,293 97 2,393 — 161 1,101 1,262 — 2,160 — 2,160 — 74,971 — 74,971 $ 293 $ 127,799 $ 5,118 $ 133,210 $ — $ — $ (265 ) $ (265 ) — — (564 ) (564 ) — 9 — 9 $ — $ 9 $ (829 ) $ (820 ) Our investment securities are valued using marketpricing matrices. We use observable and unobservable inputs includingto 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 as well asand observations of general market movements for those assetsecurity classes.30The following tables summarize 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 on DAC, VOBA, DSI and DFEL. When a determination is made to classify an asset or liability within level 3 of the fair value hierarchy, the determination is based upon the significance of the unobservable inputs to the overall fair value measurement. Certain For those securities tradetrading in less liquid or illiquid markets with limited or no pricing information, andwe use unobservable inputs in order to measure the determination of fair value of these securities. In cases where this information is not available, such as for theseprivately placed securities, is inherently more difficult. However, level 3 fair value investmentsis 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.include, inbe prioritized differently or may not be available for all AFS securities on any given day. In addition to the unobservable or level 3defined standard inputs observable components (that is, components thatto our valuation methodologies, we also use Trade Reporting and Compliance EngineTM reported tables for our corporate bonds and vendor trading platform data for our U.S. Government bonds. MBS and ABS utilize additional inputs which include new issues data, monthly payment information and monthly collateral performance, including prepayments, severity, delinquencies, step down features and over collateralization features. The valuation methodologies for our state and municipal bonds 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. Our hybrid and redeemable preferred stocks and equity AFS securities utilize additional inputs of exchange prices (underlying and common stock of the same issuer).actively quoted or can be validated to market-based sources). The gains and lossesdetermined in the table below may include changes insame manner as our securities classified as AFS discussed above. For discussion of the significant inputs of our embedded derivatives for Level 2 and Level 3, see the discussion of derivative investments below.due in part to observable inputs that are a component of the valuation methodology. For the Three Months Ended September 30, 2008 Beginning
Fair
Value Items
Included
in
Net
Income Gains
(Losses)
in
OCI Sales,
Issuances,
Maturities,
Settlements,
Calls,
Net Transfers
In or
Out
of
Level 3,
Net(1) Ending
Fair
Value $ 4,231 $ (25 ) $ (206 ) $ (90 ) $ (94 ) $ 3,816 146 (23 ) (38 ) 19 — 104 101 (2 ) — (5 ) 3 97 866 127 6 102 — 1,101 (298 ) 23 — 10 — (265 ) (335 ) (190 ) — (39 ) — (564 ) $ 4,711 $ (90 ) $ (238 ) $ (3 ) $ (91 ) $ 4,289 For the Nine Months Ended September 30, 2008 Beginning
Fair
Value Items
Included
in
Net
Income Gains
(Losses)
in
OCI Sales,
Issuances,
Maturities,
Settlements,
Calls,
Net Transfers
In or
Out
of
Level 3,
Net(1) Ending
Fair
Value $ 4,420 $ (44 ) $ (646 ) $ (55 ) $ 141 $ 3,816 54 (30 ) (6 ) 86 — 104 112 (11 ) (12 ) 8 97 767 118 13 203 — 1,101 (389 ) 34 — 90 — (265 ) (279 ) (177 ) — (108 ) — (564 ) $ 4,685 $ (110 ) $ (639 ) $ 204 $ 149 $ 4,289 (1)Transfers in or out of level 3 for available-for-sale and trading securities are displayed at amortized cost at the beginning of the period. For available-for-sale and trading securities, the difference between beginning of period amortized cost and beginning of period fair value was included in other comprehensive income (“OCI”) and earnings, respectively, in prior periods.31The following tables provide the components of the items included in net income, excluding any impact of amortization on DAC, VOBA, DSI and DFEL and changes in future contract benefits, (in millions) as reported in the table above: For the Three Months Ended September 30, 2008 (Amortization)
Accretion,
Net Other-
Than-
Temporary
Impairment Gains
(Losses)
from
Sales,
Maturities,
Settlements,
Calls Unrealized
Holding
Gains
(Losses)(3) Total $ 1 $ (29 ) $ 3 $ — $ (25 ) — (24 ) 1 — (23 ) 1 (2 ) — (1 ) (2 ) — — (15 ) 142 127 — — 5 18 23 — — 1 (191 ) (190 ) $ 2 $ (55 ) $ (5 ) $ (32 ) $ (90 ) For the Nine Months Ended September 30, 2008 (Amortization)
Accretion,
Net Other-
Than-
Temporary
Impairment Gains
(Losses)
from
Sales,
Maturities,
Settlements,
Calls Unrealized
Holding
Gains
(Losses)(3) Total $ 2 $ (52 ) $ 6 $ — $ (44 ) — (31 ) 1 — (30 ) 2 (8 ) — (5 ) (11 ) — — (61 ) 179 118 — — 14 20 34 — — 5 (182 ) (177 ) $ 4 $ (91 ) $ (35 ) $ 12 $ (110 ) (1)Amortization and accretion, net and unrealized holding losses are included in net investment income on our Consolidated Statements of Income. All other amounts are included in realized loss on our Consolidated Statements of Income.(2)All amounts are included in realized loss on our Consolidated Statements of Income.(3)This change in unrealized gains or losses relates to assets and liabilities that we still held as of September 30, 2008.32available-for-sale fixed maturity securities (in millions) classified within level 3our derivative instruments 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.hierarchy was as follows: As of September 30, 2008 Fair
Value % of Total
Fair Value $ 2,330 61.1 % 483 12.7 % 356 9.3 % 182 4.8 % 25 0.7 % 118 3.1 % 272 7.1 % 50 1.3 % $ 3,816 100.0 % As of December 31, 2007 Fair
Value % of Total
Fair Value $ 2,143 48.5 % 1,113 25.2 % 395 8.9 % 296 6.7 % 31 0.7 % 139 3.1 % 272 6.2 % 31 0.7 % $ 4,420 100.0 % 17. Segment InformationOn July 21, 2008, we announced the realignment of our segments underreinsurance related derivative assets are estimated using the same methodologies and associated inputs as our former Employer Marketsinvestments as discussed above.Individual Markets operating businesses into two new operating businesses – Retirement Solutions and Insurance Solutions. We believeassociated inputs as our investments, as discussed above. The related separate account liabilities are reported at an amount equivalent to the new structure more closely alignsseparate account assets. Investment risks associated with consumer needs and should lead to more coordinated product development and greater effectiveness across the enterprise. The segmentmarket value changes are in accordanceborne by the contract holders, except to the extent of minimum guarantees made by the Company with respect to certain accounts. See Note 9 for additional information regarding arrangements with contractual guarantees.provisions of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” and reflect the manner in which we are organized for purposes of making operating decisions and assessing performance. Accordingly, we have restated results from prior periods in a consistent manner with our realigned segments.Under our newly realigned segments, we will report the resultscontracts being valued.Executive Benefits business, which as of June 30, 2008, was part of the Retirement Products segment, in the Life Insurance segment. We do not view these changes toGLBs accounted for under SFAS 157/ SFAS 133 are based on their approximate surrender values, including an estimate for our segment reporting as material to our consolidated financial statements.businessesbusinesses: Retirement Solutions; Insurance Solutions; Investment Management; and Lincoln UK, and report results through six segments as follows:BusinessCorresponding SegmentsRetirement SolutionsAnnuitiesDefined Contribution (formerly Retirement Products)Insurance SolutionsLife Insurance (including Executive Benefits business)Group ProtectionInvestment ManagementInvestment ManagementLincoln UKLincoln UK33our run-offthe Institutional Pension business, which is a closed-block of pension business, the majority of which was previously reportedsold on a group annuity basis, and is currently in Employer Markets – Retirement Products and the results of our remaining media businesses.Beginning with the quarter ended June 30, 2008, we changed our definitions of segment operating revenues and income from operations to better reflect: the underlying economics of our variable and indexed annuities that employ derivative instruments to hedge policy benefits and the manner in which management evaluates that business. Our change in the definition of income from operations is primarily the result of our adoption of SFAS 157 during the first quarter of 2008. See Note 2. Under SFAS 157, we are required to measure the fair value of these annuities from an “exit value” perspective, (i.e., what a market participant or willing buyer would charge to assume the liability). We, therefore, must include margins that a market participant buyer would require as well as a factor for non-performance risk related to our credit risk. We do not believe that these factors relate to the economics of the underlying business and do not reflect the manner in which management evaluates the business. The items that are now excluded from our operating results that were previously included are as follows: GLB net derivatives results; indexed annuity forward-starting option; and GDB derivatives results. See Note 12 for more information about these items.We continue to exclude the effects of any realized gain (loss) on investments from segment operating revenues and income from operations as we believe that such items are not necessarily indicative of current operating fundamentals or future performance of the business segments, and, in many instances, decisions regarding these items do not necessarily relate to the operations of the individual segments.We believe that our new definitions of operating revenues and income (loss) from operations will provide investors with a more valuable measure of our performance because it better reveals trends in our business.Realized gains and losses associated with the following (“excluded realized gain (loss)”):Sale or disposal of securities;· Realized gains and losses associated with the following (“excluded realized loss”): Impairments of securities;§ Sale or disposal of securities; Change in the fair value of embedded derivatives within certain reinsurance arrangements and the change in the fair value of related trading securities;§ Impairments of securities; Change in the fair value of the embedded derivatives of our GLBs within our variable annuities net of the change in the fair value of the derivatives we own to hedge the changes in the embedded derivative;§ Change in the fair value of embedded derivatives within certain reinsurance arrangements and the change in the fair value of related trading securities; Net difference between the benefit ratio unlocking of SOP No. 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” reserves on our GDB riders within our variable annuities and the change in the fair value of the derivatives excluding our expected cost of purchasing the hedging instruments; and§ Change in the fair value of the embedded derivatives of our GLBs within our variable annuities net of the change in the fair value of the derivatives we own to hedge the changes in the embedded derivative; Changes in the fair value of the embedded derivative liabilities related to index call options we may purchase in the future to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products as required under SFAS 133 and 157.§ Net difference between the benefit ratio unlocking of SOP 03-1 reserves on our GDB riders within our variable annuities and the change in the fair value of the derivatives excluding our expected cost of purchasing the hedging instruments; and Income (loss) from the initial adoption of changes in accounting principles;§ Changes in the fair value of the embedded derivative liabilities related to index call options we may purchase in the future to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products as required under SFAS 133 and 157. Income (loss) from reserve changes (net of related amortization) on business sold through reinsurance;· Income (loss) from the initial adoption of changes in accounting principles; Losses on early retirement of debt, including subordinated debt;· Income (loss) from reserve changes (net of related amortization) on business sold through reinsurance; Losses from the impairment of intangible assets; and· Gains (losses) on early retirement of debt, including subordinated debt; Income (loss) from discontinued operations.· Losses from the impairment of intangible assets; and · Income (loss) from discontinued operations. Excluded realized gain (loss);Amortization of deferred gains arising from the reserve changes on business sold through reinsurance; and· Excluded realized loss; Revenue adjustments from the initial impact of the adoption of changes in accounting principles.· Amortization of deferred gains arising from the reserve changes on business sold through reinsurance; and · Revenue adjustments from the initial impact of the adoption of changes in accounting principles. 34 For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 2008 2007 $ 675 $ 647 $ 1,916 $ 1,861 241 243 718 742 916 890 2,634 2,603 1,072 1,056 3,210 3,121 403 368 1,227 1,119 1,475 1,424 4,437 4,240 110 150 354 451 80 89 263 272 111 113 341 345 (256 ) (66 ) (421 ) (27 ) — 1 2 9 $ 2,436 $ 2,601 $ 7,610 $ 7,893 For the Three Months Ended March 31, 2009 2008 Revenues Operating revenues: Retirement Solutions: Annuities $ 599 $ 623 Defined Contribution 225 238 Total Retirement Solutions 824 861 Insurance Solutions: Life Insurance 1,076 1,055 Group Protection 422 399 Total Insurance Solutions 1,498 1,454 82 120 47 86 Other Operations 83 117 Excluded realized loss, pre-tax (290 ) (45 ) Amortization of deferred gain arising from reserve changes on business sold through reinsurance, pre-tax 1 1 Total revenues $ 2,245 $ 2,594 $21$20 million and $23 million for both the three months ended September 30, 2008March 31, 2009 and 2007, respectively, and $61 million and $67 million for the nine months ended September 30, 2008 and 2007, respectively.35 For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 2008 2007 $ 131 $ 126 $ 365 $ 366 42 41 124 138 173 167 489 504 137 182 458 548 27 33 86 85 164 215 544 633 5 22 32 49 12 10 41 33 (39 ) (49 ) (127 ) (115 ) (166 ) (42 ) (274 ) (16 ) — — 1 (7 ) — — (139 ) — 149 323 567 1,081 (1 ) 7 (5 ) 21 $ 148 $ 330 $ 562 $ 1,102 18. For the Three Months Ended March 31, 2009 2008 Net Income (Loss) Income (loss) from operations: Retirement Solutions: Annuities $ 74 $ 118 Defined Contribution 30 40 Total Retirement Solutions 104 158 Insurance Solutions: Life Insurance 142 157 Group Protection 26 26 Total Insurance Solutions 168 183 Investment Management 1 12 Lincoln UK 6 11 Other Operations (109 ) (42 ) Excluded realized loss, after-tax (188 ) (29 ) Early extinguishment of debt 42 - Impairment of intangibles, after-tax (603 ) - Income (loss) from continuing operations, after-tax (579 ) 293 - (4) Net income (loss) $ (579 ) $ 289 and Fair Value of Financial Instruments Information For the Nine
Months Ended
September 30, 2008 2007 $ — $ 86 — (20 ) — (1 ) — 65 (732 ) — 126 — 647 — 41 — (54 ) $ (13 ) $ — $ 6 $ — 36 For the Three Months Ended March 31, 2009 2008 Significant non-cash investing and financing transactions: Business dispositions: Assets disposed (includes cash and invested cash) $ (2 ) $ (732 ) Liabilities disposed 2 127 Cash received - 647 Realized gain on disposal - 42 Estimated gain on net assets held-for-sale in prior periods - (54 ) Loss on dispositions $ - $ (12 ) Sale of subsidiaries/businesses: Proceeds from sale of subsidiaries/businesses, reported as gain on sale of subsidiaries/businesses $ 2 $ 3 The carrying valuesestimated fair valuesAnalysis of our debt financial instruments (in millions) were as follows: As of
September 30, 2008 As of
December 31, 2007 Carrying
Value Fair
Value Carrying
Value Fair
Value $ (635 ) $ (600 ) $ (550 ) $ (550 ) (4,569 ) (3,930 ) (4,618 ) (4,511 ) 37Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations“Company,”“Company” which also may be referred to as “we,” “our” or “us”) as of September 30, 2008,March 31, 2009, compared with December 31, 2007,2008, and the results of operations of LNC for the three and nine months ended September 30, 2008,March 31, 2009, as compared with the corresponding periodsperiod in 2007.2008. The MD&A is provided as a supplement to, and should be read in conjunction with our consolidated financial statements and the accompanying notes to the consolidated financial statements (“Notes”) presented in “Item 1. Financial Statements” and our Form 10-K for the year ended December 31, 20072008 (“20072008 Form 10-K”), including the sections entitled “Part I – Item 1A. Risk Factors,” as updated in “Part II – Item 1A. Risk Factors” below, “Part II – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Part II – Item 8. Financial Statements and Supplementary Data”, as well as “Part II – Item 1A. Risk Factors” below.Realized gains and losses associated with the following (“excluded realized gain (loss)”):Sale or disposal of securities;· Realized gains and losses associated with the following (“excluded realized loss”): Impairments of securities;§ Sale or disposal of securities; Change in the fair value of embedded derivatives within certain reinsurance arrangements and the change in the fair value of related trading securities;§ Impairments of securities; Change in the fair value of the embedded derivatives of our guaranteed living benefits (“GLB”) within our variable annuities net of the change in the fair value of the derivatives we own to hedge the changes in the embedded derivative;§ Change in the fair value of embedded derivatives within certain reinsurance arrangements and the change in the fair value of related trading securities; Net difference between the benefit ratio unlocking of Statement of Position (“SOP”) No. 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (“SOP 03-1”) reserves on our guaranteed death benefit (“GDB”) riders within our variable annuities and the change in the fair value of the derivatives excluding our expected cost of purchasing the hedging instruments; and§ Change in the fair value of the embedded derivatives of our guaranteed living benefits (“GLB”) within our variable annuities net of the change in the fair value of the derivatives we own to hedge the changes in the embedded derivative (“GLB net derivative results”); Changes in the fair value of the embedded derivative liabilities related to index call options we may purchase in the future to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products as required under Statements of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and SFAS No. 157, “Fair Value Measurements” (“SFAS 157”).§ Net difference between the benefit ratio unlocking of Statement of Position (“SOP”) No. 03-1, “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate Accounts” (“SOP 03-1”) reserves on our guaranteed death benefit (“GDB”) riders within our variable annuities and the change in the fair value of the derivatives excluding our expected cost of purchasing the hedging instruments (“GDB derivatives results”); and Income (loss) from the initial adoption of changes in accounting principles;§ Changes in the fair value of the embedded derivative liabilities related to index call options we may purchase in the future to hedge contract holder index allocations applicable to future reset periods for our indexed annuity products as required under Statements of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and SFAS No. 157, “Fair Value Measurements” (“SFAS 157”) (“Indexed annuity forward-starting option”). Income (loss) from reserve changes (net of related amortization) on business sold through reinsurance;· Income (loss) from the initial adoption of changes in accounting principles; Losses on early retirement of debt, including subordinated debt;· Income (loss) from reserve changes (net of related amortization) on business sold through reinsurance; Losses from the impairment of intangible assets; and· Gain (loss) on early retirement of debt, including subordinated debt; Income (loss) from discontinued operations.· Losses from the impairment of intangible assets; and · Income (loss) from discontinued operations. Excluded realized gain (loss);Amortization of deferred gains arising from the reserve changes on business sold through reinsurance; and· Excluded realized loss; Revenue adjustments from the initial impact of the adoption of changes in accounting principles.· Amortization of deferred gains arising from the reserve changes on business sold through reinsurance; and · Revenue adjustments from the initial impact of the adoption of changes in accounting principles. 17.16. Our management and Board of Directors believe that operating revenues and income (loss) from operations explain the results of our ongoing businesses in a manner that allows for a better understanding of the underlying trends in our current businesses because the excluded items are unpredictable and not necessarily indicative of current operating fundamentals or future performance of the business segments, and, in many instances, decisions regarding these items do not necessarily relate to the operations of the individual segments. Operating revenues and income (loss) from operations do not replace revenues and net income as the GAAP measures of our consolidated results of operations.See Note 2. Under SFAS 157’sthe fair value calculation,measurement provisions of SFAS 157, we are required to measure the fair value of these annuities from an “exit value”price” perspective, (i.e., what athe exchange price between market participant or willing buyer would chargeparticipants to assumetransfer the liability). We, therefore, must include margins that a market participant buyer would require as well as a factor for non-performance risk (“NPR”) related to our credit quality. We do not believe that these factors relate to the38In addition,To that end, we have reclassified the results of certain derivatives and embedded derivatives to realized gain (loss),loss, which were previously reported within insurance fees, net investment income, interest credited or benefits. The associated amortization expense of deferred acquisition costs (“DAC”) and value of business acquired (“VOBA”) (previously reported within underwriting, acquisition, insurance and other expenses), deferred sales inducements (“DSI”) (previously reported within interest credited), deferred front-end loads (“DFEL”) (previously reported within insurance fees) and changes in contract holder funds (previously reported within benefits) have also been reclassified to realized gain (loss).loss. See “Basis of Presentation” in Note 1 for additional information.Continued deterioration in general economic and business conditions, both domestic and foreign, that may affect foreign exchange rates, premium levels, claims experience, the level of pension benefit costs and funding and investment results;Continued economic declines and credit market illiquidity could cause us to realize additional impairments on investments and certain intangible assets including a valuation allowance against deferred tax assets, which may reduce future earnings and/or affect our financial condition and ability to raise additional capital or refinance existing debt as it matures;· Continued deterioration in general economic and business conditions, both domestic and foreign, that may affect foreign exchange rates, premium levels, claims experience, the level of pension benefit costs and funding and investment results; Uncertainty about the effectiveness of the U.S. government’s plan to purchase large amounts of illiquid, mortgage-backed and other securities from financial institutions;· Continued economic declines and credit market illiquidity could cause us to realize additional impairments on investments and certain intangible assets, including goodwill and a valuation allowance against deferred tax assets, which may reduce future earnings and/or affect our financial condition and ability to raise additional capital or refinance existing debt as it matures; Legislative, regulatory or tax changes, both domestic and foreign, that affect the cost of, or demand for, LNC’s products, the required amount of reserves and/or surplus, or otherwise affect our ability to conduct business, including changes to statutory reserves and/or risk-based capital (“RBC”) requirements related to secondary guarantees under universal life and variable annuity products such as Actuarial Guideline VACARVM (“VACARVM”); restrictions on revenue sharing and 12b-1 payments; and the potential for U.S. Federal tax reform;· Uncertainty about the impact of the U.S. Treasury’s Troubled Asset Relief Program (“TARP”) on the economy, and LNC’s ability to participate in the program; The initiation of legal or regulatory proceedings against LNC or its subsidiaries, and the outcome of any legal or regulatory proceedings, such as: adverse actions related to present or past business practices common in businesses in which LNC and its subsidiaries compete; adverse decisions in significant actions including, but not limited to, actions brought by federal and state authorities and extra-contractual and class action damage cases; new decisions that result in changes in law; and unexpected trial court rulings;· Legislative, regulatory or tax changes, both domestic and foreign, that affect the cost of, or demand for, LNC’s products, the required amount of reserves and/or surplus, or otherwise affect our ability to conduct business, including changes to statutory reserves and/or risk-based capital (“RBC”) requirements related to secondary guarantees under universal life and variable annuity products such as Actuarial Guideline (“AG”) 43 (“AG43,” also known as Commissioners Annuity Reserve Valuation Method for Variable Annuities or “VACARVM”); restrictions on revenue sharing and 12b-1 payments; and the potential for U.S. Federal tax reform; Changes in interest rates causing a reduction of investment income, the margins of LNC’s fixed annuity and life insurance businesses and demand for LNC’s products; · A decline in the equity markets causing a reduction in the sales of LNC’s products, a reduction of asset-based fees that LNC charges on various investment and insurance products, an acceleration of amortization of DAC, VOBA, DSI and DFEL and an increase in liabilities related to guaranteed benefit features of LNC’s variable annuity products;39Ineffectiveness of LNC’s various hedging strategies used to offset the impact of changes in the value of liabilities due to changes in the level and volatility of the equity markets and interest rates;A deviation in actual experience regarding future persistency, mortality, morbidity, interest rates or equity market returns from LNC’s assumptions used in pricing its products, in establishing related insurance reserves and in the amortization of intangibles that may result in an increase in reserves and a decrease in net income, including as a result of stranger-originated life insurance business;· Changes in interest rates causing a reduction of investment income, the margins of LNC’s fixed annuity and life insurance businesses and demand for LNC’s products; Changes in GAAP that may result in unanticipated changes to LNC’s net income, including the impact of SFAS 157 and SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”;· A decline in the equity markets causing a reduction in the sales of LNC’s products, a reduction of asset-based fees that LNC charges on various investment and insurance products, an acceleration of amortization of DAC, VOBA, DSI and DFEL and an increase in liabilities related to guaranteed benefit features of LNC’s variable annuity products; Lowering of one or more of LNC’s debt ratings issued by nationally recognized statistical rating organizations and the adverse impact such action may have on LNC’s ability to raise capital and on its liquidity and financial condition;· Ineffectiveness of LNC’s various hedging strategies used to offset the impact of changes in the value of liabilities due to changes in the level and volatility of the equity markets and interest rates; Lowering of one or more of the insurer financial strength ratings of LNC’s insurance subsidiaries and the adverse impact such action may have on the premium writings, policy retention and profitability of its insurance subsidiaries;· A deviation in actual experience regarding future persistency, mortality, morbidity, interest rates or equity market returns from LNC’s assumptions used in pricing its products, in establishing related insurance reserves and in the amortization of intangibles that may result in an increase in reserves and a decrease in net income, including as a result of stranger-originated life insurance business; Significant credit, accounting, fraud or corporate governance issues that may adversely affect the value of certain investments in the portfolios of LNC’s companies requiring that LNC realize losses on such investments;· Changes in GAAP that may result in unanticipated changes to LNC’s net income; The impact of acquisitions and divestitures, restructurings, product withdrawals and other unusual items, including LNC’s ability to integrate acquisitions and to obtain the anticipated results and synergies from acquisitions, including LNC’s ability to successfully integrate Jefferson-Pilot Corporation (“Jefferson-Pilot”) businesses acquired on April 3, 2006, to achieve the expected synergies from the merger or to achieve such synergies within our expected timeframe;· Lowering of one or more of LNC’s debt ratings issued by nationally recognized statistical rating organizations and the adverse impact such action may have on LNC’s ability to raise capital and on its liquidity and financial condition; The adequacy and collectibility of reinsurance that LNC has purchased;· Lowering of one or more of the insurer financial strength ratings of LNC’s insurance subsidiaries and the adverse impact such action may have on the premium writings, policy retention, profitability of its insurance subsidiaries and liquidity; Acts of terrorism, war or other man-made and natural catastrophes that may adversely affect LNC’s businesses and the cost and availability of reinsurance;· Significant credit, accounting, fraud or corporate governance issues that may adversely affect the value of certain investments in the portfolios of LNC’s companies requiring that LNC realize losses on such investments; Competitive conditions, including pricing pressures, new product offerings and the emergence of new competitors, that may affect the level of premiums and fees that LNC can charge for its products;· The impact of acquisitions and divestitures, restructurings, product withdrawals and other unusual items, including LNC’s ability to integrate acquisitions and to obtain the anticipated results and synergies from acquisitions; The unknown impact on LNC’s business resulting from changes in the demographics of LNC’s client base, as aging baby-boomers move from the asset-accumulation stage to the asset-distribution stage of life; and· The adequacy and collectibility of reinsurance that LNC has purchased; Loss of key management, portfolio managers in the Investment Management segment, financial planners or wholesalers.· Acts of terrorism, a pandemic, war or other man-made and natural catastrophes that may adversely affect LNC’s businesses and the cost and availability of reinsurance; · Competitive conditions, including pricing pressures, new product offerings and the emergence of new competitors, that may affect the level of premiums and fees that LNC can charge for its products; · The unknown impact on LNC’s business resulting from changes in the demographics of LNC’s client base, as aging baby-boomers move from the asset-accumulation stage to the asset-distribution stage of life; and · Loss of key management, portfolio managers in the Investment Management segment, financial planners or wholesalers. 20072008 Form 10-K, current reports on Form 8-K and other documents filed with the Securities and Exchange Commission (“SEC”) include additional factors that could impact LNC’s business and financial performance, including “Item 3. Quantitative and Qualitative Disclosures About Market Risk” and the risk discussions included in this section under “Critical Accounting Policies and Estimates,” “Consolidated Investments” and “Reinsurance,” which are incorporated herein by reference. Moreover, LNC operates in a rapidly changing and competitive environment. New risk factors emerge from time to time, and it is not possible for management to predict all such risk factors.40 Retirement Solutions Annuities Defined Contribution (formerly Retirement Products) Insurance Solutions Life Insurance (including Executive Benefits business) Group Protection Investment Management Investment Management Investment ManagementLincoln UK Lincoln UK which was previously reported in Employer Markets – Retirement Products and the results of our remaining media businesses.nine monthsquarter of the year,2009, the capital markets continued to experience high volatility that affected both equity market returns and interest rates. In addition, credit spreads widened across asset classes and reduced liquidity in the credit markets. The price of our common stock declined during the first quarter of 2009 to close at $6.69 on March 31, 2009, as compared to $18.84 on December 31, 2008, and during that time it traded at a low of $4.90. During the first quarter of 2009, analysts and economists noted that the US economy lost more jobs in 2008 than in any year subsequent to World War II and projected that the economic recovery might take longer than previously expected. We also experienced a series of ratings downgrades as depressed capital markets continued to strain our liquidity as we prepared to fund debt maturities in the second quarter of 2009.for the remainder of 2008in 2009 will continue to be unfavorably impacted by the significant decline in the equity markets during the first nine months of 2008.markets. Due to these challenges, the capital markets had a significant effect on our segment operating income (loss) from operations and consolidated net income forduring the threefirst quarter of 2009. In the face of these capital market challenges, we continue to focus on building our businesses through these difficult markets and nine months ended September 30, 2008. Furthermore, although the fourth quarter is normally the strongestbeyond by developing and introducing high quality products, expanding distribution in terms of sales fornew and existing key accounts and channels and targeting market segments that have high growth potential while maintaining a disciplined approach to managing our Life Insurance segment, we expect that those results will be muted in the fourth quarter.expenses. The markets impactimpacted primarily the following areas:segments:segments – Retirement Solutions – Annuities;Annuities, Retirement Solutions – Defined Contribution;Contribution and Investment Management;Management – are the most sensitive to the equity markets. We discuss the earnings impact of the equity markets on account values, assets under management and the related asset-based fees below in “Item 3. Quantitative and Qualitative Disclosures About Market Risk – Equity Market Risk – Impact of Equity Market Sensitivity.” From the end of 2007December 31, 2008, to September 30, 2008,March 31, 2009, the daily average value of the Standard & Poor’sS&P 500 Index® (“S&P”&P 500”) 500 Index® decreased 10%. Solely as a result of the equity markets, our assets under management as of September 30, 2008,March 31, 2009, were down $30.1$5.8 billion from the end of the prior year.December 31, 2008. Strong deposits overin the last yearfirst quarter of 2009 have only helped to partially offset this impact, for the three and nine months ended September 30, 2008, compared to the same periodsperiod in 2007.We have continued to experience unfavorable2008. The effect of the negative equity markets as the October 2008 daily average of the S&P 500 Index® declined 17% from its value as of September 30, 2008, resulting in an approximate $18 billion decline inon our assets under management. We expectmanagement that we experienced in 2008 and the first quarter of 2009 will continue to dampen our income from operationsearnings throughout 2009 even if the equity market returns become consistent with our long-term assumptions. Accordingly, we may continue to be negatively impacted in our asset-gathering businesses fromreport lower asset-based earningsfees, higher DAC and expectVOBA amortization and higher reserves related to our net flows in these businessesGDB guarantees relative to continue to be pressured from these unfavorable equity market conditions.perform in lineunder-perform relative to our long-term return expectations, butand we expect these assets to continue to under-perform going forward,at least in the short term. ThisThese investments impact was primarily in our Insurance Solutions – Life Insurance, Retirement Solutions – Annuities and Retirement Solutions – Defined Contribution segments. See “Consolidated Investments – Alternative Investments” for additional information on our investment portfolio.41 Living Benefit Hedge Program Results These guarantees are considered embedded derivatives and are recorded on our Consolidated Balance Sheets at fair value under SFAS 133 and SFAS 157. Effective January 1, 2008, we adopted SFAS 157, which affected the valuation of our embedded derivatives. See Note 2 of this report for details on the adoption of SFAS 157. As described below in “Critical Accounting Policies and Estimates – Derivatives – Guaranteed Living Benefits,” we use derivative instruments to hedge our exposure to the risks and earnings volatility that result from the embedded derivatives for living benefits in certain of our variable annuity products. The change in fair value of these instruments tends to move in the opposite direction of the change in fair value of the embedded derivatives. For the three and nine months ended September 30, 2008,first quarter of 2009, the market conditions noted above negatively affected the net result of the change in the fair value of the living benefit embedded derivative, excluding the effect of a change in our non-performance riskNPR factor, and the change in fair value of the hedging derivatives. The change in our non-performance riskNPR factor used in the calculation of the embedded derivative liability relates to the change in the spreads of our credit default swaps and the associated volume related to volatilities and interest rates adjusted for factors such as liquidity and the priority of our claims-paying rating and had a favorablean unfavorable effect resulting in anon the overall positive outcome.result during the first three months of 2009. These results are excluded from operating revenues and income from operations.of $314 million and $480which reduced net income by $87 million for the three and nine months ended September 30, 2008, whichMarch 31, 2009, and included grosscredit related write-downs of securities for other-than-temporary impairments (“OTTI”) of $312 million and $523 million, respectively.$139 million. Widening spreads was the primary cause of ana $247 million increase in gross unrealized losses of $3.7 billion on investmentsthe available-for-sale (“AFS”) fixed maturity securities in our general account for the ninethree months ended September 30, 2008, for our available-for-sale fixed maturity securities.March 31, 2009. These unrealized losses were concentrated in the investment grade category of investments and demonstrate how reduced liquidity in the credit markets have resulted in a decline in asset values as investors shift their investments to saferless volatile government securities, such as U.S. Treasuries.The effect of the negative equity markets on our assets under management in the first nine months of 2008 will continue to dampen our earnings throughout 2008 even if, for the remainder of the year, the equity market returns are consistent with our long-term assumptions. Accordingly, we may continue to report lower asset-based fees relative to expectations or prior periods. The volatility and uncertainty in the capital markets will also likely result in lower than expected returns in the short term on alternative investments. In addition, continued weakness in the economic environment could lead to increased credit defaults, resulting in additional write-downs of securities for other-than-temporary impairments.In the face of these capital market challenges, we continue to focus on building our businesses through these difficult markets and beyond by developing and introducing high quality products, expanding distribution in new and existing key accounts and channels and targeting market segments that have high growth potential while maintaining a disciplined approach to managing our expenses.Capital PreservationOn October 10, 2008, the Board of Directors approved a decrease in the quarterly dividend to stockholders from $0.415 per share to $0.21 per share effective in 2009, which is expected to add approximately $50 million to capital each quarter. Additionally, we have suspended further stock repurchase activity. Both of these changes will favorably impact our capital position prospectively.Emergency Economic Stabilization Act of 2008Septemberthe latter part of 2008 and October of 2008,into 2009, Congress enacted the Emergency Economic Stabilization Act of 2008 (“EESA”) on October 3, 2008, and the American Recovery and Reinvestment Act of 2009 (“ARRA”) which was signed into law on February 17, 2009, in an effort to restore liquidity to the U.S. credit markets.markets and stimulate the U.S. economy. The EESA defines financial institutions to include insurance companies. The EESAcompanies and contains the Troubled Assets Relief Program (“TARP”).TARP. The ARRA and TARP authorized the U.S. Treasury to purchase of “troubled assets” (as defined in the TARP) from financial institutions, including insurance companies. Pursuant to the authority granted under the TARP, the U.S. Treasury also adopted the Capital Purchase Program (“CPP”), the Generally Available Capital Access Program and the Exceptional Financial Recovery Assistance Program. Under the Capital Purchase Program,CPP, as currently adopted, bank and thrift holding companies may apply to the U.S. Treasury for the direct sale of preferred stock and warrants to the U.S. Treasury. It remains unclear at this point, if and when the EESA and ARRA will restore sustained liquidity and confidence in the markets and its affect on the fair value of our invested assets.42StrategicOperational ReviewProduct developmentloan holding company and strong distribution are importantour acquisition of Newton County Loan & Savings, FSB, a federally regulated savings bank, located in Indiana. We contributed $10 million to our abilitythe capital of Newton County Loan & Savings, FSB, and closed on the purchase on January 15, 2009. We also previously filed an application to meetparticipate in the challengesCPP. Our application to participate in the CPP is subject to approval from the U.S. Treasury. Accordingly, there can be no assurance that we will be able to participate in the CPP or any of the competitive marketplace. In the third quarter of 2008, our Insurance Solutions – Life Insurance segment launchedLincoln AssetEdgeSM VUL, a variable life insurance product offering clients the ability to align their portfolio to match investment goals, while retaining the flexibility to change allocations as needs change. In February 2008, our Retirement Solutions – Annuities segment launched a new guaranteed withdrawal benefit (“GWB”),Lincoln Lifetime IncomeSMAdvantage, which includes features such as: a reduced minimum age for lifetime income eligibility; a 5% benefit enhancement in each year an owner does not take a withdrawal; a health care benefit; and a guaranteed minimum accumulation benefit. Within the mid-sized market of our Retirement Solutions – Defined Contribution segment, in the first quarterother programs or that we launched ourLincoln SmartFutureSM retirement program to fill the gap between our Alliance program and our group variable annuities.In the third quarter we launched our new LINCOLN DIRECTORSM product that offers more than 80 investment options and will be positioned as our primary product in the micro-to small 401(k) plan marketplace. This product includes fiduciary support for plan sponsors, accumulation strategies and tools for plan participants and will also offer our patented distribution option,i4LIFE® Advantage.In terms of increasing our distribution breadth, we launched variable annuity products into three large banks during the first nine months of 2008. In support of these and other activities, Lincoln Financial Distributors (“LFD”) increased the number of wholesalers by 13% since the end of 2007.of 2008,2009, we expect major challenges to include:Continuation of volatility in the equity markets and hedge breakage, as the October 2008 daily average of the S&P 500 Index® declined 17% from its value as of September 30, 2008, causing continued variable account value erosion;Continuation of illiquid credit markets and impact on spreads and on other-than-temporary impairments;· Continuation of volatility in the equity markets, resulting in hedge breakage and possible additional erosion in variable account values; Continuation of the low interest rate environment, which creates a challenge for our products that generate investment margin profits, such as fixed annuities and UL;· Continuation of illiquid credit markets and impact on spreads and on other-than-temporary securities impairments; Continuation of challenges in the economy, including the potential for a recession;· Continuation of the current credit and capital market conditions, restricting our ability to access capital; Achieving success in our portfolio of products, marketplace acceptance of new variable annuity features and maintaining management and wholesalers that will help maintain our competitive position; and· Continuation of the low interest rate environment, which creates a challenge for our products that generate investment margin profits, such as fixed annuities and UL; Continuation of focus by the government on tax reform including potential changes in company dividends-received deduction (“DRD”) calculations, which may impact our products and overall earnings.· Possible additional intangible asset impairments, such as goodwill, if the financial performance of our reporting units does not improve, our market capitalization remains below book value for a prolonged period of time or business valuation assumptions (such as discount rates and equity market volatility) deteriorate further; · Continuation of the recession and other challenges in the economy; · Achieving success in our portfolio of products, marketplace acceptance of new variable annuity features and maintaining management and wholesalers that will help maintain our competitive position; and · Continuation of focus by the government on tax reform including potential changes in company dividends-received deduction (“DRD”) calculations, which may impact our products and overall earnings. 2008:2009:· Continue near term product development in our manufacturing units and future product development initiatives, with particular focus on further reducing risk related to guaranteed benefit riders offered with certain variable annuities; · Evaluate and potentially pursue the sale of non-core businesses and other options to raise additional capital; · Manage our expenses aggressively and utilize cost reduction initiatives and continue embedding financial and execution discipline throughout our operations; and · Substantially complete the remaining platform and system consolidations necessary to achieve the final portion of integration cost saves as well as prepare us for more effective customer interaction in the future. manufacturing units2008 Form 10-K, as updated in “Part II – Item 1A. Risk Factors” below, and future product development initiatives“Forward-Looking Statements – Cautionary Language” in our Retirement Income Security Venture unit related to the evolving retirement income security marketplace;this report.Engage in cost reduction initiatives and further embed financial and execution discipline throughout our operations by using technology and making other investments to improve operating effectiveness and lower unit costs; andSubstantially complete the remaining platform and system consolidations necessary to achieve the final portion of integration cost saves as well as prepare us for more effective customer interaction in the future.4320072008 Form 10-K contains a detailed discussion of our critical accounting policies and estimates. The following information updates the critical accounting policies and estimates provided in our 20072008 Form 10-K and, accordingly, should be read in conjunction with the critical accounting policies and estimates discussed in our 20072008 Form 10-K.Adoption of SFAS No. 157 – Fair Value MeasurementsWe adopted SFAS 157 for all our financial instruments effective January 1, 2008. For detailed discussions of the methodologies and assumptions used to determine the fair value of our financial instruments and a summary of our financial instruments carried at fair value as of September 30, 2008, see Notes 2 and 16 of this report and Notes 1 and 19 to the consolidated financial statements in our 2007 Form 10-K.The adoption of SFAS 157 decreased income from continuing operations by $16 million. The impact to revenue is reported in realized gain (loss) and such amount along with the associated federal income taxes is excluded from income from operations of our segments. For a detailed description of the impact of adoption on our consolidated financial statements, see Note 2.We did not make any material changes to valuation techniques or models used to determine the fair value of our assets and liabilities carried at fair value during the three and nine months ended September 30, 2008, subsequent to the adoption of SFAS 157. As part of our on-going valuation process, we assess the reasonableness of all our valuation techniques or models and make adjustments as necessary.Our investment securities are valued using market inputs, including benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data. In addition, market indicators and industry and economic events are monitored, and further market data is acquired if certain triggers are met. Credit risk is also incorporated and considered in the valuation of our investment securities as we incorporate the issuer’s credit rating and a risk premium, if warranted, due to the issuer’s industry and the security’s time to maturity. The credit rating is based upon internal and external analysis of the issuer’s financial strength. For certain security types, additional inputs may be used, or some of the inputs described above may not be applicable. For broker-quoted only securities, quotes from market makers or broker-dealers are obtained from sources recognized to be market participants. In order to validate the pricing information and broker/dealer quotes, we employ, where possible, procedures that include comparisons with similar observable positions, comparisons with subsequent sales, discussions with senior business leaders and brokers as well as observations of general market movements for those asset classes. The broker/dealer quotes are non-binding. Our broker-quoted only securities are generally classified as Level 3 in the SFAS 157 hierarchy.It is possible that different valuation techniques and models, other than those described above, could produce materially different estimates of fair values.The following summarizes our financial instruments carried at fair value by pricing source and SFAS 157 hierarchy level (in millions): As of September 30, 2008 Level 1 Level 2 Level 3 Total $ 293 $ 43,861 $ — $ 44,154 — — 2,528 2,528 — 6,807 — 6,807 — — 2,590 2,590 — 2,160 — 2,160 $ 293 $ 52,828 $ 5,118 $ 58,239 1 % 90 % 9 % 100 % (1)Represents primarily securities for which pricing models were used to compute the fair values.(2)Valued primarily at amortized cost, which approximates fair value.Our insurance liabilities that contain embedded derivatives are valued based on a stochastic projection of scenarios of the embedded derivative fees, benefits and expenses. The scenario assumptions, at each valuation date, are those we view to be appropriate for a hypothetical market participant and include assumptions for capital markets, actuarial lapse, benefit utilization, mortality, risk margin, administrative expenses and a margin for profit. In addition, a non-performance risk component is determined each valuation date that reflects our risk of not fulfilling the obligations of the underlying liability. The spread for the non-performance risk is added to the discount rates used in determining the fair value from the net cash flows. We believe these44assumptions are consistent with those that would be used by a market participant; however, as the related markets develop we will continue to reassess our assumptions. It is possible that different valuation techniques and assumptions could produce a materially different estimate of fair value.The adoption of SFAS 157 increased our exposure to earnings volatility from period to period due primarily to the inclusion of the non-performance risk into the calculation of the GLB embedded derivative liability. For additional information, see our discussion in “Realized Loss” below and “Item 3. Quantitative and Qualitative Disclosures About Market Risk.”The following summarizes the percentages of our financial instruments carried at fair value on a recurring basis by the SFAS 157 hierarchy levels: As of September 30, 2008 Level 1 Level 2 Level 3 Total
Fair
Value 1 % 90 % 9 % 100 % 0 % 0 % 100 % 100 % Note: The percentages above are calculated excluding separate account assets.Changes of our financial instruments carried at fair value and classified within level 3 of the fair value hierarchy result from changes in market conditions, as well as changes in our portfolio mix and increases and decreases in fair values as a result of those classifications. During the three and nine months ended September 30, 2008, there were no material changes in financial instruments classified as level 3 of the fair value hierarchy. For further detail, see Note 16.See “Consolidated Investments” below for a summary of our investments in available-for-sale securities backed by pools of residential mortgages.DAC, VOBA, DSI and DFELOn a quarterly basis, we may record an adjustment to the amounts included within our Consolidated Balance Sheets for DAC, VOBA, DSI and DFEL with an offsetting benefit or charge to revenue or expense for the impact of the difference between the estimates of future gross profits used in the prior quarter and the emergence of actual and updated estimates of future gross profits in the current quarter (“retrospective unlocking”). In addition, in the third quarter of each year, we conduct our annual comprehensive review of the assumptions and the projection models used for our estimates of future gross profits underlying the amortization of DAC, VOBA, DSI and DFEL and the calculations of the embedded derivatives and reserves for annuity and life insurance products with living benefit and death benefit guarantees. These assumptions include investment margins, mortality, retention and rider utilization. Based on our review, the cumulative balances of DAC, VOBA, DSI and DFEL, included on our Consolidated Balance Sheets, are adjusted with an offsetting benefit or charge to revenue or amortization expense to reflect such change (“prospective unlocking – assumption changes”). We may also identify and implement actuarial modeling refinements (“prospective unlocking – model refinements”) that result in increases or decreases to the carrying values of DAC, VOBA, DSI, DFEL, embedded derivatives and reserves for annuity and life insurance products with living benefit and death benefit guarantees. The primary distinction between retrospective and prospective unlocking is that retrospective unlocking is driven by the emerging experience period-over-period, while prospective unlocking is driven by changes in assumptions or projection models related to estimated future gross profits.In discussing our results of operations below in this MD&A, we refer to favorable and unfavorable unlocking. With respect to DAC, VOBA and DSI, favorable unlocking refers to a decrease in the amortization expense in the period, whereas unfavorable unlocking refers to an increase in the amortization expense in the period. With respect to DFEL, favorable unlocking refers to an increase in the amortization expense in the period, whereas unfavorable unlocking refers to a decrease in the amortization expense in the period. With respect to the calculations of the embedded derivatives and reserves for annuity and life insurance products with living benefit and death benefit guarantees, favorable unlocking refers to a decrease in the change in reserves in the period, whereas unfavorable unlocking refers to an increase in the change in reserves in the period.45Details underlying the increase to income from continuing operations from our prospective unlocking (in millions) were as follows: For the Three
Months Ended
September 30, 2008 2007 $ (1 ) $ (1 ) (28 ) 26 (1 ) 5 (30 ) 30 — 1 48 2 48 3 18 33 — (1 ) — (1 ) — 2 85 — 85 2 (2 ) (12 ) — 3 (81 ) 21 4 2 (79 ) 14 6 15 12 18 4 6 $ 8 $ 12 As equity markets do not move in a systematic manner, we use a “reversion to the mean” (“RTM”) process to compute our best estimate long-term gross growth rate assumption. Under our current RTM process, on each valuation date, future estimated gross profits (“EGPs”) are projected using stochastic modeling of a large number of future equity market scenarios in conjunction with best estimates of lapse rates, interest rate spreads and mortality to develop a statistical distribution of the present value of future EGPs for our variable annuity, annuity-based 401(k) and unit-linked product blocks of business. This process is not applied to our life insurance and fixed annuity businesses, as equity market performance does not have as significant of an impact on these products. Because future equity market returns are unpredictable, the underlying premise of this process is that best estimate projections of future EGPs, as required by SFAS No. 97, “Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments” (“SFAS 97”), need not be affected by random short-term and insignificant deviations from expectations in equity market returns. However, long-term or significant deviations from expected equity market returns require a change to best estimate projections of EGPs and prospective unlocking of DAC, VOBA, DSI and DFEL. The statistical distribution is designed to identify when the equity market return deviations from expected returns have become significant enough to warrant a change of the future equity return EGP assumption.The stochastic modeling performed for our variable annuity blocks of business as described above is used to develop a range of reasonably possible future EGPs. We compare the range of the present value of the future EGPs from the stochastic modeling to that used in our amortization model. A set of intervals around the mean of these scenarios is utilized to calculate two separate statistical ranges of reasonably possible EGPs. These intervals are then compared again to the present value of the EGPs used in the amortization model. If the present value of EGP assumptions utilized for amortization were to exceed the margin of the46reasonable range of statistically calculated EGPs, a revision of the EGPs used to calculate amortization would occur. If a revision is deemed necessary, future EGPs would be re-projected using the current account values at the end of the period during which the revision occurred along with a revised long-term annual equity market gross return assumption such that the reprojected EGPs would be our best estimate of EGPs.Notwithstanding these intervals, if a severe decline or advance in equity markets were to occur or should other circumstances, including contract holder behavior, suggest that the present value of future EGPs no longer represents our best estimate, we could determine that a revision of the EGPs is necessary.Our practice is not necessarily to unlock immediately after exceeding the first of the two statistical ranges, but, rather, if we stay between the first and second statistical range for several quarters, we would likely unlock. Additionally, if we exceed the ranges as a result of a short-term market reaction, we would not necessarily unlock. However, if the second statistical range is exceeded for more than one quarter, it is likely that we would unlock. While this approach reduces adjustments to DAC, VOBA, DSI and DFEL due to short-term equity market fluctuations, significant changes in the equity markets that extend beyond one or two quarters could result in a significant favorable or unfavorable unlocking.The October 2008 daily average of the S&P 500 Index® declined 17% from its value as of September 30, 2008, negatively impacting our variable account values. If equity markets do not materially improve over the remainder of the fourth quarter, we may unlock our model assumption for equity market returns for DAC, VOBA, DSI and DFEL and the calculations of the embedded derivatives and reserves for annuity products with living and death benefit guarantees, resulting in a significant unfavorable impact to net income. We estimate that if the variable account values were to decline approximately 20% at December 31, 2008 from the levels at September 30, 2008, an unlocking during the fourth quarter could reduce net income by approximately $250 million, after-tax.techniquestechnique. In determining the estimated fair value of these reporting units, we useincorporated consideration of discounted cash flow calculations, the level of our own share price and assumptions that market participants would make in valuing these reporting units. Our fair value estimations were based primarily on an in-depth analysis of projected future cash flows and relevant discount rates, which considered market participant inputs (“income approach”). The discounted cash flow analysis required us to estimatemake judgments about revenues, earnings projections, capital market assumptions and discount rates. The key assumptions used in the analysis to determine the fair value of the group of assets comprising the differentthese reporting units variesincluded:· New business for 10 years and run off of cash flows on in-force and new business for the life of the reporting unit; · Adjustments of several assumptions in our projections to reflect conservatism in the near-term as a result of the current volatility in the capital markets, including: § Lower equity market returns for 2 years; § Lower alternative investment income returns for 2 years; § Higher line of credit costs related to reserve securitizations; · Discount rates ranging from 11.0% to 16.0%, which were based on the weighted average cost of capital for each of our reporting units adjusted for the risks associated with the operations. We used 11.0% for our Insurance Solutions – Life reporting unit and 16.0% for our Retirement Solutions – Annuities reporting unit. characteristicsStep 1 analysis, except for our Retirement Solutions – Annuities reporting unit, which required a Step 2 analysis to be completed. In our Step 2 analysis, we estimated the implied fair value of eachthe reporting unit’s goodwill as determined by allocating the reporting unit’s fair value determined in Step 1 to all of its net assets (recognized and unrecognized) as if the reporting unit had been acquired in a business and operations. A market-based valuation technique that focuses on price-to-earnings multiplier andcombination at the segment-level operating income is useddate of the impairment test.Insurance Solutions segmentsequity market volatility, deterioration in equity markets and lower annuity sales.remaining media businessamount related to all other factors (“noncredit loss”), which is recognized in other comprehensive income (“OCI”). In addition, FSP FAS 115-2 replaces the requirement for management to assert that it has the intent and ability to hold an impaired security until recovery with the requirement that management assert that it does not have the intent to sell the security and that it is now reportedmore likely than not that it will not have to sell the security before recovery of its cost basis.Other Operations. Forfair value that we determine to be other-than-temporary. In accordance with FSP FAS 115-2, if we intend to sell a security and the Lincoln UK segment,market value of the security is below amortized cost, the amortized cost is written down to current fair value with a discountedcorresponding charge to realized loss on our Consolidated Statements of Income, as this is deemed a credit-related event. If we do not intend to sell a security but believe we will not recover a security’s amortized cost, the amortized cost is written down to the estimated recovery value with a corresponding charge to realized loss on our Consolidated Statements of Income, as this is also deemed a credit-related event, and the remainder of the decline to fair value is recorded to unrealized OTTI loss on AFS securities on our Consolidated Statements of Stockholders’ Equity, as this is considered a noncredit (i.e., recoverable) event. The determination of our intent to sell a security is based upon whether we can assert that we do not have the intent to sell the security and if it is more likely than not that we will not have to sell the security before recovery of the securities cost basis. In making this determination, we evaluate facts and circumstances such as, but not limited to, decisions to reposition our security portfolio, sale of securities to meet cash flow modelneeds and sales of securities to capitalize on favorable pricing. The credit loss on a security is utilizedbased upon our estimate of the decrease in expected cash flows or our best estimate of credit deterioration. If an OTTI exists and we do not have sufficient cash flow or other information to determine a recovery value for the security, we would conclude that the entire OTTI is credit-related and the amortized cost for the security is written down to current fair value with a corresponding charge to realized loss on our Consolidated Statements of Income.value. Avalue objective remains the same. Fair value is the price that would be received to sell the security in an orderly transaction (i.e., not a forced liquidation or distressed sale), between market participants at the measurement date in the current inactive market (i.e., an “exit price” notion).· Few recent transactions based on volume and level of activity in the market, therefore there is not sufficient frequency and volume to provide pricing information on an ongoing basis; · Price quotations are not based on current information; · Price quotations vary substantially either over time or among market makers; · Indexes that previously were highly correlated with the fair values of the asset are demonstrably uncorrelated with recent fair values; · Abnormal, or significant increases in, liquidity risk premiums or implied yields for quoted prices when compared with reasonable estimates using realistic assumptions of credit and other nonperformance risk for the asset class; · Abnormally wide bid-ask spread or significant increases in the bid-ask spread; and · Little information is released publicly. technique combining multiplestechniques (or a change in valuation technique) may be appropriate. The circumstances that may indicate a transaction is not orderly could include:· The seller is in or near bankruptcy or receivership or the seller was required to sell the asset to meet regulatory requirements; · There was a usual and customary marketing period, but the seller marketed the asset to a single market participant; and · The transaction price is significantly different relative to other similar transactions. revenues, earnings before interest, taxes, depreciationfair value or of market participant risk premiums. In estimating fair value, an entity should place more weight on transactions that it concludes are orderly. Less weight should be placed on transactions that the reporting entity does not have sufficient information to conclude whether the transaction is orderly.amortization and assets under management is usedconcluded that none were inactive. We will continue to assess the goodwill in our Investment Management segment.DerivativesSeptember 30, 2008,March 31, 2009, contain industry standard terms and are entered into with financial institutions with long-standing, superior performance records.terms. Our accounting policies for derivatives and the potential impact on interest spreads in a falling rate environment are discussed in “Item 3. Quantitative and Qualitative Disclosures About Market Risk” and Note 6 of this report and “Part II – Item 7A. Quantitative and Qualitative Disclosures About Market Risk” and Note 56 to the consolidated financial statements in our 20072008 Form 10-K.GWBguaranteed withdrawal benefit (“GWB”) feature and ouri4LIFE® Advantage and 4LATER® Advantage guaranteed income benefit (“GIB”) featurefeatures that isare available in our variable annuity products. In the second quarter of 2007, we also began hedging our 4LATER® Advantage GIB feature available in our variable annuity products. These living benefit features are collectively referred to as GLBs. During 2007, we made adjustments to our hedging program to purchase longer dated volatility protection and increased our hedges related to volatility to better match liability sensitivities under SFAS 157. In addition, in early January 2008, we added the GLB features that are available in our variable annuity businessproducts in our New York insurance subsidiary, with total account values of approximately $1.1 billion as of September 30, 2008,LLANY, to our hedge program. In February 2008, we also added our new GWBLincoln Lifetime IncomeSMAdvantage to our hedging program. Our GIB and 4LATER® features have elements of both insurance benefits accounted for under SOP 03-1 and embedded derivatives accounted for under SFAS 133 and SFAS 157. We weight these features and their associated reserves accordingly based on their hybrid nature. In addition to mitigating selected risk and47performancegoal of the hedge programaccumulating assets that could be used to pay claims under these benefits, recognizing that any material potentialsuch claims under the GLBs are likely to begin no earlier than approximately a decade in the future.GWB and GIBGLB features. This dynamic hedging strategy utilizes options on U.S.-based equity indices, futures on U.S.-based and international equity indices and variance swaps on U.S.-based equity indices, as well as interest rate futures and swaps. The notional amounts of the underlying hedge instruments are such that the magnitude of the change in the value of the hedge instruments due to changes in equity markets, interest rates and implied volatilities is designed to offset the magnitude of the change in the fair value of the GWB and GIBGLB guarantees caused by those same factors. As of September 30, 2008,March 31, 2009, the fair value of the embedded derivativesderivative liability, before adjustment for the NPR factor required by SFAS 157, for GWB, thei4LIFE® Advantage GIB and the 4LATER® Advantage GIB were liabilities valued at $249 million, $200$2.3 billion, $709 million and $115$201 million, netrespectively. See “Realized Loss – Operating Realized Gain – GLB” for information on how we determine our NPR.non-performanceunderlying funds and the hedging indices, divergence between the actual and expected performance of the hedge instruments or our ability to purchase hedging instruments at prices consistent with our desired risk factor (“NPR”) required by SFAS 157, respectively.additionalmore information on our GDB hedging strategy, see the discussion in “Future Contract Benefits and Other Contract Holder Obligations” below.AcquisitionsDispositionsDispositionsMedia BusinessOn June 7, 2007,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 announced plans to explore strategic options for our former business segment, Lincoln Financial Media. Duringconsider many factors, including: the fourth quarter of 2007, we decided to divest our televisionnature and Charlotte radio broadcasting and sports programming businesses, and, on November 12, 2007, we signed agreements to sell them. The divestiturecharacter of the sports programming business closed on November 30, 2007, the Charlotte radio broadcasting business closed on January 31, 2008, and the television broadcasting business closed on March 31, 2008. Accordingly, we have reported the results of these businesses as discontinued operations on our Consolidated Statements of Income and thedeferred tax assets and liabilities as held for sale onliabilities; taxable income in prior carryback years; projected taxable earnings, including capital gains exclusive of reversing temporary differences and carryforwards; 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 more likely than not that the deferred tax assets, including our Consolidated Balance Sheets for all periods presented. We continue to actively manage our investment in our remaining radio clusters, which are now being reported within Other Operations, to maximize station performance and future valuation.capital loss deferred tax asset, will be realized. For additional information on our income taxes, see Note 3.The proceeds from7 in this report and Note 7 to the sales of the above media properties were used for repurchase of shares, repayment of debtconsolidated financial statements in our 2008 Form 10-K.other strategic initiatives.The results of operations of these businesses have been reclassified into income from discontinued operations for all periods presented on the Consolidated Statements of Income. The amounts (in millions) related to operations of these businesses, included in income from discontinued operations, were as follows: For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 Change 2008 2007 Change $ — $ 33 -100 % $ 22 $ 104 -79 % $ — $ 10 -100 % $ 8 $ 32 -75 % — 3 -100 % 3 11 -73 % — 7 -100 % 5 21 -76 % — — NM (13 ) — NM 1 — NM (3 ) — NM (1 ) — NM (10 ) — NM $ (1 ) $ 7 NM $ (5 ) $ 21 NM During the first quarter of 2008, we adjusted our loss on disposal of discontinued media properties due primarily to changes in the net assets disposed of for the television broadcasting business.48Fixed Income Investment Management BusinessDuring the fourth quarter of 2007, we sold certain institutional taxable fixed income business to an unaffiliated investment management company. Investment Management transferred $12.3 billion of assets under management as part of this transaction. Based upon the assets transferred as of October 31, 2007, the purchase price is expected to be no more than $49 million. The impact of this transaction is discussed further below in results of Investment Management.During the fourth quarter of 2007, we received $25 million of the purchase price, with additional scheduled payments over the next three years. During 2007, we recorded an after-tax realized loss of $2 million on our Consolidated Statements of Income as a result of goodwill we attributed to this business. During the three and nine months ended September 30, 2008, we recorded an after-tax gain of $1 million and $4 million, respectively, on our Consolidated Statements of Income related to this transaction. additional information about acquisitions and dispositions,divestitures, see Note 3 in this report and “Part III – Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations1. Business – Introduction – AcquisitionAcquisitions and Dispositions” and Note 3 to the consolidated financial statements in our 20072008 Form 10-K.RESULTS OF CONSOLIDATED OPERATIONSRESULTS OF CONSOLIDATED OPERATIONS For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, �� 2008 2007 Change 2008 2007 Change $ 533 $ 491 9 % $ 1,572 $ 1,439 9 % 791 836 -5 % 2,446 2,342 4 % 68 89 -24 % 220 272 -19 % 1,089 1,062 3 % 3,231 3,285 -2 % (204 ) (65 ) NM (347 ) (24 ) NM 19 19 0 % 57 65 -12 % 140 169 -17 % 431 514 -16 % 2,436 2,601 -6 % 7,610 7,893 -4 % 625 611 2 % 1,849 1,817 2 % 836 623 34 % 2,199 1,866 18 % 754 850 -11 % 2,408 2,475 -3 % 69 69 0 % 209 204 2 % — — NM 175 — NM 2,284 2,153 6 % 6,840 6,362 8 % 152 448 -66 % 770 1,531 -50 % 3 125 -98 % 203 450 -55 % 149 323 -54 % 567 1,081 -48 % (1 ) 7 NM (5 ) 21 NM $ 148 $ 330 -55 % $ 562 $ 1,102 -49 % 49 For the Three Months Ended March 31, 2009 2008 Change Revenues Insurance premiums $ 518 $ 509 2 % Insurance fees 728 814 -11 % Investment advisory fees 44 76 -42 % Net investment income 1,027 1,065 -4 % Realized loss: Total other-than-temporary impairment losses on securities (214 ) (57 ) NM Portion of loss recognized in other comprehensive income 89 - NM Net other-than-temporary impairment losses on securities recognized in earnings (125 ) (57 ) NM Realized gain, excluding other-than-temporary impairment losses on securities (68 ) 22 NM Total realized loss (193 ) (35 ) NM Amortization of deferred gain on business sold through reinsurance 19 19 0 % Other revenues and fees 102 146 -30 % Total revenues 2,245 2,594 -13 % Benefits and Expenses Interest credited 627 612 2 % Benefits 939 679 38 % Underwriting, acquisition, insurance and other expenses 725 809 -10 % Interest and debt expense - 76 -100 % Impairment of intangibles 603 - NM Total benefits and expenses 2,894 2,176 33 % Income (loss) from continuing operations before taxes (649 ) 418 NM Federal income tax expense (benefit) (70 ) 125 NM Income (loss) from continuing operations (579 ) 293 NM Loss from discontinued operations, net of federal incomes taxes - (4 ) 100 % Net income (loss) $ (579 ) $ 289 NM For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 Change 2008 2007 Change $ 675 $ 647 4 % $ 1,916 $ 1,861 3 % 241 243 -1 % 718 742 -3 % 916 890 3 % 2,634 2,603 1 % 1,072 1,056 2 % 3,210 3,121 3 % 403 368 10 % 1,227 1,119 10 % 1,475 1,424 4 % 4,437 4,240 5 % 110 150 -27 % 354 451 -22 % 80 89 -10 % 263 272 -3 % 111 113 -2 % 341 345 -1 % (256 ) (66 ) NM (421 ) (27 ) NM — 1 -100 % 2 9 -78 % $ 2,436 $ 2,601 -6 % $ 7,610 $ 7,893 -4 % For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 Change 2008 2007 Change $ 131 $ 126 4 % $ 365 $ 366 0 % 42 41 2 % 124 138 -10 % 173 167 4 % 489 504 -3 % 137 182 -25 % 458 548 -16 % 27 33 -18 % 86 85 1 % 164 215 -24 % 544 633 -14 % 5 22 -77 % 32 49 -35 % 12 10 20 % 41 33 24 % (39 ) (49 ) 20 % (127 ) (115 ) -10 % (166 ) (42 ) NM (274 ) (16 ) NM — — NM 1 (7 ) 114 % — — NM (139 ) — NM 149 323 -54 % 567 1,081 -48 % (1 ) 7 NM (5 ) 21 NM $ 148 $ 330 -55 % $ 562 $ 1,102 -49 % 50 For the Three Months Ended March 31, 2009 2008 Change Revenues Operating revenues: Retirement Solutions: Annuities $ 599 $ 623 -4 % Defined Contribution 225 238 -5 % Total Retirement Solutions 824 861 -4 % Insurance Solutions: Life Insurance 1,076 1,055 2 % Group Protection 422 399 6 % Total Insurance Solutions 1,498 1,454 3 % Investment Management 82 120 -32 % Lincoln UK 47 86 -45 % Other Operations 83 117 -29 % Excluded realized loss, pre-tax (290 ) (45 ) NM Amortization of deferred gain arising from reserve changes on business sold through reinsurance, pre-tax 1 1 0 % Total revenues $ 2,245 $ 2,594 -13 % For the Three Months Ended March 31, 2009 2008 Change Net Income (Loss) Income (loss) from operations: Retirement Solutions: Annuities $ 74 $ 118 -37 % Defined Contribution 30 40 -25 % Total Retirement Solutions 104 158 -34 % Insurance Solutions: Life Insurance 142 157 -10 % Group Protection 26 26 0 % Total Insurance Solutions 168 183 -8 % Investment Management 1 12 -92 % Lincoln UK 6 11 -45 % Other Operations (109 ) (42 ) NM Excluded realized loss, after-tax (188 ) (29 ) NM Early extinguishment of debt 42 - NM Impairment of intangibles, after-tax (603 ) - NM Income (loss) from continuing operations, after-tax (579 ) 293 NM Loss from discontinued operations, after-tax - (4 ) 100 % Net income (loss) $ (579 ) $ 289 NM For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 Change 2008 2007 Change $ 2,948 $ 3,478 -15 % $ 9,410 $ 9,577 -2 % 1,334 1,525 -13 % 4,306 4,285 0 % 1,082 1,032 5 % 3,276 3,219 2 % 3,988 5,745 -31 % 12,217 17,929 -32 % (1,118 ) (907 ) -23 % (3,514 ) (2,896 ) -21 % $ 8,234 $ 10,873 -24 % $ 25,695 $ 32,114 -20 % $ 944 $ 1,291 -27 % $ 3,714 $ 3,185 17 % 93 133 -30 % 610 428 43 % 690 629 10 % 2,018 1,863 8 % (3,332 ) 90 NM (5,970 ) (423 ) NM 169 200 -16 % 79 547 -86 % $ (1,436 ) $ 2,343 NM $ 451 $ 5,600 -92 % For the Three Months Ended March 31, 2009 2008 Change Deposits Retirement Solutions: �� Annuities $ 2,197 $ 3,025 -27 % Defined Contribution 1,575 1,552 1 % Insurance Solutions - Life Insurance 1,058 1,132 -7 % Investment Management 5,130 4,724 9 % (842 ) (1,587 ) 47 % Total deposits $ 9,118 $ 8,846 3 % Net Flows Retirement Solutions: Annuities $ 430 $ 1,181 -64 % Defined Contribution 659 281 135 % Insurance Solutions - Life Insurance 557 651 -14 % Investment Management 211 (1,165 ) 118 % 57 (70 ) 181 % Total net flows $ 1,914 $ 878 118 % As of
September 30, 2008 2007 Change $ 57,662 $ 89,540 -36 % 72,468 77,500 -6 % 6,585 9,192 -28 % 2,870 2,841 1 % 59,922 72,406 -17 % $ 199,507 $ 251,479 -21 % As of March 31, 2009 2008 Change Assets Under Management by Advisor Investment Management: External assets $ 44,305 $ 69,346 -36 % Inter-segment assets 72,329 76,531 -5 % Lincoln UK (excluding policy loans) 5,497 9,442 -42 % Policy loans 2,908 2,855 2 % Assets administered through unaffiliated third parties 46,169 66,602 -31 % Total assets under management $ 171,208 $ 224,776 -24 % September 30,March 31, 2009 to 2008 to 2007Higher write-downs for other-than-temporary impairments on our available-for-sale securities attributable primarily to unfavorable changes in credit quality and increases in credit spreads;A $72 million unfavorable retrospective unlocking of DAC, VOBA, DSI, DFEL and the reserves for annuity and life insurance products with living benefit and death benefit guarantees in the third quarter of 2008 compared to a $9 million favorable retrospective unlocking in the third quarter of 2007;· Impairment of goodwill of $600 million for Retirement Solutions – Individual Annuities due to continued market volatility, the corresponding increase in discount rates and lower annuity sales (see “Critical Accounting Policies and Estimates – Goodwill and Other Intangible Assets” above for additional information on our goodwill impairment); however, this non-cash impairment did not impact our liquidity and will not impact our future liquidity; Higher benefits due to growth in business in force and higher death claims;· A $128 million unfavorable retrospective unlocking of DAC, VOBA, DSI, DFEL and the reserves for annuity and life insurance products with living benefit and death benefit guarantees in the first quarter of 2009 due primarily to the overall performance of our GLB derivative program (see “Realized Loss” below for more information on our GLB derivative performance) and the impact of lower equity market performance and higher lapses than our model projections assumed, partially offset by the favorable change in the fair value of GDB derivatives compared to a $5 million unfavorable retrospective unlocking in the first quarter of 2008 due primarily to lower investment income on alternative investments and prepayment and bond makewhole premiums, higher death claims and lapses than our model projections assumed and model adjustments on certain life insurance policies; Unfavorable GDB derivative results driven by lower account values from unfavorable equity markets; andLower earnings from our variable annuity and mutual fund products as a result of declines in assets under management caused by decreases in the level of the equity markets.· Higher benefits due primarily to an increase in the change in GDB reserves from an increase in our expected GDB benefit payments attributable primarily to the decline in account values from the unfavorable equity markets and the increase in reserves for products with secondary guarantees from continued growth of business in force and higher mortality due to an increase in the average attained age of the in-force block; · The $64 million unfavorable impact of the rescission of the reinsurance agreement on certain disability income business sold to Swiss Re in the first quarter of 2009, as discussed in “Reinsurance” below; · The $43 million increase in write-downs for OTTI on our AFS securities attributable primarily to unfavorable changes in credit quality and increases in credit spreads; · Lower earnings from our variable annuity and mutual fund products as a result of declines in assets under management caused by decreases in the equity markets; · Unfavorable GLB net derivatives results, excluding unlocking, due primarily to intermittent market conditions that resulted in non-linear changes in reserves that our derivatives are not specifically designed to mitigate and losses from the strengthening of the dollar as compared to the euro, pound and yen, partially offset by favorable underlying fund performance relative to the hedge instruments used (see “Realized Loss” below for more information on our GLB derivative performance); · Unfavorable GDB net derivatives results, excluding unlocking, due primarily to intermittent market conditions that resulted in non-linear changes in reserves that our derivatives are not specifically designed to mitigate and losses from the strengthening of the dollar as compared to the euro, pound and yen; and · Lower net investment income attributable primarily to higher cash balances related to our short-term liquidity strategy during the recent volatile markets that has reduced our portfolio yield. causes of decreasesdecrease in net income were partially offset by:Favorable GLB net derivatives results as gains attributable to the SFAS 157 non-performance risk adjustment attributable primarily to widening credit spreads more than offset the GLB hedge program ineffectiveness and unfavorable GDB results, both excluding the impact of unlocking, due to extreme market conditions;51Lower DAC and VOBA amortization, net of interest and excluding unlocking, due primarily to declines in variable account values from unfavorable equity markets during 2008;A reduction in income tax expense related to favorable tax return true-ups and other items driven primarily by the separate account DRD in 2008, compared to unfavorable tax return true-ups and other items in 2007;Higher net investment income driven by more favorable results from our surplus and alternative investments; andLower broker-dealer expenses driven by lower sales and lower merger-related expenses.Comparison of the Nine Months Ended September 30, 2008 to 2007In addition to the items discussed above, excluding the unfavorable retrospective unlocking, lower earnings on variable annuity and mutual fund products and higher net investment income items, net income for the nine months ended September 30, 2008, compared to the same period in 2007 was also affected by:Impairment of goodwill and our FCC license intangible assets on our remaining radio clusters during the second quarter of 2008 attributable primarily to declines in advertising revenues for the entire radio market; however, these non-cash impairments will not impact our future liquidity;A $73 million unfavorable retrospective unlocking of DAC, VOBA, DSI, DFEL and the reserves for annuity and life insurance products with living benefit and death benefit guarantees in 2008 compared to a $34 million favorable retrospective unlocking in 2007;Growth in insurance fees driven by increases in life insurance in force as a result of new sales since September 30, 2007, and favorable persistency along with increases in variable account values from positive net flows and transfers from fixed account values, including the fixed portion of variable, partially offset by unfavorable equity markets and adjustments during the second quarter of 2007 resulting from adjusting account values for certain of our life insurance policies and modifying the accounting for certain of our life insurance policies;Lower net investment income driven by less favorable results from our alternative investments and prepayment and bond makewhole premiums;· Lower DAC and VOBA amortization, net of interest and excluding unlocking, and lower asset-based expenses due primarily to declines in variable account values from unfavorable equity markets during the first quarter of 2009; Lower incentive compensation accruals as a result of lower earnings and production performance relative to planned goals;· A $42 million gain associated with the early extinguishment of long-term debt; The first quarter of 2008 adjustment to our loss on disposition of our discontinued operations;· A reduction in federal income tax expense due primarily to favorable tax return true-ups driven by the separate account DRD, foreign tax credit adjustments and other items; A $16 million effect of the initial adoption of SFAS 157 on January 1, 2008; and· Lower broker-dealer expenses due primarily to lower sales of non-proprietary products, lower merger expenses as many of our integration efforts related to our acquisition of Jefferson-Pilot have been completed, lower incentive compensation accruals as a result of lower earnings and production performance relative to planned goals and the implementation of several expense management controls and practices that are focused on expense reduction initiatives; and A reduction in benefits in the first quarter of 2007 related to a purchase accounting adjustment to the opening balance sheet of Jefferson-Pilot.· The $16 million impact of the initial adoption of SFAS 157 on January 1, 2008. 52Details underlying the results for Retirement Solutions (in millions) were as follows: For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 Change 2008 2007 Change $ 52 $ 43 21 % $ 103 $ 72 43 % 302 324 -7 % 927 916 1 % 424 422 0 % 1,263 1,315 -4 % 52 1 NM 74 3 NM 86 100 -14 % 267 297 -10 % 916 890 3 % 2,634 2,603 1 % 277 269 3 % 816 806 1 % 112 56 100 % 199 108 84 % 331 341 -3 % 1,003 1,009 -1 % 720 666 8 % 2,018 1,923 5 % 196 224 -13 % 616 680 -9 % 23 57 -60 % 127 176 -28 % $ 173 $ 167 4 % $ 489 $ 504 -3 % 53Details underlying account values for Retirement Solutions (in millions) were as follows: As of September 30, 2008 2007 Change $ 63,462 $ 76,873 -17 % 9,661 9,418 3 % 73,123 86,291 -15 % 19,446 19,286 1 % (1,196 ) (1,430 ) 16 % 18,250 17,856 2 % 91,373 104,147 -12 % 7,675 7,165 7 % $ 99,048 $ 111,312 -11 % For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 Change 2008 2007 Change $ 70,299 $ 73,989 -5 % $ 72,298 $ 70,965 2 % 28,495 28,263 1 % 28,524 28,534 0 % The discussion of Retirement Solutions is provided in “Retirement Solutions – Annuities” and “Retirement Solutions – Defined Contribution” below.54 For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 52 $ 43 21 % $ 103 $ 72 43 % 246 259 -5 % 749 724 3 % 243 249 -2 % 736 780 -6 % 52 1 NM 74 3 NM 82 95 -14 % 254 282 -10 % 675 647 4 % 1,916 1,861 3 % 170 165 3 % 496 492 1 % 112 56 100 % 199 108 84 % 254 256 -1 % 774 772 0 % 536 477 12 % 1,469 1,372 7 % 139 170 -18 % 447 489 -9 % 8 44 -82 % 82 123 -33 % $ 131 $ 126 4 % $ 365 $ 366 0 % For the Three Months Ended March 31, 2009 2008 Change Operating Revenues Insurance premiums $ 27 $ 32 -16 % Insurance fees 181 246 -26 % Net investment income 240 248 -3 % Operating realized gain 90 10 NM 61 87 -30 % Total operating revenues 599 623 -4 % Operating Expenses Interest credited 161 163 -1 % Benefits 169 51 231 % Underwriting, acquisition, insurance and other expenses 206 252 -18 % Total operating expenses 536 466 15 % Income from operations before taxes 63 157 -60 % Federal income tax expense (benefit) (11 ) 39 NM Income from operations $ 74 $ 118 -37 % September 30,March 31, 2009 to 2008 to 2007increased due primarily to the following:Lower DAC and VOBA amortization, net of interest and excluding unlocking, due primarily to declines in variable account values from unfavorable equity markets during 2008 and lower incentive compensation accruals as a result of production performance relative to planned goals; andA reduction in income tax expense related to favorable tax return true-ups and other items driven primarily by the separate account DRD in 2008, compared to unfavorable tax return true-ups and other items in 2007.The increase in income from operations was partially offset by the following:A $9 million unfavorable retrospective unlocking of DAC, VOBA, DSI, DFEL and reserves for annuity products with living benefit and death benefit guarantees in 2008 compared to a $4 million favorable retrospective unlocking in 2007;A $7 million favorable prospective unlocking of DAC, VOBA, DSI, DFEL and reserves for annuity products with living benefit and death benefit guarantees (an $18 million favorable unlocking from assumption changes net of a $11 million unfavorable unlocking from model refinements) in 2007;Lower insurance fees driven by lower average daily variable account values due to unfavorable equity markets, partially offset by an increase in surrender charges; andA decline in surplus investment income, which was attributable to a decision to hold more cash, thereby lowering earnings, and declines in investment income on alternative investments and commercial mortgage loan prepayment and bond makewhole premiums.55Comparison of the Nine Months Ended September 30, 2008 to 2007Income from operations for this segment modestly decreased due primarily to the following:Lower investment income from fixed maturity securities, mortgage loans on real estate and other net investment income primarily attributable to the decline in the average fixed account values, including the fixed portion of variable, driven primarily by transfers to variable account values in excess of net flows;A $6 million unfavorable retrospective unlocking of DAC, VOBA, DSI, DFEL and reserves for annuity products with living benefit and death benefit guarantees in 2008 compared to a $14 million favorable retrospective unlocking in 2007;· Lower insurance fees driven primarily by lower average daily variable account values due to unfavorable equity markets, partially offset by increased higher average expense assessment rates due to continued growth in rider elections that have incremental charges associated with them; The impact of prospective unlocking discussed above; and· Higher benefits from an increase in the change in GDB reserves due to an increase in our expected GDB benefit payments attributable primarily to the decline in account values below guaranteed levels due to the unfavorable equity markets; A less favorable net broker-dealer margin attributable to lower earnings from unfavorable equity markets.· A $7 million unfavorable retrospective unlocking of DAC, VOBA, DSI, DFEL and reserves for our guarantee riders in the first quarter of 2009 due primarily to higher lapses, higher death benefit costs and the impact of lower equity market performance than our model projections assumed; · Lower net investment income attributable primarily to higher cash balances related to our short-term liquidity strategy during the recent volatile markets that has reduced our portfolio yield by 54 basis points; and · A less favorable net broker-dealer margin attributable primarily to lower sales of non-proprietary products and lower earnings due to the unfavorable equity markets. · A reduction in federal income tax expense due primarily to favorable tax return true-ups driven by the separate account DRD, foreign tax credit adjustments and other items; and · Lower underwriting, acquisition, insurance and other expenses, excluding unlocking, due primarily to lower DAC and VOBA amortization, net of interest, and lower asset-based expenses driven by the declines in our variable account values from unfavorable equity markets, lower incentive compensation accruals as a result of lower earnings and production performance relative to planned goals and the implementation of several expense management controls and practices that are focused on expense reduction initiatives. · Lower expense assessments and higher changes in reserves related to our GDB features, partially offset by lower asset-based expenses, due to the variable account value erosion from unfavorable equity market returns experienced during the fourth quarter of 2008 and continuing in the first quarter of 2009 resulting in lower account values; · Lower investment income on the segment’s alternative investments due to the market conditions in both the equity and credit markets (see “Consolidated Investments – Alternative Investments” below for additional information on our alternative investments) and lower yields from the impact of holding higher levels of cash, which we plan to reduce as we progress through 2009, during the recent volatile markets as part of our short-term liquidity strategy; and · Higher expenses attributable to our U.S. pension plans (see “Critical Accounting Policies and Estimates – Pension and Other Postretirement Benefit Plans” in our 2008 Form 10-K for additional information). VOBA amortization,the economic environment, its overall net flows were relatively strong in a challenging economic environment. New deposits are an important component of interestnet flows and excluding unlocking,key to our efforts to grow our business. Although deposits do not significantly impact current period income from operations, they are an important indicator of future profitability.a decline in the emergence of gross profitschallenging economic environment, the overall increase is relatively moderate and lower incentive compensation accruals as a result of lower earnings and production performance relativestill falls within pricing parameters.planned goals;A reduction in income tax expensecontract holders related to favorable tax return true-upsGDB features.other items driven primarily byportfolio management. Our expectation includes the separate account DRDassumption that there are no significant changes in 2008, compared to unfavorable tax return true-ups and other items in 2007; andAn increase in insurance fees driven by higher average daily variable account values attributable to positive net flows in or out of our fixed accounts or other changes that may cause interest rate spreads to differ from our expectation.transfers from fixed accountare not subject to surrender charges. Account values for these products, including the fixed portion of variable, partially offset by unfavorable equity markets.The foregoing items are discussed further below following “Impact of Current Market Conditions.” For detail on the operating realized gain, see “Realized Loss” below.Impact of Current Market ConditionsThe October 2008 daily average of the S&P 500 Index® declined 17% from its valuewere $7.2 billion as of September 30, 2008, negatively impacting our variable account values. Consequently, we expect lower earningsMarch 31, 2009, with 63% already at their minimum guaranteed rates. The average crediting rates for these products were approximately 35 basis points in excess of average minimum guaranteed rates. Our ability to retain annual reset annuities will be subject to current competitive conditions at the fourth quarter as a result of October’s results, includingtime interest rates for these products reset. For information on interest rate spreads and the following:Lower variable account values, which will reduce expense assessment revenue, partially offset by lower asset-based expenses;Higher unfavorable retrospective unlockinginterest rate risk due to lower equity market performance thanfalling interest rates, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk on Fixed Insurance Business – Falling Rates” in our model projections assumed; andIf equity markets do not materially improve over the remainder of the fourth quarter, we may unlock our amortization model assumption for equity market returns for DAC, VOBA, DSI, DFEL and reserves for annuity products with living and death benefit guarantees, resulting in a significant decrease to income from operations in the period. For more information, see “Critical Accounting Policies and Estimates – DAC, VOBA, DSI and DFEL” above.20072008 Form 10-K, as updated by “Partin Part II – Item 1A. Risk Factors” below, and “Forward-Looking Statements – Cautionary Language” in this report.56 For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 245 $ 258 -5 % $ 748 $ 717 4 % 13 10 30 % 32 30 7 % (13 ) (12 ) -8 % (38 ) (33 ) -15 % (1 ) (1 ) 0 % (1 ) (1 ) 0 % 3 — NM 3 (1 ) NM (1 ) 4 NM 5 12 -58 % $ 246 $ 259 -5 % $ 749 $ 724 3 % As of September 30, Change 2008 2007 $ 49,982 $ 58,293 -14 % 3,547 3,470 2 % 53,529 61,763 -13 % 14,142 14,343 -1 % (1,196 ) (1,430 ) 16 % 12,946 12,913 0 % $ 66,475 $ 74,676 -11 % For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 54,717 $ 55,827 -2 % $ 55,929 $ 52,922 6 % 1,255.42 1,489.60 -16 % 1,325.03 1,470.65 -10 % 57 For the Three Months Ended March 31, 2009 2008 Change Insurance Fees Mortality, expense and other assessments $ 181 $ 246 -26 % Surrender charges 9 10 -10 % DFEL: Deferrals (11 ) (12 ) 8 % Retrospective unlocking 7 (1 ) NM Amortization, net of interest, excluding unlocking (5 ) 3 NM Total insurance fees $ 181 $ 246 -26 % As of March 31, 2009 2008 Change Account Values Variable portion of variable annuities $ 39,301 $ 54,966 -28 % Fixed portion of variable annuities 3,699 3,469 7 % Total variable annuities 43,000 58,435 -26 % Fixed annuities, including indexed 14,154 14,232 -1 % Fixed annuities ceded to reinsurers (1,094 ) (1,306 ) 16 % Total fixed annuities 13,060 12,926 1 % Total account values $ 56,060 $ 71,361 -21 % For the Three Months Ended March 31, 2009 2008 Change Averages Daily variable account values, excluding the fixed portion of variable $ 39,035 $ 55,318 -29 % Daily S&P 500 810.65 1,349.16 -40 % For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 1,672 $ 2,247 -26 % $ 5,602 $ 6,543 -14 % (1,216 ) (1,296 ) 6 % (3,704 ) (3,722 ) 0 % 456 951 -52 % 1,898 2,821 -33 % 896 746 20 % 2,631 1,943 35 % (124 ) (181 ) 31 % (358 ) (486 ) 26 % 772 565 37 % 2,273 1,457 56 % 2,568 2,993 -14 % 8,233 8,486 -3 % (1,340 ) (1,477 ) 9 % (4,062 ) (4,208 ) 3 % 1,228 1,516 -19 % 4,171 4,278 -3 % 215 199 8 % 789 550 43 % (114 ) (59 ) -93 % (299 ) (182 ) -64 % 101 140 -28 % 490 368 33 % 165 286 -42 % 388 541 -28 % (550 ) (651 ) 16 % (1,335 ) (2,002 ) 33 % (385 ) (365 ) -5 % (947 ) (1,461 ) 35 % 2,948 3,478 -15 % 9,410 9,577 -2 % (2,004 ) (2,187 ) 8 % (5,696 ) (6,392 ) 11 % $ 944 $ 1,291 -27 % $ 3,714 $ 3,185 17 % For the Three Months Ended March 31, 2009 2008 Change Net Flows on Account Values Variable portion of variable annuity deposits $ 834 $ 1,865 -55 % Variable portion of variable annuity withdrawals (1,000 ) (1,259 ) 21 % Variable portion of variable annuity net flows (166 ) 606 NM Fixed portion of variable annuity deposits 760 856 -11 % Fixed portion of variable annuity withdrawals (156 ) (124 ) -26 % Fixed portion of variable annuity net flows 604 732 -17 % Total variable annuity deposits 1,594 2,721 -41 % Total variable annuity withdrawals (1,156 ) (1,383 ) 16 % Total variable annuity net flows 438 1,338 -67 % Fixed indexed annuity deposits 367 218 68 % Fixed indexed annuity withdrawals (214 ) (83 ) NM Fixed indexed annuity net flows 153 135 13 % Other fixed annuity deposits 236 86 174 % Other fixed annuity withdrawals (397 ) (378 ) -5 % Other fixed annuity net flows (161 ) (292 ) 45 % Total annuity deposits 2,197 3,025 -27 % Total annuity withdrawals (1,767 ) (1,844 ) 4 % Total annuity net flows $ 430 $ 1,181 -64 % For the Three Months Ended March 31, 2009 2008 Change Other Changes to Account Values Interest credited and change in market value on variable, excluding the fixed portion of variable $ (2,016 ) $ (4,758 ) 58 % Transfers from the fixed portion of variable annuity products to the variable portion of variable annuity products 558 680 -18 % products. Theproducts; see “Realized Gain (Loss) – Operating Realized Gain – GLB” below for discussion of these attributed fees are the portion of rider charges used in the calculation of the embedded derivative and represent net valuation premium plus a margin that a theoretical market participant would include for risk/profit, including a non-performance risk factor required by SFAS 157. Net valuation premium represents a level portion of rider fees required to fund potential claims for the living benefit. Operating realized gain is the attributed fees less the net valuation premium, net of the associated amortization expense of DAC, VOBA, DSI and DFEL.New deposits are an important component of our effort to grow the annuity business. Although deposits do not significantly impact current period income from operations, they are an important indicator of future profitability.The other component of net flows relates to the retention of the business. One of the key assumptions in pricing a product is the account persistency, which we refer to as the lapse rate. The lapse rate compares the amount of withdrawals to the average account values.Comparison of the Three Months Ended September 30, 2008 to 2007The decrease in insurance fees was due primarily to lower expense assessments attributable to a decrease in average daily variable annuity account values partially offset by expense assessments based on guaranteed amounts, which, in some cases, are above actual account values. Additionally, an increase in surrender charges and continued growth in rider elections partially offset the overall decline in insurance fees.Overall lapse rates for the three months ended September 30, 2008, were 9% compared to 10% for the same period in 2007.The decrease in DFEL amortization, net of interest and excluding unlocking, was attributable primarily to declines in variable account values from unfavorable equity markets during 2008.The three months ended September 30, 2008, had favorable retrospective unlocking due primarily to actual gross profits being lower than EGPs driven by lower maintenance and expense charges and lower equity market performance than our model projections assumed.58Comparison of the Nine Months Ended September 30, 2008 to 2007The increase in insurance fees was due primarily to growth in average daily variable annuity account values. The increase in account values reflects cumulative positive net flows, which offset the reduction in variable account values from unfavorable equity markets during the first nine months of 2008. Additionally, an increase in surrender charges, continued growth in rider elections and an increase in the average expense assessment rates contributed to the overall increase in insurance fees.Overall lapse rates for the nine months ended September 30, 2008, were 8% compared to 10% for the same period in 2007.The nine months ended September 30, 2008, had favorable retrospective unlocking due primarily to lower maintenance and expense charges and lower equity market performance than our model projections assumed. The nine months ended September 30, 2007, had unfavorable retrospective unlocking due primarily to lower lapses and higher equity market performance than our model projections assumed. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 222 $ 224 -1 % $ 675 $ 691 -2 % 1 2 -50 % 2 7 -71 % — (1 ) 100 % (1 ) 1 NM 19 24 -21 % 57 78 -27 % 1 — NM 3 3 0 % $ 243 $ 249 -2 % $ 736 $ 780 -6 % $ 187 $ 186 1 % $ 550 $ 555 -1 % — — NM — (4 ) 100 % (25 ) (30 ) 17 % (76 ) (81 ) 6 % 162 156 4 % 474 470 1 % — (2 ) 100 % — (2 ) 100 % — 1 -100 % — 1 -100 % 3 — NM 2 (2 ) 200 % 5 10 -50 % 20 25 -20 % $ 170 $ 165 3 % $ 496 $ 492 1 % For the Three Months Ended March 31, 2009 2008 Change Net Investment Income Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses $ 224 $ 228 -2 % Commercial mortgage loan prepayment and bond - 1 -100 % (1 ) - NM 17 18 -6 % Broker-dealer - 1 -100 % Total net investment income $ 240 $ 248 -3 % Interest Credited Amount provided to contract holders $ 172 $ 183 -6 % DSI deferrals (16 ) (26 ) 38 % Interest credited before DSI amortization 156 157 -1 % DSI amortization: Retrospective unlocking 6 (1 ) NM Amortization, excluding unlocking (1 ) 7 NM Total interest credited $ 161 $ 163 -1 % (4)Net adjustment to the opening balance sheet of Jefferson-Pilot finalized in 2007.59 For the Three
Months Ended
September 30, Basis
Point
Change For the Nine
Months Ended
September 30, Basis
Point
Change 2008 2007 2008 2007 5.82 % 5.82 % — 5.85 % 5.83 % 2 0.02 % 0.05 % (3 ) 0.02 % 0.06 % (4 ) 0.00 % -0.03 % 3 -0.01 % 0.01 % (2 ) 5.84 % 5.84 % — 5.86 % 5.90 % (4 ) 3.95 % 3.77 % 18 3.83 % 3.71 % 12 1.89 % 2.07 % (18 ) 2.03 % 2.19 % (16 ) �� For the Three Months Ended Basis March 31, Point 2009 2008 Change Interest Rate Spread Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses 5.28 % 5.85 % (57 ) Commercial mortgage loan prepayment and bond make whole premiums 0.00 % 0.03 % (3 ) Alternative investments -0.01 % -0.01 % - Net investment income yield on reserves 5.27 % 5.87 % (60 ) Interest rate credited to contract holders 3.84 % 3.81 % 3 Interest rate spread 1.43 % 2.06 % (63 ) For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 15,615 $ 15,749 -1 % $ 15,691 $ 16,109 -3 % 17,174 17,358 -1 % 17,291 17,590 -2 % 488 340 44 % 1,816 364 NM For the Three Months Ended March 31, 2009 2008 Change Other Information Average invested assets on reserves $ 16,915 $ 15,715 8 % Average fixed account values, including the fixed portion of variable 17,152 17,315 -1 % Transfers from the fixed portion of variable annuity products to the variable portion of variable annuity products (558 ) (680 ) 18 % Net flows for fixed annuities, including the fixed portion of variable 596 575 4 % accountprogram interest expense and interest on collateral divided by average invested assets on reserves. The average invested assets on reserves is calculated based upon total invested assets, excluding hedge derivatives and collateral. The average crediting rate is calculated as interest credited before DSI amortization, plus the immediate annuity reserve change (included within benefits) divided by the average fixed account values, including the fixed portion of variable annuity contracts, net of coinsured account values. Fixed account values reinsured under modified coinsurance agreements are included in account values for this calculation. Changes in commercial mortgage loan prepayments and bond makewhole premiums, investment income on alternative investments and surplus investment income can vary significantly from period to period due to a number of factors and, therefore, may contribute to investment income results that are not indicative of the underlying trends. For the Three Months Ended March 31, 2009 2008 Change Underwriting, Acquisition, Insurance and Other Expenses Total expenses incurred, excluding broker-dealer $ 202 $ 254 -20 % DAC and VOBA deferrals (128 ) (173 ) 26 % Total pre-broker-dealer expenses incurred, excluding amortization, net of interest 74 81 -9 % DAC and VOBA amortization, net of interest: Retrospective unlocking 63 1 NM Amortization, net of interest, excluding unlocking 4 79 -95 % Broker-dealer expenses incurred 65 91 -29 % Total underwriting, acquisition, insurance and other expenses $ 206 $ 252 -18 % DAC and VOBA Deferrals As a percentage of sales/deposits 5.8 % 5.7 % For the Three Months Ended March 31, 2009 2008 Change Operating Revenues Insurance fees $ 41 $ 61 -33 % Net investment income 175 172 2 % Operating realized gain 7 - NM Other revenues and fees 2 5 -60 % Total operating revenues 225 238 -5 % Operating Expenses Interest credited 111 106 5 % Benefits 6 - NM Underwriting, acquisition, insurance and other expenses 71 77 -8 % Total operating expenses 188 183 3 % Income from operations before taxes 37 55 -33 % Federal income tax expense 7 15 -53 % Income from operations $ 30 $ 40 -25 % · Lower insurance fees driven primarily by lower average daily variable account values resulting from the unfavorable equity markets and an overall shift in business mix toward products with lower expense assessment rates; · Higher benefits from an increase in the change in GDB reserves due to an increase in our expected GDB benefit payments attributable primarily to the decline in account values due to the unfavorable equity markets; and · Higher interest credited driven primarily by higher average fixed account values, including the fixed portion of variable annuity contracts, driven by transfers from variable to fixed. · A reduction in federal income tax expense due primarily to favorable tax return true-ups driven by the separate account DRD, foreign tax credit adjustments and other items; · Lower underwriting, acquisition, insurance and other expenses, excluding unlocking, due primarily to lower DAC and VOBA amortization, net of interest, driven by the declines in our variable account values from unfavorable equity markets, and the implementation of several expense management controls and practices that are focused on expense reduction initiatives; and · Higher net investment income driven primarily by higher average fixed account values, including the fixed portion of variable annuity contracts, driven by transfers from variable to fixed, partially offset by our liquidity strategy of maintaining higher cash balances during the recent volatile markets that has reduced our portfolio yield by 16 basis points. · Lower expense assessments and higher changes in reserves related to our GDB features, partially offset by lower asset-based expenses, due to the variable account value erosion from unfavorable equity market returns experienced during the fourth quarter of 2008 and continuing in the first quarter of 2009 resulting in lower account values; · Lower investment income on the segment’s alternative investments due to the market conditions in both the equity and credit markets (see “Consolidated Investments – Alternative Investments” below for additional information on our alternative investments) and lower yields from the impact of holding higher levels of cash, which we plan to reduce as we progress through 2009, during the recent volatile markets as part of our short-term liquidity strategy; · Lower insurance fees driven by a continuing overall shift in business mix toward products with lower expense assessments and lower margins; and · Higher expenses attributable to our U.S. pension plans (see “Critical Accounting Policies and Estimates – Pension and Other Postretirement Benefit Plans” in our 2008 Form 10-K for additional information). Comparison of the Three Months Ended September 30, 2008 to 2007The decrease in net investment income related primarily to declines in surplus investment income, which was attributable to a decision to hold more cash, thereby lowering earnings, and declines in investment income on alternative investments and commercial mortgage loan prepayment and bond makewhole premiums.The three months ended September 30, 2008, had unfavorable retrospective unlocking due primarily to lower maintenance and expense charges and lower equity market performance than our model projections assumed.60Comparison of the Nine Months Ended September 30, 2008 to 2007The decrease in investment income from fixed maturity securities, mortgage loans on real estate and other net investment income was primarily attributable to the decline in the average fixed account values, including the fixed portion of variable, driven primarily by transfers to variable account values in excess of net flows. The decrease in investment income on surplus and alternative investments was primarily attributable to less favorable results from our limited partnership investments.The nine months ended September 30, 2008, had unfavorable retrospective unlocking due primarily to lower maintenance and expense charges and lower equity market performance than our model projections assumed. The nine months ended September 30, 2007, had favorable retrospective unlocking due primarily to lower lapses and higher equity market performance than our model projections assumed.Our fixed annuity business includes products with crediting rates that are reset on an annual basis and are not subject to surrender charges. Account values for these products were $5.0 billion as of September 30, 2008, with 41% already at their minimum guaranteed rates. The average crediting rates for these products were approximately 47 basis points in excess of average minimum guaranteed rates. Our ability to retain annual reset annuities will be subject to current competitive conditions at the time interest rates for these products reset. In addition to the separate items identified in the interest rate spread table above, the other component of the interest rate credited to contract holders decreased due primarily to a roll-off of multi-year guarantee and annual reset annuities with higher interest rates.BenefitsBenefits for this segment include changes in reserves on immediate annuity account values driven by premiums, death benefits paid and changes in reserves on guaranteed death benefits.Comparison of the Three and Nine Months Ended September 30, 2008 to 2007The increase in benefits was attributable to an increase in reserves for single premium immediate annuities, which resulted in a corresponding increase in insurance premiums. Additionally, benefits increased due to an unfavorable variance in the SOP 03-1 benefit ratio unlocking, which was offset by changes in the value of the derivative included in operating realized gain.On August 15, 2007, we entered into a reinsurance arrangement with Swiss Re coveringLincoln SmartSecurity® Advantage, our GWB rider related to our variable annuity products. For additional information about this agreement, refer to “Reinsurance” in this report.61Underwriting, Acquisition, Insurance and Other ExpensesDetails underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows: For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 161 $ 188 -14 % $ 513 $ 520 -1 % 83 82 1 % 243 231 5 % 5 5 0 % 21 17 24 % 249 275 -9 % 777 768 1 % (170 ) (196 ) 13 % (534 ) (543 ) 2 % 79 79 0 % 243 225 8 % (2 ) (28 ) 93 % (2 ) (28 ) 93 % — 16 -100 % — 16 -100 % 35 (7 ) NM 35 (21 ) 267 % 63 103 -39 % 241 304 -21 % 60 72 -17 % 191 212 -10 % 18 20 -10 % 62 60 3 % 1 1 0 % 4 4 0 % $ 254 $ 256 -1 % $ 774 $ 772 0 % 5.8 % 5.6 % 5.7 % 5.7 % Commissions and other costs that vary with and are related primarily to the production of new business are deferred to the extent recoverable and are amortized over the lives of the contracts in relation to EGPs. We have certain trail commissions that are based upon account values that are expensed as incurred rather than being deferred and amortized.Broker-dealer expenses that vary with and are related to sales are expensed as incurred and not deferred and amortized. These expenses are more than offset by increases to other income.Comparison of the Three Months Ended September 30, 2008 to 2007The decrease in expenses incurred, excluding broker-dealer, was attributable primarily to the decrease in commissions from lower sales and lower incentive compensation accruals as a result of production performance relative to planned goals.The decrease in DAC and VOBA amortization, net of interest and excluding unlocking, was attributable primarily to lower emergence of gross profits.The decrease in broker-dealer commissions was due to lower sales of non-proprietary products.The third quarter of 2008 had favorable prospective unlocking – assumption changes related primarily to maintenance expenses and fee margins partially offset by lapses. The third quarter of 2007 had favorable prospective unlocking – assumption changes related primarily to favorable interest rates, maintenance expense and account retention assumptions partially offset by unfavorable asset-based commission assumptions.62The third quarter of 2008 had unfavorable retrospective unlocking due primarily to lower maintenance and expense charges and lower equity market performance than our model projections assumed. The third quarter of 2007 had favorable retrospective unlocking due primarily to lower lapses and higher equity market performance than our model projections assumed.Comparison of the Nine Months Ended September 30, 2008 to 2007The increase in expenses incurred, excluding broker-dealer, was attributable primarily to increased distribution expenses and Federal Insurance Contributions Act taxes associated with the expansion of the wholesaling force in LFD, partially offset by lower incentive compensation accruals as a result of lower earnings and production performance relative to planned goals.The decrease in DAC and VOBA amortization, net of interest and excluding unlocking, was attributable primarily to declines in variable account values from unfavorable equity markets during 2008.The decrease in broker-dealer commissions was due to lower sales of non-proprietary products.See the discussion above regarding prospective unlocking in 2008 and 2007.The first nine months of 2008 had unfavorable retrospective unlocking due primarily to lower maintenance and expense charges and lower equity market performance than our model projections assumed. The first nine months of 2007 had favorable retrospective unlocking due primarily to lower lapses and higher equity market performance than our model projections assumed.Federal Income TaxesComparison of the Three and Nine Months Ended September 30, 2008 to 2007The effective federal income tax rate decreased to 6% and 18% for the three and nine months ended September 30, 2008, from 26% and 25% for the same periods in 2007. Federal income tax expense for the three and nine months ended September 30, 2008, included a reduction of $21 million related to favorable tax return true-ups and other items driven primarily by the separate account DRD in 2008, compared to a $2 million unfavorable tax return true-up and other items for the same periods in 2007. For additional information on our effective tax rates, see Note 4 to our consolidated financial statements.63Retirement Solutions–Defined ContributionIncome from OperationsDetails underlying the results for Retirement Solutions – Defined Contribution (in millions) were as follows: For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 56 $ 65 -14 % $ 178 $ 192 -7 % 181 173 5 % 527 535 -1 % 4 5 -20 % 13 15 -13 % 241 243 -1 % 718 742 -3 % 107 104 3 % 320 314 2 % 77 85 -9 % 229 237 -3 % 184 189 -3 % 549 551 0 % 57 54 6 % 169 191 -12 % 15 13 15 % 45 53 -15 % $ 42 $ 41 2 % $ 124 $ 138 -10 % Comparison of the Three Months Ended September 30, 2008 to 2007Income from operations for this segment modestly increased due primarily to the following:Higher net investment income attributable primarily to the growth in the average fixed account values, including the fixed portion of variable, driven by transfers from variable to fixed, and more favorable results from commercial mortgage loan prepayments and bond makewhole premiums and investment income on alternative investments;Lower underwriting, acquisition, insurance and other expenses due in part to the implementation of several expense management controls and practices that are focused on aggressively managing expenses and lower incentive compensation accruals as a result of production performance relative to planned goals; andA $2 million unfavorable prospective unlocking from assumption changes of DAC and VOBA in 2007.The increase in income from operations was partially offset by lower insurance fees driven by lower average daily account values due to unfavorable equity markets. In addition, the third quarters of 2008 and 2007 had $2 million unfavorable retrospective unlocking of DAC, VOBA and DSI.Comparison of the Nine Months Ended September 30, 2008 to 2007Income from operations for this segment decreased due primarily to the following:Lower insurance fees driven by lower average daily account values due to unfavorable equity markets; andLower net investment income attributable to less favorable investment income on surplus and alternative investments.The decrease in income from operations was partially offset by the following:Lower underwriting, acquisition, insurance and other expenses due in part to the implementation of several expense management controls and practices that are focused on aggressively managing expenses and lower incentive compensation accruals as a result of lower earnings and production performance relative to planned goals; andThe impact of prospective unlocking discussed above.In addition, the first nine months of 2008 and 2007 had $3 million unfavorable retrospective unlocking of DAC, VOBA and DSI.The foregoing items are discussed further below following “Impact of Current Market Conditions.”64Impact of Current Market ConditionsThe October 2008 daily average of the S&P 500 Index® declined 17% from its value as of September 30, 2008, negatively impacting our variable account values. Consequently, we expect lower earnings in the fourth quarter as a result of October’s results, including the following:Lower variable account values, which will reduce expense assessment revenue, partially offset by lower asset-based expenses;Higher unfavorable retrospective unlocking due to lower equity market performance than our model projections assumed; andIf equity markets do not materially improve over the remainder of the fourth quarter, we may unlock our amortization model assumption for equity market returns for DAC, VOBA and DSI, resulting in a significant increase to amortization in the period. For more information, see “Critical Accounting Policies and Estimates – DAC, VOBA, DSI and DFEL” above.Due to a change in business mix, a substantial increase in new deposit production in other products is necessary to maintain earnings at current levels.20072008 Form 10-K, as updated byin “Part II – Item 1A. Risk Factors” below, and “Forward-Looking Statements – Cautionary Language” in this report. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 50 $ 59 -15 % $ 159 $ 174 -9 % 5 4 25 % 14 12 17 % 55 63 -13 % 173 186 -7 % 1 2 -50 % 5 6 -17 % $ 56 $ 65 -14 % $ 178 $ 192 -7 % $ 15,582 $ 18,162 -14 % $ 16,369 $ 18,043 -9 % 1,255.42 1,489.60 -16 % 1,325.03 1,470.65 -10 % As of September 30, Change 2008 2007 $ 13,480 $ 18,580 -27 % 6,114 5,948 3 % 19,594 24,528 -20 % 5,304 4,943 7 % 24,898 29,471 -16 % 7,675 7,165 7 % $ 32,573 $ 36,636 -11 % 65 For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 7,286 $ 8,012 -9 % $ 7,798 $ 7,535 3 % 389 391 -1 % 1,276 1,229 4 % (465 ) (481 ) 3 % (1,429 ) (1,366 ) -5 % (76 ) (90 ) 16 % (153 ) (137 ) -12 % — — NM (12 ) (5 ) NM (653 ) — NM (653 ) — NM (767 ) 155 NM (1,190 ) 684 NM $ 5,790 $ 8,077 -28 % $ 5,790 $ 8,077 -28 % $ 9,985 $ 8,555 17 % $ 9,463 $ 6,975 36 % 687 861 -20 % 2,203 2,162 2 % (222 ) (263 ) 16 % (679 ) (512 ) -33 % 465 598 -22 % 1,524 1,650 -8 % (4 ) (51 ) 92 % (44 ) (14 ) NM 653 — NM 653 — NM (789 ) 130 NM (1,286 ) 621 NM $ 10,310 $ 9,232 12 % $ 10,310 $ 9,232 12 % $ 17,771 $ 19,396 -8 % $ 18,797 $ 19,146 -2 % 258 273 -5 % 827 894 -7 % (554 ) (648 ) 15 % (1,588 ) (1,979 ) 20 % (296 ) (375 ) 21 % (761 ) (1,085 ) 30 % (1 ) (1 ) — (1 ) (5 ) 80 % — — NM 295 — NM (1,001 ) 307 NM (1,857 ) 1,271 NM $ 16,473 $ 19,327 -15 % $ 16,473 $ 19,327 -15 % $ 35,042 $ 35,963 -3 % $ 36,058 $ 33,656 7 % 1,334 1,525 -13 % 4,306 4,285 0 % (1,241 ) (1,392 ) 11 % (3,696 ) (3,857 ) 4 % 93 133 -30 % 610 428 43 % (5 ) (52 ) 90 % (57 ) (24 ) NM — — NM 295 — NM (2,557 ) 592 NM (4,333 ) 2,576 NM $ 32,573 $ 36,636 -11 % $ 32,573 $ 36,636 -11 % For the Three Months Ended March 31, 2009 2008 Change Insurance Fees Annuity expense assessments $ 35 $ 55 -36 % Mutual fund fees 5 4 25 % Total expense assessments 40 59 -32 % Surrender charges 1 2 -50 % Total insurance fees $ 41 $ 61 -33 % For the Three Months Ended March 31, 2009 2008 Change Averages Daily variable account values, excluding the fixed portion of variable $ 9,846 $ 16,640 -41 % Daily S&P 500 810.65 1,349.16 -40 % As of March 31, 2009 2008 Change Account Values Variable portion of variable annuities $ 9,721 $ 16,292 -40 % Fixed portion of variable annuities 6,150 6,051 2 % Total variable annuities 15,871 22,343 -29 % Fixed annuities 5,774 5,166 12 % Total annuities 21,645 27,509 -21 % Mutual funds 6,848 7,254 -6 % Total annuities and mutual funds $ 28,493 $ 34,763 -18 % For the Three Months Ended March 31, 2009 2008 Change Account Value Roll Forward – By Product Balance at beginning-of-period $ 4,888 $ 7,798 -37 % Gross deposits 306 499 -39 % Withdrawals and deaths (266 ) (570 ) 53 % Net flows 40 (71 ) 156 % Transfers between fixed and variable accounts (4 ) (12 ) 67 % Investment increase and change in market value (214 ) (497 ) 57 % Balance at end-of-period $ 4,710 $ 7,218 -35 % Balance at beginning-of-period $ 9,540 $ 9,463 1 % Gross deposits 1,026 769 33 % Withdrawals and deaths (233 ) (159 ) -47 % Net flows 793 610 30 % Transfers between fixed and variable accounts (13 ) (29 ) 55 % Investment increase and change in market value (400 ) (423 ) 5 % Balance at end-of-period $ 9,920 $ 9,621 3 % Balance at beginning-of-period $ 14,450 $ 18,797 -23 % Gross deposits 243 284 -14 % Withdrawals and deaths (417 ) (542 ) 23 % Net flows (174 ) (258 ) 33 % Transfers between fixed and variable accounts (1 ) (1 ) - Inter-segment transfer - 294 -100 % Investment increase and change in market value (412 ) (908 ) 55 % Balance at end-of-period $ 13,863 $ 17,924 -23 % Total Annuities and Mutual Funds: Balance at beginning-of-period $ 28,878 $ 36,058 -20 % Gross deposits 1,575 1,552 1 % Withdrawals and deaths (916 ) (1,271 ) 28 % Net flows 659 281 135 % Transfers between fixed and variable accounts (18 ) (42 ) 57 % Inter-segment transfer - 294 -100 % Investment increase and change in market value (1,026 ) (1,828 ) 44 % $ 28,493 $ 34,763 -18 % TheOn September 30, 2008, $653 million relating to the Lincoln Employee 401(k) Plan transferred from LINCOLN DIRECTORSM toLincoln Alliance® effective September 30, 2008.to LINCOLN ALLIANCE®.Sheets.66 For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 532 $ 564 -6 % $ 1,767 $ 1,795 -2 % (723 ) (810 ) 11 % (2,202 ) (2,370 ) 7 % (191 ) (246 ) 22 % (435 ) (575 ) 24 % 94 84 12 % 279 272 3 % (228 ) (235 ) 3 % (620 ) (704 ) 12 % (134 ) (151 ) 11 % (341 ) (432 ) 21 % 626 648 -3 % 2,046 2,067 -1 % (951 ) (1,045 ) 9 % (2,822 ) (3,074 ) 8 % (325 ) (397 ) 18 % (776 ) (1,007 ) 23 % 196 221 -11 % 623 565 10 % (183 ) (215 ) 15 % (541 ) (520 ) -4 % 13 6 117 % 82 45 82 % 822 869 -5 % 2,669 2,632 1 % (1,134 ) (1,260 ) 10 % (3,363 ) (3,594 ) 6 % (312 ) (391 ) 20 % (694 ) (962 ) 28 % 512 656 -22 % 1,637 1,653 -1 % (107 ) (132 ) 19 % (333 ) (263 ) -27 % 405 524 -23 % 1,304 1,390 -6 % 1,334 1,525 -13 % 4,306 4,285 0 % (1,241 ) (1,392 ) 11 % (3,696 ) (3,857 ) 4 % $ 93 $ 133 -30 % $ 610 $ 428 43 % For the Three Months Ended March 31, 2009 2008 Change Net Flows on Account Values Variable portion of variable annuity deposits $ 425 $ 674 -37 % Variable portion of variable annuity withdrawals (419 ) (833 ) 50 % Variable portion of variable annuity net flows 6 (159 ) 104 % Fixed portion of variable annuity deposits 99 93 6 % Fixed portion of variable annuity withdrawals (202 ) (210 ) 4 % Fixed portion of variable annuity net flows (103 ) (117 ) 12 % Total variable annuity deposits 524 767 -32 % Total variable annuity withdrawals (621 ) (1,043 ) 40 % Total variable annuity net flows (97 ) (276 ) 65 % Fixed annuity deposits 317 240 32 % Fixed annuity withdrawals (186 ) (160 ) -16 % Fixed annuity net flows 131 80 64 % Total annuity deposits 841 1,007 -16 % Total annuity withdrawals (807 ) (1,203 ) 33 % Total annuity net flows 34 (196 ) 117 % Mutual fund deposits 734 545 35 % Mutual fund withdrawals (109 ) (68 ) -60 % Mutual fund net flows 625 477 31 % Total annuity and mutual fund deposits 1,575 1,552 1 % Total annuity and mutual fund withdrawals (916 ) (1,271 ) 28 % Total annuity and mutual fund net flows $ 659 $ 281 135 % For the Three Months Ended March 31, 2009 2008 Change Other Changes to Account Values Interest credited and change in market value on variable, excluding the fixed portion of variable $ (706 ) $ (1,488 ) 53 % Transfers from the fixed portion of variable annuity products to the variable portion of variable annuity products (166 ) (143 ) -16 % New deposits are an important component of our effort to grow our business. Although deposits do not significantly impact current period income from operations, they are an important indicator of future profitability.The other component of net flows relates to the retention of the business. One of the key assumptions in pricing a product is the account persistency, which we refer to as the lapse rate. The lapse rate compares the amount of withdrawals to the average account values.We serve the mid-large case 401(k) and 403(b) markets with our mutual fund programs. Our programs bundle our fixed annuity products with mutual funds, along with record keeping and employee education components. The amounts associated with the mutual fund programs are not included in the assets or liabilities reported on our Consolidated Balance Sheets.The distribution model for the micro-small case 401(k) market is focused on driving growth through financial intermediaries. As of September 30, 2008, we had approximately 70 wholesalers in place to support this business and plan for additional growth during the remainder of 2008. We are beginning to experience an increase in new business activity as a result of building our own wholesaling force for this market.Comparison of the Three and Nine Months Ended September 30, 2008 to 2007The decrease in expense assessments was driven by lower average daily variable annuity account values due to unfavorable equity markets, customer transfers out of variable and into fixed account values and an overall shift in business mix toward products with lower expense assessment rates.Overall lapse rates for our annuity products for the three and nine months ended September 30, 2008, were 14% and 15%, respectively, compared to 16% and 15%, respectively, for the same periods in 2007. The return on assets, calculated as income67divided by average assets under management, forMulti-Fund® and Other Variable Annuities, our oldest block of annuity business, is more than two times that of new deposits. Therefore, a substantial increase in new deposit production in other products is necessary to maintain earnings at current levels.As of September 30, 2008, $12.1 billion, or 62%, of variable annuity contract account values contained a return of premium death benefit feature, and the net amount at risk related to these contracts was $115 million. The remaining variable annuity contract account values contain no GDB feature.Additionally, deposits in our mid-large segment (including mutual fund program fixed annuity deposits) increased for the nine months ended September 30, 2008, compared to the same period in 2007 due to an increase in the number of mutual fund program accounts, which resulted in both an increase in initial deposits and an increase in ongoing periodic deposits. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 165 $ 161 2 % $ 489 $ 485 1 % 5 2 150 % 7 5 40 % — (3 ) 100 % (2 ) 2 NM 11 13 -15 % 33 43 -23 % $ 181 $ 173 5 % $ 527 $ 535 -1 % $ 107 $ 104 3 % $ 320 $ 314 2 % For the Three Months Ended March 31, 2009 2008 Change Net Investment Income Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses $ 165 $ 162 2 % - (1 ) 100 % 10 11 -9 % Total net investment income $ 175 $ 172 2 % Interest Credited $ 111 $ 106 5 % See “Consolidated Investments – Commercial Mortgage Loan Prepayment and Bond Makewhole Premiums” below for additional information.(2)(3) For the Three
Months Ended
September 30, Basis
Point
Change For the Nine
Months Ended
September 30, Basis
Point
Change 2008 2007 2008 2007 5.94 % 6.04 % (10 ) 5.91 % 6.04 % (13 ) 0.17 % 0.07 % 10 0.08 % 0.06 % 2 -0.01 % -0.10 % 9 -0.02 % 0.02 % (4 ) 6.10 % 6.01 % 9 5.97 % 6.12 % (15 ) 3.77 % 3.84 % (7 ) 3.79 % 3.82 % (3 ) 2.33 % 2.17 % 16 2.18 % 2.30 % (12 ) For the Three Months Ended Basis March 31, Point 2009 2008 Change Interest Rate Spread Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses 5.70 % 5.93 % (23 ) Commercial mortgage loan prepayment and bond makewhole premiums 0.00 % 0.02 % (2 ) Alternative investments -0.01 % -0.03 % 2 Net investment income yield on reserves 5.69 % 5.92 % (23 ) Interest rate credited to contract holders 3.78 % 3.81 % (3 ) Interest rate spread 1.91 % 2.11 % (20 ) 68 For the Three Months Ended March 31, 2009 2008 Change Other Information Average invested assets on reserves $ 11,603 $ 10,888 7 % Average fixed account values, including the fixed portion of variable 11,783 11,123 6 % Transfers from the fixed portion of variable annuity products to the variable portion of variable annuity products 166 143 16 % Net flows for fixed annuities, including the fixed portion of variable 28 (37 ) 176 % For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 11,146 $ 10,666 5 % $ 11,034 $ 10,721 3 % 11,321 10,905 4 % 11,233 10,944 3 % (121 ) (145 ) 17 % (259 ) (387 ) 33 % accountprogram interest expense and interest on collateral, divided by average invested assets on reserves. The average invested assets on reserves are calculated based upon total invested assets, excluding hedge derivatives. The average crediting rate is calculated as interest credited before DSI amortization, plus the immediate annuity reserve change (included within benefits), divided by the average fixed account values, including the fixed portion of variable annuities.annuity contracts. Commercial mortgage loan prepayments and bond makewhole premiums, investment income on alternative investments and surplus investment income can vary significantly from period to period due to a number of factors and, therefore, may contribute to investment income results that are not indicative of the underlying trends.Comparison of the Three Months Ended September 30, 2008 to 2007The increase in fixed maturity securities, mortgage loans on real estate and other net investment income was attributable primarily to the growth in the average fixed account values, including the fixed portion of variable, driven by transfers from variable to fixed, partially offset by the yield decline due to lower reinvestment rates. Towards the end of the third quarter of 2008,held less cash thaninclude changes in previous periodsreserves on GDBs and death benefits paid.an effort to be more invested in higher yielding assets.The increase in investment income on alternative investments was driven primarily by more favorable results from our limited partnership investments. Earnings on investments supporting statutory surplus were negatively impacted by unfavorable equity markets.The increase in interest credited was primarilyreserves attributable to the growthsegment’s benefit ratio unlocking of its SOP 03-1 reserves for GDB riders is offset in the average fixed account values, including the fixed portion of variable, driven by transfers from variable to fixed. In response to the competitive environment, during the third quarter of 2008, we reduced crediting rates by 10 basis pointsoperating realized gain. See “Realized Gain (Loss) – Operating Realized Gain – GDB” below forMulti-Fund® products andLincoln Alliance® program fixed annuity products and increased new money rates by 25 basis points forMulti-Fund® products. For information on interest rate spreads and the interest rate risk due to falling interest rates, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk.”Comparison of the Nine Months Ended September 30, 2008 to 2007The decrease in investment income on surplus and alternative investments was driven by less favorable results from our limited partnership investments.The modest increase in fixed maturity securities, mortgage loans on real estate and other net investment income was attributable primarily to the growth in the average fixed account values, including the fixed portion of variable, driven by transfers from variable to fixed, partially offset by the yield decline due to lower reinvestment rates.The increase in interest credited was attributable primarily to the growth in the average fixed account values, including the fixed portion of variable, driven by transfers from variable account values. The 10 basis point crediting rate reduction discussed above was the first such rate change in 2008, while the 25 basis point increase in new money rates followed a reduction in the previous quarter. We plan to take further crediting rate action in the fourth quarter of 2008, with the expectation of maintaining stable spreads over the near term, excluding the effects of prepayment and makewhole premiums.69 For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 17 $ 20 -15 % $ 56 $ 60 -7 % 53 60 -12 % 158 164 -4 % 3 2 50 % 10 12 -17 % 73 82 -11 % 224 236 -5 % (20 ) (24 ) 17 % (66 ) (68 ) 3 % 53 58 -9 % 158 168 -6 % — 3 -100 % — 3 -100 % 3 2 50 % 5 5 0 % 21 22 -5 % 66 61 8 % $ 77 $ 85 -9 % $ 229 $ 237 -3 % 1.5 % 1.6 % 1.5 % 1.6 % For the Three Months Ended March 31, 2009 2008 Change Underwriting, Acquisition, Insurance and Other Expenses Total expenses incurred $ 72 $ 76 -5 % DAC deferrals (18 ) (24 ) 25 % Total expenses recognized before amortization 54 52 4 % DAC and VOBA amortization, net of interest: Retrospective unlocking 4 3 33 % Amortization, net of interest, excluding unlocking 13 22 -41 % Total underwriting, acquisition, insurance and other expenses $ 71 $ 77 -8 % DAC Deferrals As a percentage of annuity sales/deposits 2.1 % 2.4 % productionsale of new business, excluding those associated with our mutual fund products,annuity contracts, are deferred to the extent recoverable and are amortized over the lives of the contracts in relation to EGPs. For certain annuity contracts, trail commissions that are based upon account values are expensed as incurred rather than deferred and amortized. We do not pay commissions on sales of our mutual fund products, and distribution expenses associated with the sale of these mutual fund products are not deferred and amortized, as is the case for our insurance products.Comparison of the Three and Nine Months Ended September 30, 2008 to 2007The decrease in expenses incurred was due in part to the implementation of several expense management controls and practices that are focused on aggressively managing expenses and lower incentive compensation accruals as a result of production performance relative to planned goals. Additionally, lower earnings for the nine months ended September 30, 2008, contributed to the decrease in incentive compensation accruals. The decrease in commissions was primarily a result of lower sales.The third quarter and first nine months of 2007 had unfavorable prospective unlocking due to assumption changes primarily reflecting higher lapse rates and separate account fees partially offset by lower expenses.The third quarter and first nine months of 2008 and 2007 had unfavorable retrospective unlocking due primarily to higher lapses and lower equity market performance than our model projections assumed.70our Executive Benefits business’s corporate-owned UL and VUL (“COLI”) and bank-owned UL and VUL (“BOLI”) products. The Insurance Solutions – Group Protection segment offers group life, disability and dental insurance to employers and its products are marketed primarily through a national distribution system of regional group offices. These offices develop business through employee benefit brokers, third-party administrators and other employee benefit firms.20072008 Form 10-K, as updated byin “Part II – Item 1A. Risk Factors” below, and “Forward-Looking Statements – Cautionary Language” in this report. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 91 $ 85 7 % $ 267 $ 261 2 % 449 469 -4 % 1,380 1,283 8 % 522 496 5 % 1,541 1,553 -1 % 10 6 67 % 22 24 -8 % 1,072 1,056 2 % 3,210 3,121 3 % 305 293 4 % 902 875 3 % 398 266 50 % 1,000 780 28 % 167 227 -26 % 621 639 -3 % 870 786 11 % 2,523 2,294 10 % 202 270 -25 % 687 827 -17 % 65 88 -26 % 229 279 -18 % $ 137 $ 182 -25 % $ 458 $ 548 -16 % For the Three Months Ended March 31, 2009 2008 Change Operating Revenues Insurance premiums $ 91 $ 87 5 % Insurance fees 482 460 5 % Net investment income 498 499 0 % Other revenues and fees 5 9 -44 % Total operating revenues 1,076 1,055 2 % Operating Expenses Interest credited 303 297 2 % Benefits 356 300 19 % Underwriting, acquisition, insurance and other expenses 224 219 2 % Total operating expenses 883 816 8 % Income from operations before taxes 193 239 -19 % Federal income tax expense 51 82 -38 % Income from operations $ 142 $ 157 -10 % September 30,March 31, 2009 to 2008 to 2007the following:A $9 million unfavorable retrospective unlocking of DAC, VOBA, DFEL, andan increase in benefits attributable primarily to an increase in reserves for life insurance products with secondary guarantees from continued growth of business in 2008 comparedforce and higher mortality due to an $11 million favorable retrospective unlockingincrease in 2007; andA $21 million unfavorable prospective unlocking (a $34 million unfavorable unlocking from model refinements netthe average attained age of a $13 million favorable unlocking from assumption changes) of DAC, VOBA, DFEL and reserves for life insurance products with secondary guaranteesthe in-force block (discussed in 2008 compared to a $4 million favorable prospective unlocking (a $12 million favorable unlocking from assumption changes net of an $8 million unfavorable unlocking from model refinements) in 2007.The $9 million unfavorable retrospective unlocking and the $21 million unfavorable prospective unlocking to DAC, VOBA, DFEL and reserves for life insurance products with secondary guarantees discussed above resulted in an additional unfavorable earnings impact for the current period of $7 million that will recur in future periods.higherthe following:· · A reduction in federal income tax expense due primarily to favorable tax return true-ups. growthoperations will be partially offset by a $2 million increase in fixed product account values driven by positiveOther Operations as it will have higher net flows andinvestment income due to the transfer of assets from the reduction in capital as a result of this coinsurance agreement; therefore, the net impact from this transaction to our consolidated income from operations will be a reduction of $5 million per quarter. See “Reinsurance” below for more favorable results frominformation.alternative investments.71ComparisonUL products with secondary guarantees as a result of executing on a reinsurance transaction to release statutory reserves related to the Application of the Nine Months Ended September 30, 2008Valuation of Life Insurance Policies Model Regulation (“AG38”). This reduction in capital lowered the level of assets supporting this business, as assets were transferred to 2007Income from operations for this segment decreased due primarily to the following:A $17Other Operations, which reduced net investment income by approximately $4 million unfavorable retrospective unlocking of DAC, VOBA, and DFEL in 2008 compared to a $23 million favorable retrospective unlocking in 2007;The impact of prospective unlocking discussed above;Higher death claims in 2008 and lower benefits in the first quarter of 2007 partially related2009 that will also recur in future quarters.a reduction in benefits relatedincrease future spreads by approximately 5 basis points.a purchase accounting adjustmentreduce as we progress through 2009. As of March 31, 2009, 72% of interest-sensitive account values had crediting rates at contract guaranteed levels, and 15% had crediting rates within 50 basis points of contractual guarantees. Going forward, we expect to be able to manage the opening balance sheeteffects of Jefferson-Pilot; andLower net investmentspreads on near-term income from operations through a reductioncombination of rate actions and portfolio management, which assumes no significant changes in statutory reservesnet flows into or out of our fixed accounts or other changes that may cause interest rate spreads to differ from our expectations. For information on interest rate spreads and the interest rate risk due to falling interest rates, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk.”mergeraverage attained age of several of our insurance subsidiaries and certain assumption changes in the fourth quarter of 2007, capital transactions providing relief from AG38 reserve requirements in the fourth quarter of 2007 and less favorable results from our investment income on alternative investments and prepayment and bond makewhole premiums.The decrease in income from operations was partially offset by growth in insurance fees driven by an increase in business in force as a result of newin-force block. We have screening procedures to identify sales since September 30, 2007, and favorable persistency partially offset by the impact on insurance fees from lower sales in 2008 compared to 2007 and adjustments during the second quarter of 2007 resulting from adjusting account values for certain of ourthat we believe have characteristics associated with stranger-originated life insurance, which typically involve the use of premium financing, face amount in excess of $2 million and older aged individuals, in order to prevent policies with these characteristics from being issued. With stranger-originated arrangements, a third-party investor with no relationship to an individual initiates the purchase of a policy by paying the premiums and modifyinglater buying the accounting for certainpolicy, thereby profiting upon the death of the insured. However, accurate identification of these policies can be difficult, and we continue to modify our screening procedures. We believe that our sales of UL products include some sales with stranger-originated life insurance policies.The foregoingcharacteristics. We expect no significant impact to our profitability; however, returns on UL business sold as part of stranger-originated designs are believed to be lower than traditional estate planning UL sales due in part to no expected lapses.discussed furtherrecognized, key drivers of changes and historical details underlying the line items and their associated drivers below.Comparison of the Three and Nine Months Ended September 30, 2008 to 2007Traditional in-force face amount, and thus premiums, remained relatively flat. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 332 $ 312 6 % $ 982 $ 903 9 % 178 160 11 % 520 472 10 % 16 14 14 % 46 45 2 % (97 ) (85 ) -14 % (276 ) (265 ) -4 % (4 ) — NM (4 ) — NM (25 ) 26 NM (25 ) 26 NM 12 1 NM 27 (8 ) NM 37 41 -10 % 110 110 0 % $ 449 $ 469 -4 % $ 1,380 $ 1,283 8 % 72 For the Three Months Ended March 31, 2009 2008 Change Insurance Fees Mortality assessments $ 344 $ 322 7 % Expense assessments 178 170 5 % Surrender charges 22 17 29 % DFEL: Deferrals (97 ) (89 ) -9 % Amortization, net of interest: Retrospective unlocking 3 4 -25 % Amortization, net of interest, excluding unlocking 32 36 -11 % Total insurance fees $ 482 $ 460 5 % For the Three Months Ended March 31, 2009 2008 Change Sales by Product UL: $ 103 $ 114 -10 % 11 11 0 % Total UL 114 125 -9 % VUL 9 16 -44 % COLI and BOLI 12 28 -57 % Term/whole life 10 5 100 % Total sales $ 145 $ 174 -17 % Net Flows Deposits $ 1,058 $ 1,132 -7 % Withdrawals and deaths (501 ) (481 ) -4 % Net flows $ 557 $ 651 -14 % Contract holder assessments $ 725 $ 663 9 % For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 144 $ 144 0 % $ 382 $ 455 -16 % 14 11 27 % 37 28 32 % 158 155 2 % 419 483 -13 % 12 18 -33 % 39 55 -29 % 13 18 -28 % 54 52 4 % 7 7 0 % 18 25 -28 % $ 190 $ 198 -4 % $ 530 $ 615 -14 % $ 1,082 $ 1,032 5 % $ 3,276 $ 3,219 2 % (392 ) (403 ) 3 % (1,258 ) (1,356 ) 7 % $ 690 $ 629 10 % $ 2,018 $ 1,863 8 % $ 705 $ 623 13 % $ 2,060 $ 1,845 12 % As of September 30, Change 2008 2007 $ 24,951 $ 23,896 4 % 5,056 6,104 -17 % 2,276 2,266 0 % $ 32,283 $ 32,266 0 % $ 306,293 $ 294,833 4 % 233,671 236,414 -1 % $ 539,964 $ 531,247 2 % As of March 31, 2009 2008 Change Account Values $ 24,388 $ 24,450 0 % 3,352 5,615 -40 % Interest-sensitive whole life 2,291 2,276 1 % Total account values $ 30,031 $ 32,341 -7 % In-Force Face Amount $ 288,826 $ 302,013 -4 % Term insurance 236,408 234,860 1 % Total in-force face amount $ 525,234 $ 536,873 -2 % (1) Effective March 31, 2009, UL and VUL account values were reduced by $938 million and $640 million, respectively, and UL and other face amount in force was reduced by $20.9 billion as a result of the coinsurance agreement with Commonwealth. belowabove were reported as follows:UL (excluding linked-benefit products) and VUL (including COLI and BOLI) – first year commissionable premiums plus 5% of excess premiums received, including an adjustment for internal replacements at approximately 50% of target;• UL (excluding linked-benefit products) and VUL (including COLI and BOLI) – first year commissionable premiums plus 5% of excess premiums received, including an adjustment for internal replacements of approximately 50% of commissionable premiums; · Whole life and term – 100% of first year paid premiums.· Whole life and term – 100% of first year paid premiums. Sales are not recorded as a component of revenues (other than for traditional products) and do not have a significant impact on current quarter income from operations but are indicators of future profitability. Generally, we have higher sales during the last half of the year with the fourth quarter being our strongest; however, expectations for this year are muted given the current economic conditions.We have screening procedures to identify sales that we believe have characteristics associated with stranger-originated life insurance in order to prevent policies with these characteristics from being issued. However, accurate identification of these policies can be difficult, and we continue to modify our screening procedures. We believe that our sales of UL products include some sales with stranger-originated life insurance characteristics. We expect no significant impact to our profitability; however, returns on UL business sold as part of stranger-originated designs are believed to be lower than traditional estate planning UL sales due in part to no expected lapses.7333%37% of interest-sensitive life insurance in force as of September 30, 2008,March 31, 2009, and approximately 74% and 69%73% of sales for the first three and nine months ended September 30, 2008.of 2009. AG38 imposes additional statutory reserve requirements for these products. See “Review of Consolidated Financial Condition – Liquidity and Capital Resources – Sources of Liquidity and Cash Flow” for further information on the manner in which we reinsure our AG38 reserves.Comparison of the Three and Nine Months Ended September 30, 2008 to 2007The growth in mortality and expense assessments was attributable primarily to increased business in force. Life insurance in force and account values grew from new sales since September 30, 2007, an increase in the average attained age of the in-force block (which also led to increases in benefits as discussed below) and favorable persistency.The third quarter of 2008 had unfavorable prospective unlocking – assumption changes, which reflected primarily improved investment spreads, lower death claims, improved lapse and expense rates and adjustments to the reserves for products with secondary guarantees.The third quarter of 2008 had favorable retrospective unlocking due primarily to lower premiums received and higher death claims, partially offset by higher investment income on alternative investments and prepayment and bond makewhole premiums and lower maintenance expenses than our model projections assumed.The first nine months of 2008 had favorable retrospective unlocking due primarily to lower premiums received and higher death claims than our model projections assumed and model adjustments on certain life insurance policies, partially offset by lower maintenance expenses than our model projections assumed. The first nine months of 2007 had unfavorable retrospective unlocking due primarily to higher persistency, higher investment income on alternative investments and prepayment and bond makewhole premiums and lower maintenance expenses than our model projections assumed, partially offset by the impact of the correction to account values in the second quarter of 2007 mentioned above. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 478 $ 468 2 % $ 1,425 $ 1,399 2 % 1 6 -83 % 14 27 -48 % 21 (2 ) NM 35 48 -27 % 22 24 -8 % 67 79 -15 % $ 522 $ 496 5 % $ 1,541 $ 1,553 -1 % $ 305 $ 293 4 % $ 902 $ 875 3 % For the Three Months Ended March 31, 2009 2008 Change Net Investment Income Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses $ 481 $ 474 1 % Commercial mortgage loan prepayment and - 3 -100 % (4 ) - NM 21 22 -5 % Total net investment income $ 498 $ 499 0 % Interest Credited $ 303 $ 297 2 % 74 For the Three Months Ended Basis March 31, Point 2009 2008 Change Interest Rate Yields and Spread Attributable to interest-sensitive products: Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses 5.83 % 6.00 % (17 ) Commercial mortgage loan prepayment and bond makewhole premiums 0.00 % 0.04 % (4 ) Alternative investments -0.06 % 0.00 % (6 ) Net investment income yield on reserves 5.77 % 6.04 % (27 ) Interest rate credited to contract holders 4.25 % 4.37 % (12 ) Interest rate spread 1.52 % 1.67 % (15 ) Attributable to traditional products: Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses 6.00 % 6.12 % (12 ) Commercial mortgage loan prepayment and bond makewhole premiums 0.01 % 0.11 % (10 ) Alternative investments -0.01 % -0.02 % 1 Net investment income yield on reserves 6.00 % 6.21 % (21 ) For the Three
Months Ended
September 30, Basis
Point
Change For the Nine
Months Ended
September 30, Basis
Point
Change 2008 2007 2008 2007 5.92 % 6.01 % (9 ) 5.94 % 6.07 % (13 ) 0.02 % 0.08 % (6 ) 0.06 % 0.13 % (7 ) 0.31 % -0.01 % 32 0.18 % 0.25 % (7 ) 6.25 % 6.08 % 17 6.18 % 6.45 % (27 ) 4.35 % 4.43 % (8 ) 4.36 % 4.45 % (9 ) 1.90 % 1.65 % 25 1.82 % 2.00 % (18 ) 6.06 % 6.15 % (9 ) 6.13 % 6.27 % (14 ) 0.00 % 0.09 % (9 ) 0.04 % 0.08 % (4 ) -0.01 % -0.06 % 5 -0.01 % 0.01 % (2 ) 6.05 % 6.18 % (13 ) 6.16 % 6.36 % (20 ) Note: The yields, rates For the Three Months Ended March 31, 2009 2008 Change Averages Attributable to interest-sensitive products: $ 27,998 $ 26,292 6 % 28,156 26,622 6 % Attributable to traditional products: Invested assets on reserves 4,841 5,304 -9 % spreads above are calculated using whole dollars insteadaccount values attributable to interest-sensitive products during the second quarter of dollars rounded to millions. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 27,398 $ 26,071 5 % $ 26,773 $ 25,636 4 % 27,713 26,013 7 % 27,063 25,753 5 % 4,814 5,040 -4 % 5,137 5,023 2 % interest sensitiveinterest-sensitive products. The yield on invested assets on reserves is calculated as net investment income, excluding amounts attributable to our surplus investments and reverse repurchase agreement interest expense, divided by average invested assets on reserves. In addition, we exclude the impact of earnings from affordable housing tax credit securities, which is reflected as a reduction to federal income tax expense, from our spread calculations. Traditional products use interest income to build the policy reserves. Commercial mortgage loan prepayments and bond makewhole premiums and investment income on alternative investments can vary significantly from period to period due to a number of factors, and, therefore, may contribute to investment income results that are not indicative of the underlying trends.Comparison of the Three Months Ended September 30, 2008 to 2007The increase in fixed maturity securities, mortgage loans on real estate and other net investment income was due to continued growth of business in force partially offset by the impact of reductions in statutory reserves. The increase in investment income on alternative investments was driven primarily by favorable results from limited partnership investments. Higher AG38 statutory75reserve liabilities on UL policies with secondary guarantees contributed to invested asset growth. At June 30, 2007, we reduced statutory reserves related to our secondary guarantee UL products by approximately $150 million, which has reduced the amount of net investment income allocated to this segment by $2 million per quarter. This statutory reserve reduction related to modifying the accounting for certain of our life insurance policies. In October 2007, we released approximately $300 million of capital that had previously supported our UL products with secondary guarantees as a result of executing on a capital transaction to provide AG38 relief. This release of capital lowered the level of assets supporting this business and has reduced net investment income by approximately $5 million per quarter. As of December 31, 2007, we reduced statutory reserves related primarily to legal entity consolidation by $344 million, which has reduced the amount of net investment income allocated to this segment by approximately $5 million in the first quarter of 2008. This reduction in statutory reserves was primarily a result of the merger of several of our insurance subsidiaries.The increase in interest credited was attributable primarily to growth in UL account values. On June 1, 2007, we implemented a 10 basis point decrease in crediting rates on most interest-sensitive products not already at contractual guarantees, which has increased spreads approximately 5 basis points. On June 1, 2008, we implemented a 10 basis point decrease in crediting rates on most interest-sensitive products not already at contractual guarantees, which has increased spreads approximately 5 basis points.At the end of the third quarter of 2008, new money rates exceeded the portfolio rate by roughly 24 basis points. At the end of the third quarter of 2007, new money rates exceeded the portfolio rate by roughly 17 basis points. As of September 30, 2008, 45% of interest-sensitive account values have crediting rates at contract guaranteed levels, and 39% have crediting rates within 50 basis points of contractual guarantees. Going forward, we expect to be able to manage the effects of spreads on near-term income from operations through a combination of rate actions and portfolio management, which assumes no significant changes in net flows into or out of our fixed accounts or other changes that may cause interest rate spreads to differ from our expectations. For information on interest rate spreads and the interest rate risk due to falling interest rates, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk.”Comparison of the Nine Months Ended September 30, 2008 to 2007The increase in fixed maturity securities, mortgage loans on real estate and other net investment income was due to continued growth of business in force partially offset by the impact of reductions in statutory reserves. The decrease in investment income on alternative investments was driven primarily by less favorable results from limited partnership investments.Benefits For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 536 $ 430 25 % $ 1,612 $ 1,270 27 % (249 ) (172 ) -45 % (722 ) (532 ) -36 % (80 ) (69 ) -16 % (271 ) (160 ) -69 % 207 189 10 % 619 578 7 % 8 (3 ) NM 8 (3 ) NM 76 3 NM 76 3 NM 38 19 100 % 92 37 149 % 69 58 19 % 205 165 24 % $ 398 $ 266 50 % $ 1,000 $ 780 28 % 1.47 1.33 11 % 1.46 1.36 7 % For the Three Months Ended March 31, 2009 2008 Change Benefits Death claims direct and assumed $ 565 $ 555 2 % Death claims ceded (242 ) (239 ) -1 % Reserves released on death (103 ) (104 ) 1 % Net death benefits 220 212 4 % Change in reserves for products with secondary guarantees 53 26 104 % Change in reserves for products with secondary guarantees - reinsurance 20 - NM 63 62 2 % Total benefits $ 356 $ 300 19 % Death claims per $1,000 of inforce 1.66 1.59 4 % death claims incurred during the period in excess of the associated reserves for its interest-sensitive and traditional products. In addition, benefits include the change in reserves for our products with secondary guarantees. The reserve for secondary guarantees is impacted by changes in expected future trends of claims andexpense assessments causing unlocking adjustments to this liability similar to DAC, VOBA and DFEL.76Comparison Additionally, we establish a reserve for reinsurance margin (reinsurance premiums paid less death benefit recoveries) and amortize this margin over the life of the Three Months Ended September 30, 2008expected insurance assessments for certain blocks of secondary guarantee UL business. When we experience unfavorable mortality, particularly on higher face amount claims, our reinsurance recoveries can increase significantly and are deferred, which reduces the amount by which the expense for the direct claims are offset by reinsurance. The reinsurance on our secondary guarantee UL business is excess of loss reinsurance, and this block has a large range of face amounts, both of which contribute to 2007The increasevolatility in benefits, excluding unlocking, was due primarilyour actual experience of reinsurance recoveries as compared to an increase in reserves for products with secondary guarantees from continued growth of business in force and the effects of model refinements and higher mortality due to an increase in the average attained age of the in-force block (which also led to increases in insurance fees as discussed above).The third quarter of 2008 had unfavorable prospective unlocking – assumption changes, which reflected primarily improved lapse rates and improved investment spreads.Comparison of the Nine Months Ended September 30, 2008 to 2007The increase in benefits, excluding unlocking, was due primarily to an increase in reserves for products with secondary guarantees from continued growth of business in force and the effects of model refinements and higher mortality due to an increase in the average attained age of the in-force block (which also led to increases in insurance fees as discussed above) and by a decrease to benefits in the first quarter of 2007 related to a purchase accounting adjustment to the opening balance sheet of Jefferson-Pilot.The nine months ended September 30, 2008, had unfavorable prospective unlocking – assumption changes, discussed above.Details underlying underwriting, acquisition, insurance and other expenses (in millions) were as follows: For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 209 $ 220 -5 % $ 584 $ 672 -13 % 102 107 -5 % 308 335 -8 % 36 27 33 % 95 90 6 % 347 354 -2 % 987 1,097 -10 % (261 ) (277 ) 6 % (744 ) (852 ) 13 % 86 77 12 % 243 245 -1 % (31 ) (15 ) NM (31 ) (15 ) NM (49 ) 36 NM (49 ) 36 NM 26 (16 ) 263 % 53 (43 ) 223 % 134 144 -7 % 402 413 -3 % 1 1 0 % 3 3 0 % $ 167 $ 227 -26 % $ 621 $ 639 -3 % 137.4 % 139.9 % 140.4 % 138.5 % 77Comparison of the Three and Nine Months Ended September 30, 2008 to 2007The decrease in expenses incurred was primarily a result of lower sales and lower incentive compensation accruals based upon lower earnings and production performance relative to planned goals. The decrease was partially offset by an increase in taxes, licenses and fees due primarily to premium tax true-ups.The decrease in DAC and VOBA amortization, net of interest and excluding unlocking, was primarily attributable to model refinements and decreased business in force on traditional products.The third quarter of 2008 had favorable prospective unlocking – assumption changes, which reflected primarily improved investment spreads, lower death claims, improved lapse and expense rates and adjustments to the reserves for products with secondary guarantees.The third quarter of 2007 had favorable prospective unlocking – assumption changes, which reflected primarily improved lapse, expense and interest rates.The third quarter of 2008 had unfavorable retrospective unlocking due primarily to lower premiums received and higher death claims, partially offset by higher investment income on alternative investments and prepayment and bond makewhole premiums and lower maintenance expenses than our model projections assumed.The third quarter of 2007 had favorable retrospective unlocking due primarily to higher persistency and lower maintenance expenses than our model projections assumed.The first nine months of 2008 had unfavorable retrospective unlocking due primarily to lower premiums received and higher death claims than our model projections assumed and model adjustments on certain life insurance policies, partially offset by lower maintenance expenses than our model projections assumed.The first nine months of 2007 had favorable retrospective unlocking due primarily to higher persistency, higher investment income on alternative investments and prepayment and bond makewhole premiums and lower maintenance expenses than our model projections assumed, partially offset by the impact of the correction to account values in the second quarter of 2007 discussed above.78 For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 371 $ 337 10 % $ 1,134 $ 1,029 10 % 31 30 3 % 89 86 3 % 1 1 0 % 4 4 0 % 403 368 10 % 1,227 1,119 10 % 1 — NM 1 — NM 268 236 14 % 823 748 10 % 92 81 14 % 271 240 13 % 361 317 14 % 1,095 988 11 % 42 51 -18 % 132 131 1 % 15 18 -17 % 46 46 0 % $ 27 $ 33 -18 % $ 86 $ 85 1 % For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 9 $ 11 -18 % $ 30 $ 30 0 % 16 19 -16 % 51 50 2 % 1 1 0 % 1 1 0 % 26 31 -16 % 82 81 1 % 1 2 -50 % 4 4 0 % $ 27 $ 33 -18 % $ 86 $ 85 1 % For the Three Months Ended March 31, 2009 2008 Change Operating Revenues Insurance premiums $ 390 $ 370 5 % Net investment income 30 28 7 % Other revenues and fees 2 1 100 % Total operating revenues 422 399 6 % Operating Expenses Interest credited 1 - NM Benefits 282 269 5 % Underwriting, acquisition, insurance and other expenses 99 90 10 % Total operating expenses 382 359 6 % Income from operations before taxes 40 40 0 % Federal income tax expense 14 14 0 % Income from operations $ 26 $ 26 0 % For the Three Months Ended March 31, 2009 2008 Change Income from Operations by Product Line Life $ 1 $ 10 -90 % Disability 25 15 67 % Dental (1 ) - NM Total non-medical 25 25 0 % Medical 1 1 0 % Total income from operations $ 26 $ 26 0 % September 30,March 31, 2009 to 2008 to 2007decreasedremained flat. Insurance premiums increased due primarily to less favorable total non-medical loss ratio experience, although still on the low end of our expected range.The decrease in income from operations was partially offset by a growth in insurance premiums driven by normal, organic business growth in our non-medical products and favorable persistency.Comparison of the Nine Months Ended September 30, 2008 to 2007Income from operations for this segment modestly increased due primarily to growthproducts. The increase in insurance premiums driven by normal, organic business growth inand more favorable total non-medical loss ratio experience, slightly outside the low end of our non-medical products and favorable persistency.The increase in income from operations was partiallyexpected range, entirely offset by an increase to underwriting, acquisition, insurance and other expenses. The increase in underwriting, acquisition and other expenses duewas in line with the increase in insurance premiums and included higher expenses attributable to growthour U.S. pension plans (see “Critical Accounting Policies and Estimates – Pension and Other Postretirement Benefit Plans” in our business2008 Form 10-K for additional information).force, higher 401(k) expenses, elevated costs associated with investments in strategic initiatives and an increasefuture quarters. In addition, we experienced significantly unfavorable life loss ratios in the allocationfirst quarter of expenses2009 due primarily to this segment.The foregoing items are discussed further below.79Insurance PremiumsDetails underlying insurance premiums (in millions) were as follows: For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 136 $ 124 10 % $ 402 $ 367 10 % 168 151 11 % 499 446 12 % 38 34 12 % 112 101 11 % 342 309 11 % 1,013 914 11 % 29 28 4 % 121 115 5 % $ 371 $ 337 10 % $ 1,134 $ 1,029 10 % $ 68 $ 61 11 % $ 187 $ 183 2 % Our costadverse mortality experience, the one-time adjustment noted below and the downward effects of insurance and policy administration charges are embeddedwhole-case pricing on premium rates, which we do not expect to recur in future quarters.premiums chargedfirst quarter of 2009 relating to unfavorable waiver claim reserves.customers. The premiums are a function of the rates priced into the productU.S. pension plans during 2009. See “Critical Accounting Policies and Estimates – Pension and Other Postretirement Benefit Plans” in our business in force. Business in force, in turn, is driven by sales and persistency experience.Sales in the table above and as discussed below are the combined annualized premiums2008 Form 10-K for our life, disability and dental products. additional information.TheWe believe that the trend in sales is an important indicator of development of business in force over time.Comparison of the Three and Nine Months Ended September 30, 2008 to 2007The increase in insurance premiums in our non-medical business reflects normal business growth and favorable persistency experience.Net Investment IncomeWe use our interest income to build the associated policy reserves, which is a function of our insurance premiums and the yields on our invested assets.Comparison of the Three and Nine Months Ended September 30, 2008 to 2007Net investment income remained relatively flat as continued growth of business in force was offset by lower yields on investments supporting statutory surplus due to weaker results from our alternative investments.80Benefits and Interest CreditedDetails underlying benefits and interest credited (in millions) were as follows: For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 100 $ 88 14 % $ 293 $ 269 9 % 116 99 17 % 337 300 12 % 29 26 12 % 89 78 14 % 245 213 15 % 719 647 11 % 24 23 4 % 105 101 4 % $ 269 $ 236 14 % $ 824 $ 748 10 % 74.0 % 71.2 % 72.7 % 73.3 % 68.6 % 65.0 % 67.6 % 66.9 % 75.9 % 74.9 % 79.2 % 77.8 % 71.6 % 68.6 % 70.9 % 70.7 % 86.2 % 82.8 % 87.7 % 87.5 % Note: Loss ratios presented above are calculated using whole dollars instead of dollars rounded to millions.ComparisonDetails underlying insurance premiums (in millions) were as follows: For the Three Months Ended March 31, 2009 2008 Change Insurance Premiums by Product Line Life $ 142 $ 133 7 % Disability 174 162 7 % Dental 38 37 3 % Total non-medical 354 332 7 % Medical 36 38 -5 % Total insurance premiums $ 390 $ 370 5 % Sales $ 54 $ 54 0 % Three Months Ended September 30, 2008rates priced into the product and our business in force. Business in force, in turn, is driven by sales and persistency experience. Sales in the table above are the combined annualized premiums for our life, disability and dental products.2007experienced exceptional claim experienceuse our interest income to build the associated policy reserves, which is a function of our insurance premiums and the yields on our total non-medical products during 2007 that we did not believe was sustainable. The experience during 2008 was less favorable, but still on the low endinvested assets. For the Three Months Ended March 31, 2009 2008 Change Benefits and Interest Credited by Product Line Life $ 116 $ 95 22 % Disability 103 111 -7 % Dental 32 30 7 % Total non-medical 251 236 6 % Medical 32 33 -3 % Total benefits and interest credited $ 283 $ 269 5 % Loss Ratios by Product Line Life 81.6 % 71.9 % Disability 59.1 % 68.1 % Dental 84.2 % 80.8 % Total non-medical 70.8 % 71.0 % Medical 88.9 % 87.6 % our expected range.Comparison of the Nine Months Ended September 30, 2008dollars rounded to 2007Our total non-medical loss ratio remained relatively flat and was within our expected range. Our life loss ratio benefited from favorable waiver claims experience. Our disability loss ratio was affected by unfavorable termination and incidence experience, but was still well below our expected range.81 For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 44 $ 40 10 % $ 132 $ 121 9 % 43 38 13 % 125 108 16 % 9 8 13 % 28 27 4 % 96 86 12 % 285 256 11 % (13 ) (13 ) 0 % (40 ) (38 ) -5 % 83 73 14 % 245 218 12 % 9 8 13 % 26 22 18 % $ 92 $ 81 14 % $ 271 $ 240 13 % 3.5 % 3.9 % 3.5 % 3.7 % For the Three Months Ended March 31, 2009 2008 Change Underwriting, Acquisition, Insurance and Other Expenses Total expenses incurred $ 102 $ 96 6 % DAC and VOBA deferrals (13 ) (14 ) 7 % Total expenses recognized before amortization 89 82 9 % DAC and VOBA amortization, net of interest 10 8 25 % Total underwriting, acquisition, insurance and other expenses $ 99 $ 90 10 % DAC and VOBA Deferrals As a percentage of insurance premiums 3.3 % 3.8 % Comparison of the Three Months Ended September 30, 2008 to 2007The increase in underwriting, acquisition, insurance and other expenses was in line with the increase in insurance premiums.Comparison of the Nine Months Ended September 30, 2008 to 2007The increase in underwriting, acquisition, insurance and other expenses was in line with the increase in insurance premiums and was attributable to growth in our business in force, higher 401(k) expenses, elevated costs associated with investments in strategic initiatives and an increase in the allocation of expenses to this segment. Partially offsetting the increase in expenses were higher deferrals, driven by strategic sales expenses.82subsidiaries. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 68 $ 89 -24 % $ 220 $ 272 -19 % 21 23 -9 % 61 67 -9 % 21 38 -45 % 73 112 -35 % 110 150 -27 % 354 451 -22 % 102 116 -12 % 303 374 -19 % 8 34 -76 % 51 77 -34 % 3 12 -75 % 19 28 -32 % $ 5 $ 22 -77 % $ 32 $ 49 -35 % 7 % 23 % 14 % 17 % For the Three Months Ended March 31, 2009 2008 Change Operating Revenues Investment advisory fees – external $ 44 $ 76 -42 % Investment advisory fees – inter-segment 20 20 0 % Other revenues and fees 18 24 -25 % Total operating revenues 82 120 -32 % Operating Expenses Underwriting, acquisition, insurance and other expenses 79 101 -22 % Income from operations before taxes 3 19 -84 % Federal income tax expense 2 7 -71 % Income from operations $ 1 $ 12 -92 % 4 % 16 % and Nine Months Ended September 30,March 31, 2009 to 2008 to 2007A reduction in investment advisory fees and other revenue and fees due to lower assets under management resulting from equity market declines, negative net flows and the sale of certain institutional fixed income business; andNegative returns on seed capital driven by equity market declines.· A reduction in investment advisory fees due to lower assets under management resulting primarily from continuing significant unfavorable equity markets and the impact of negative net flows in 2008; and · A reduction in other revenues and fees due primarily to negative returns on seed capital driven by continuing significant unfavorable equity markets. expenses due to exiting certain businesses, lower asset-based expenses and lower incentive compensation accruals as a resultthe implementation of lower earningsseveral expense management controls and production performance relative to planned goals.The foregoing itemspractices that are discussed further below following “Impact of Current Market Conditions.”Impact of Current Market ConditionsThe October 2008 daily average of the S&P 500 Index® declined 17% from its value as of September 30, 2008, negatively impacting our assets under management and seed capital investments. Consequently, wefocused on expense reduction initiatives.the fourth quarter as a result of2009 than we experienced in 2008 due primarily to lower investment advisory fees, and negative returns on seed capital, partially offset by lower asset-based expenses.20072008 Form 10-K, as updated byin “Part II – Item 1A. Risk Factors” below, and “Forward-Looking Statements – Cautionary Language” in this report.83 As of September 30, Change 2008 2007 $ 21,256 $ 33,131 -36 % 11,306 10,403 9 % 32,562 43,534 -25 % 14,945 22,108 -32 % 10,155 23,898 -58 % 25,100 46,006 -45 % 8,937 10,176 -12 % 63,531 67,324 -6 % 72,468 77,500 -6 % $ 130,130 $ 167,040 -22 % $ 11,168 $ 16,380 -32 % 3,035 4,734 -36 % $ 14,203 $ 21,114 -33 % For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 800 $ 1,268 -37 % $ 3,335 $ 5,026 -34 % (2,437 ) (1,894 ) -29 % (7,233 ) (6,225 ) -16 % (1,637 ) (626 ) NM (3,898 ) (1,199 ) NM 1,137 1,029 10 % 3,725 3,237 15 % (863 ) (656 ) -32 % (2,735 ) (2,065 ) -32 % 274 373 -27 % 990 1,172 -16 % 1,937 2,297 -16 % 7,060 8,263 -15 % (3,300 ) (2,550 ) -29 % (9,968 ) (8,290 ) -20 % (1,363 ) (253 ) NM (2,908 ) (27 ) NM 688 689 0 % 2,222 2,725 -18 % (1,924 ) (1,132 ) -70 % (3,815 ) (4,914 ) 22 % (1,236 ) (443 ) NM (1,593 ) (2,189 ) 27 % 551 2,215 -75 % 1,030 5,188 -80 % (1,068 ) (1,219 ) 12 % (2,154 ) (2,894 ) 26 % (517 ) 996 NM (1,124 ) 2,294 NM 1,239 2,904 -57 % 3,252 7,913 -59 % (2,992 ) (2,351 ) -27 % (5,969 ) (7,808 ) 24 % (1,753 ) 553 NM (2,717 ) 105 NM 3,176 5,201 -39 % 10,312 16,176 -36 % (6,292 ) (4,901 ) -28 % (15,937 ) (16,098 ) 1 % $ (3,116 ) $ 300 NM $ (5,625 ) $ 78 NM As of March 31, 2009 2008 Change Assets Under Management Retail – equity $ 12,287 $ 27,409 -55 % Retail – fixed 10,935 11,238 -3 % Total retail 23,222 38,647 -40 % Institutional – equity 9,941 19,512 -49 % Institutional – fixed 11,142 11,187 0 % Total institutional 21,083 30,699 -31 % Inter-segment assets – retail and institutional 7,505 9,191 -18 % Inter-segment assets – general account 64,824 67,340 -4 % Total inter-segment assets 72,329 76,531 -5 % Total assets under management $ 116,634 $ 145,877 -20 % Total Sub-Advised Assets, Included Above Retail $ 6,076 $ 14,212 -57 % Institutional 1,919 4,071 -53 % Total sub-advised assets $ 7,995 $ 18,283 -56 % For the Three Months Ended March 31, 2009 2008 Retail equity sales $ 593 $ 1,493 Retail equity redemptions and transfers (1,527 ) (2,615 ) Retail equity net flows (934 ) (1,122 ) Retail fixed income sales 1,379 1,376 Retail fixed income redemptions and transfers (1,082 ) (978 ) Retail fixed income net flows 297 398 Total retail sales 1,972 2,869 Total retail redemptions and transfers (2,609 ) (3,593 ) Total retail net flows (637 ) (724 ) Institutional equity inflows 375 968 Institutional equity withdrawals and transfers (1,042 ) (1,043 ) Institutional equity net flows (667 ) (75 ) Institutional fixed income inflows 2,247 168 Institutional fixed income withdrawals and transfers (592 ) (574 ) Institutional fixed income net flows 1,655 (406 ) Total institutional inflows 2,622 1,136 Total institutional redemptions and transfers (1,634 ) (1,617 ) Total institutional net flows 988 (481 ) Total sales/inflows 4,594 4,005 Total redemptions and transfers (4,243 ) (5,210 ) Total net flows $ 351 $ (1,205 ) (“VIP”) funds. Lincoln FinancialOur insurance subsidiaries, as well as unaffiliated insurers, participate in these funds. In addition, sales/inflows includes contributions, dividend reinvestments and transfers in kind, and redemptions/transfers includes dividends and capital gain distributions. For the Three Months Ended March 31, 2009 2008 $ 536 $ 719 (676 ) (679 ) Total net flows $ (140 ) $ 40 (2)$12.3 billion in institutional fixed income business sold to an unaffiliated investment management company in the fourth quarter of 2007general account inflows and $154 million of 529 Plan assets transferred to an unaffiliated 529 Plan provider in the second quarter of 2007transfers because we do not consider these to be net flows.84 For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 812 $ 544 49 % $ 1,905 $ 1,753 9 % (1,028 ) (754 ) -36 % (2,250 ) (2,254 ) 0 % $ (216 ) $ (210 ) -3 % $ (345 ) $ (501 ) 31 % (1)Includes net flows from retail and institutional and excludes net flows from the general account. Also, it excludes the transfer of $3.0 billion in assets to another internal advisor, $780 million in assets to Other Operations for the nine months ended September 30, 2007, and the transfer in of $709 million in assets primarily from another internal advisor in the third quarter of 2008, because we do not consider these to be net flows.(2) For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 1,255.42 1,489.60 -16 % 1,325.03 1,470.65 -10 % For the Three Months Ended March 31, 2009 2008 Change Other Information Average daily S&P 500 810.65 1,349.16 -40 % Impact of dividends and interest and change in market value on assets under management $ (2,943 ) $ (5,654 ) 48 % isare driven by net flows and capital markets. Investment advisory fees – external include amounts that are ultimately paid to sub-advisors for managing the sub-advised assets. The amounts paid to sub-advisors are generally included in the segment’s expenses.The level of net flows may vary considerably from period to period, and therefore results in one period are not indicative of net flows in subsequent periods.Comparison of the Three Months Ended September 30, 2008 to 2007Investment advisory fees – external decreased due primarily to lower third-party average assets under management as a result of equity market declines, negative net flows and the impact of the fixed income transaction, as discussed below. Market value changes on assets under management in the third quarter of 2008 were $(3.4) billion in retail and $(2.6) billion in institutional compared to $520 million in retail and $1.2 billion in institutional for the same period in 2007.On October 31, 2007, we sold certain institutional taxable fixed income business to an unaffiliated investment management company. As a result of this transaction, assets under management decreased by $12.3 billion, which resulted in a $5 million decrease to investment advisory fees – external in the third quarter of 2008. We expect a similar impact in the fourth quarter of 2008.Investment advisory fees – inter-segment decreased due to lower average inter-segment assets under management as a result of market declines and negative net flows.85Comparison of the Nine Months Ended September 30, 2008 to 2007Investment advisory fees – external decreased due primarily to lower third-party average assets under management as a result of equity market declines, negative net flows and lower advisory revenues of $14 million as a result of the 2007 fixed income transaction, as discussed above. Market value changes on assets under management in the first nine months of 2008 were $(6.9) billion in retail and $(5.5) billion in institutional compared to $3.2 billion in retail and $2.8 billion in institutional for the same period in 2007.Investment advisory fees – inter-segment decreased due to lower average inter-segment assets under management as a result of market declines, negative net flows and as a result of the transition of the investment advisory role for the Lincoln Variable Insurance Trust product effective May 1, 2007, to Retirement Solutions. In the role of investment advisor, Investment Management provided investment performance and compliance oversight on third-party investment managers in exchange for a fee. Investment Management will continue to manage certain of the assets as a sub-advisor. As a result of this change, Investment Management’s assets under management decreased by $3.0 billion; however, there was no impact to our consolidated assets under management or consolidated net income.Comparison of the Three and Nine Months Ended September 30, 2008 to 2007decreased forconsists primarily of revenues generated from shareholder and administrative services, 12b-1 fees and the three and nine months ended September 30, 2008 and 2007, partly due to a $7 million and $16 million decrease, respectively, in the return onresults from seed capital due to unfavorable equity markets.investments. Seed capital investments are important to establishing a track record for products that will later be sold to investors. These investments are valued at market value each reporting period and the change in market value impacts other revenues. Other revenues and fees were also negatively impacted by the loss of fees from the movement of the investment accounting function to a third party and by lower 12b-1 revenue related to lower average assets under management.Operating ExpensesComparison of the Three Months Ended September 30, 2008 to 2007Operating expenses decreased due primarily to selling certain fixed income business to an unaffiliated investment management company and transitioning the investment accounting function to a third party. Also, accruals for variable compensation based on revenue and results decreased. These reductions were partially offset by an accrual for legal expenses.Comparison of the Nine Months Ended September 30, 2008 to 2007Operating expenses decreased due primarily to the elimination of certain expenses as a result of transferring the investment advisory role of Lincoln Variable Insurance Trust to another internal advisor, selling certain fixed income business to an unaffiliated investment management company and transitioning the investment accounting function to a third party. Also, accruals for variable compensation based on revenue and results have decreased. In addition, in 2007, a new closed-end fund was launched. Costs associated with the launch of this fund were $5 million.86 focuses on protecting and enhancing the value of its existing customer base. The segment accepts new deposits from existing relationships and markets a limited range of new products includinglife and retirement income products. Lincoln UK’s product portfolio principally consists of unit-linked life and pension products, which are similar to U.S. produced variable life and annuity products, where the risk associated with the underlying investments is borne by the contract holders. The segment is sensitive to changes in the foreign currency exchange rate between the U.S. dollar and the British pound sterling. A significant increase in the value of the U.S. dollar relative to the British pound would have a significant adverse effect on the segment’s operating results. For the Three Months Ended March 31, 2009 2008 Change Operating Revenues Insurance premiums $ 10 $ 19 -47 % Insurance fees 24 46 -48 % Net investment income 13 21 -38 % Total operating revenues 47 86 -45 % Operating Expenses Benefits 19 31 -39 % Underwriting, acquisition, insurance and other expenses 19 38 -50 % Total operating expenses 38 69 -45 % Income from operations before taxes 9 17 -47 % Federal income tax expense 3 6 -50 % Income from operations $ 6 $ 11 -45 % Exchange Rate Ratio-U.S. Dollars to Pounds Sterling Average for the period 1.443 1.987 -27 % End-of-period 1.435 1.985 -28 % · A decline in insurance fees driven by lower average unit-linked account values resulting primarily from unfavorable markets as the average value of the Financial Time Stock Exchange (“FTSE”) 100 index was 31% lower than the first quarter of 2008; and · A reduction in net investment income due to lower yields.
Future Expectations· Continued deterioration in general economic and business conditions that we believe will result in lower investment fee income and less favorable foreign exchange rates; · Lower net investment income on the segment’s fixed deposits from the continuation of the low interest rate environment; and · Lower net flows on unit-linked assets due to the current economic challenges, including the current expectation by analysts that a meaningful economic recovery, including reductions in unemployment, will not occur until 2010.
If there were an immediate decline in the FTSE of approximately 18% from its level as of March 31, 2009, and/or sustained under performance over a number of months, we believe it would result in approximately $50 million, after-tax, unfavorable prospective unlocking of DAC, VOBA and DFEL related to reversion to the mean.20072008 Form 10-K, as updated byin “Part II – Item 1A. Risk Factors” below, and “Forward-Looking Statements – Cautionary Language” in this report.Income from OperationsDetailsresults for Lincoln UK (in millions) were as follows: For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 19 $ 26 -27 % $ 64 $ 74 -14 % 40 42 -5 % 138 138 0 % 21 21 0 % 61 60 2 % 80 89 -10 % 263 272 -3 % 27 30 -10 % 87 100 -13 % 34 43 -21 % 113 121 -7 % 61 73 -16 % 200 221 -10 % 19 16 19 % 63 51 24 % 7 6 17 % 22 18 22 % $ 12 $ 10 20 % $ 41 $ 33 24 % For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 1.897 2.025 -6 % 1.957 1.993 -2 % 1.778 2.046 -13 % 1.778 2.046 -13 % Comparison of the Three Months Ended September 30, 2008 to 2007income from operations for this segment increased 28% due primarily to the following:An unfavorable adjustment in 2007 to our mis-selling reserves; andThe recording of a Value Added Tax (“VAT”) refund in 2008.The increase in income from operations was partially offset by the following:A reduction in premiums due to declines in the annuitization of vesting pension policies and the face amount of our insurance in force attributable to the maturity of the block of business; andA $3 million unfavorable prospective unlocking (a $13 million unfavorable unlocking from model refinements net of a $10 million favorable unlocking from assumption changes) of DAC, VOBA and DFEL in 2008 compared to a $2 million favorable prospective unlocking (a $4 million favorable unlocking from assumption changes net of a $2 million unfavorable unlocking from model refinements) in 2007.87Comparison of the Nine Months Ended September 30, 2008 to 2007Excluding the effect of the exchange rate, income from operations for this segment increased 27% due primarily to the following:A favorable adjustment in 2008 to our mis-selling reserves;An unfavorable adjustment in 2007 to our mis-selling reserves; andThe recording of a VAT refund in 2008.The increase in income from operations was partially offset by the following:A reduction in premiums due to declines in the annuitization of vesting pension policies and the face amount of our insurance in force attributable to the maturity of the block of business; andThe impact of prospective unlocking discussed above.The foregoing items are discussed further below.Insurance PremiumsInsurance premiums are primarily a function of the rates priced into the product and face amount of our insurance in force.Comparison of the Three Months Ended September 30, 2008 to 2007Excluding the effect of the exchange rate, insurance premiums decreased 22%, primarily reflecting a decrease in the annuitization of vesting pension policies, partially offset by a decrease in benefits.Comparison of the Nine Months Ended September 30, 2008 to 2007Excluding the effect of the exchange rate, insurance premiums decreased 12%, primarily reflecting a decrease in the annuitization of vesting pension policies, partially offset by a decrease in benefits.as ofwas 6.2% for the thirdfirst quarter of 2008 was 6.3% as2009 compared to 6.5%6.3% for the corresponding period in 2007,2008, as measured by the number of policies in force. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 9 $ 9 0 % $ 27 $ 28 -4 % 27 21 29 % 94 86 9 % (1 ) (1 ) 0 % (2 ) (2 ) 0 % (1 ) (3 ) 67 % (1 ) (3 ) 67 % — 8 -100 % — 8 -100 % — — NM — (1 ) 100 % 6 8 -25 % 20 22 -9 % $ 40 $ 42 -5 % $ 138 $ 138 0 % As of September 30, 2008 2007 Change $ 15,605 $ 19,757 -21 % 88 For the Three Months Ended March 31, 2009 2008 Change Insurance Fees Mortality assessments $ 7 $ 9 -22 % Expense assessments 16 30 -47 % DFEL: Deferrals (1 ) (1 ) 0 % Amortization, net of interest: Retrospective unlocking (2 ) 1 NM Amortization, net of interest, excluding unlocking 4 7 -43 % Total insurance fees $ 24 $ 46 -48 % As of March 31, 2009 2008 Change Individual life insurance in force $ 11,674 $ 18,283 -36 % For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 7,833 $ 9,168 -15 % $ 8,850 $ 8,757 1 % 81 79 3 % 242 247 -2 % (189 ) (251 ) 25 % (629 ) (742 ) 15 % (108 ) (172 ) 37 % (387 ) (495 ) 22 % (304 ) 25 NM (1,062 ) 531 NM (836 ) 171 NM (816 ) 399 NM $ 6,585 $ 9,192 -28 % $ 6,585 $ 9,192 -28 % For the Three Months Ended March 31, 2009 2008 Change Unit-Linked Assets Balance at beginning-of-period $ 4,978 $ 8,850 -44 % Deposits 39 60 -35 % Withdrawals and deaths (108 ) (213 ) 49 % Net flows (69 ) (153 ) 55 % Investment income and change in market value (279 ) (608 ) 54 % Foreign currency adjustment (79 ) (10 ) NM Balance at end-of-period $ 4,551 $ 8,079 -44 % Although the use of the reversion to the mean process has lessened the impact of short-term volatility in equity markets, theThe segment’s fee income remains subject to volatility in the equity markets as it affects the level of the underlying assets that drive the fee income.Comparison of the Three and Nine Months Ended September 30, 2008 to 2007Excluding the effects of the exchange rate and unlocking, insurance fees increased 18% and 6% in the three and nine months ended September 30, 2008, respectively, as compared to the corresponding periods in 2007 due primarily to a $9 million correction in the third quarter of 2007 that reduced expense assessments in 2007 and higher U.K. Department of Work and Pensions premiums, partially offset by lower dividend income, lower equity gains and decreasing bond values resulting in a reduced linked tax deduction from the unit-linked account. Excluding the effect of the exchange rate, individual life insurance in force decreased 9%, and unit linked assets decreased 18%, which also contributed to a reduction in linked fees.The three and nine months ended September 30, 2007, had unfavorable prospective unlocking – assumption changes related primarily to refinements to the methodology regarding future expectations of investment income and expenses offset by the expected mortality experience in the future.Comparison of the Three Months Ended September 30, 2008 to 2007Excluding the effect of the exchange rate, net investment income increased by 7%, due primarily to increased investments in short-term bonds and interest due on the VAT refund.Comparison of the Nine Months Ended September 30, 2008 to 2007Excluding the effect of the exchange rate, net investment income increased by 4%, due primarily to increased investments in short-term bonds and interest due on the VAT refund. incurred during the period in excess of the associated account balance for its unit-linked products. Benefits are recognized when incurred.Comparison of the Three Months Ended September 30, 2008 to 2007Excluding the effects of the exchange rate, benefits decreased 4% due primarily to an increase in 2007 in mis-selling reserves and a decrease in reserves due to lower levels of vested annuity premiums, partially offset by an increase from unfavorable claim experience and lower reinsurance recoveries.89Comparison of the Nine Months Ended September 30, 2008 to 2007Excluding the effects of the exchange rate, benefits decreased 11% due primarily to a reduction in the liability for mis-selling practices following a favorable finding in the second quarter of 2008 by the U.K. Financial Ombudsman Service regarding Lincoln UK’s time barring of claims compared to an increase in the liability for mis-selling practices in 2007, a one-time reduction in the death claim reserve following a reconciliation of previously paid claims and a decrease in reserves due to lower levels of vested annuity premiums. These decreases were partially offset by an unfavorable tax reserve adjustment and lower reinsurance recoveries. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 1 $ 1 0 % $ 3 $ 3 0 % 23 27 -15 % 74 80 -8 % 24 28 -14 % 77 83 -7 % (1 ) (1 ) 0 % (2 ) (3 ) 33 % 23 27 -15 % 75 80 -6 % (16 ) (9 ) -78 % (16 ) (9 ) -78 % 20 11 82 % 20 �� 11 82 % (2 ) (1 ) -100 % (3 ) (2 ) -50 % 9 15 -40 % 37 41 -10 % $ 34 $ 43 -21 % $ 113 $ 121 -7 % For the Three Months Ended March 31, 2009 2008 Change Underwriting, Acquisition, Insurance and Other Expenses Total expenses incurred $ 18 $ 28 -36 % DAC and VOBA deferrals (1 ) (1 ) 0 % Total expenses recognized before amortization 17 27 -37 % DAC and VOBA amortization, net of interest: Retrospective unlocking (5 ) (1 ) NM Amortization, net of interest, excluding unlocking 7 12 -42 % Total underwriting, acquisition, insurance and other expenses $ 19 $ 38 -50 % Comparison of the Three and Nine Months Ended September 30, 2008 to 2007Excluding the effect of the exchange rate, general and administrative expenses decreased 9% and 6% for the three and nine months ended September 30, 2008, as compared to the corresponding periods in 2007, respectively, due primarily to a refund of VAT based on approval of our claim by Customs and Excise.The three and nine months ended September 30, 2008, had favorable prospective unlocking – assumption changes related primarily to lower maintenance costs and higher persistency than our model projections assumed. The three and nine months ended September 30, 2007, had favorable prospective unlocking – assumption changes related primarily to changes in investment income, expense and mortality expectations.90corporateexternal debt and corporatebusiness sold through reinsurance. We are actively managing our remaining radio station clusters to maximize performance and future value. Other Operations also includes the Institutional Pension business, which was previously reported in Employer Markets – Retirement Products prior to our segment realignment discussed in “Introduction – Executive Summary.” The Institutional Pension business is a closed-blockclosed block of pension business, the majority of which was sold on a group annuity basis, and is currently in run-off. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 1 $ 1 0 % $ 4 $ 3 33 % 90 93 -3 % 277 271 2 % 19 19 0 % 55 56 -2 % 21 27 -22 % 66 80 -18 % 1 (4 ) 125 % — 2 -100 % (21 ) (23 ) 9 % (61 ) (67 ) 9 % 111 113 -2 % 341 345 -1 % 43 48 -10 % 131 137 -4 % 31 36 -14 % 88 110 -20 % 14 13 8 % 45 43 5 % 33 52 -37 % 120 116 3 % 69 68 1 % 209 204 2 % (21 ) (23 ) 9 % (61 ) (67 ) 9 % 169 194 -13 % 532 543 -2 % (58 ) (81 ) 28 % (191 ) (198 ) 4 % (19 ) (32 ) 41 % (64 ) (83 ) 23 % $ (39 ) $ (49 ) 20 % $ (127 ) $ (115 ) -10 % For the Three Months Ended March 31, 2009 2008 Change Operating Revenues Insurance premiums $ 1 $ 1 0 % Net investment income 70 99 -29 % Amortization of deferred gain on business sold through reinsurance 18 18 0 % Media revenues (net) 15 22 -32 % Other revenues and fees (1 ) (3 ) 67 % Inter-segment elimination of investment advisory fees (20 ) (20 ) 0 % Total operating revenues 83 117 -29 % Operating Expenses Interest credited 51 45 13 % Benefits 107 28 282 % Media expenses 13 16 -19 % Other expenses 34 35 -3 % Interest and debt expenses 65 76 -14 % Inter-segment elimination of investment advisory fees (20 ) (20 ) 0 % Total operating expenses 250 180 39 % Loss from operations before taxes (167 ) (63 ) NM Federal income tax benefit (58 ) (21 ) NM Loss from operations $ (109 ) $ (42 ) NM September 30,March 31, 2009 to 2008 to 2007Loss from operations for this segment decreased due primarily to the following:Lower other expenses due primarily to higher merger-related expenses in 2007 and a separation benefit recorded in the third quarter of 2007, partially offset by increases in litigation expense; andUnfavorable mortality in our Institutional Pension business in the third quarter of 2007.The decrease in loss from operations was partially offset by the following:Lower media earnings related primarily to lower advertising revenues caused by market conditions; andLess favorable tax items that impacted the effective tax rate.91Comparison of the Nine Months Ended September 30, 2008 to 2007Lower media earnings related primarily to lower advertising revenues caused by market conditions;Higher other expenses attributable primarily to the impact of the one-time curtailment gain recorded in the second quarter of 2007 related to our employee pension plan and the relocation costs associated with the move of our corporate office, partially offset by a separation benefit recorded in the third quarter of 2007 and lower merger-related expenses in 2008;· The $64 million unfavorable impact in the first quarter of 2009 of the rescission of the reinsurance agreement on certain disability income business sold to Swiss Re as discussed in “Reinsurance” below, which resulted in pre-tax increases in benefits of $78 million, interest credited of $15 million and other expenses of $5 million, partially offset by a $34 million tax benefit; Higher interest and debt expenses from increased debt; and· Lower net investment income from a reduction in invested assets driven by transfers to other segments for other-than-temporary impairments and dividends paid to stockholders as these items exceeded the distributable earnings received from our insurance segments, dividends received from our other segments and issuances of debt, and lower dividend income from our holdings of Bank of America common stock due to dividend rate cuts; and Less favorable tax items that impacted the effective tax rate.· Lower media earnings related primarily to declines in discretionary business spending, such as advertising, caused by the general weakening of the U.S economy causing substantial declines in revenues throughout the radio market. Higher net· Lower interest and debt expenses as a result of a decline in interest rates that affect our variable rate borrowings partially offset by higher average balances of outstanding debt in the current period; and · Lower other expenses due primarily to higher merger-related expenses in the first quarter of 2008 as a result of higher system integration work related to our administrative systems and relocation costs in the first quarter of 2008 associated with the move of our corporate office, partially offset by restructuring charges for expense initiatives in the first quarter of 2009. · Higher expected expenses attributable to restructuring charges of approximately $15 million to $20 million in the second quarter of 2009 related to recently announced expense reduction initiatives that are discussed further below; · Lower investment income due to lower dividend income from our holdings of Bank of America common stock as it announced dividend rate cuts during the latter part of 2008 and early 2009, partially offset by higher investment income of $2 million per quarter prospectively related to the coinsurance agreement that we entered into on March 31, 2009 (see “Results of Insurance Solutions – Insurance Solutions – Life Insurance” and “Reinsurance” for more information); · Lower investment income from a reduction in the distributable earnings that will be received from our insurance segments and lower dividends received from our other segments due to the current economic challenges, including the current expectation by analysts that a meaningful economic recovery, including reductions in unemployment, will not occur until 2010; · Lower investment income on alternative investment income due to the market conditions in both the equity and credit markets (see “Consolidated Investments – Alternative Investments” below for additional information on our alternative investments); · Lower investment income on fixed maturity securities and mortgage loans on real estate from the continuation of the low interest rate environment; · Lower media earnings as we believe customers will continue to reduce their advertising expenses in response to the credit markets; and · Higher expenses attributable to our U.S. pension plans (see “Critical Accounting Policies and Estimates – Pension and Other Postretirement Benefit Plans” in our 2008 Form 10-K for additional information). from an increase in invested assets driven by distributable earnings received from our insurance segments, dividends received from our other segments and issuances of debt as these items exceeded share repurchases and dividends paidbusiness results within Other Operations due to stockholders; andUnfavorable mortality in our Institutional Pension business in 2007.Certainthe rescission of the foregoing items are discussed further below following “Impact of Current Market Conditions.”Impact of Current Market ConditionsMedia earningsexperience deterioration as customers reduce their advertising expensesput pressure on many industries and companies, including our own. After reviewing the impact of this difficult economy on our anticipated sales and business activities, we initiated actions in response to the credit markets. Due to seasonality, the fourth quarter is generally our strongest quarter; however, expectations for this year areto streamline operations, reduce expenses and ensure that fourth quarter will bestaffing levels were aligned with expected business activity. We focused on reducing the lowest quarter in 2008 given the current economic conditions;workforce, reducing capital spending and addressing corporate-wide discretionary spending.Investment income is expected to be lower aslower dividend income fromshrinking revenues due to the impact of unfavorable equity markets on our holdings of Bank of America common stock, following its announcementasset management businesses and a reduction in early Octobersales volumes caused by the unfavorable economic environment, we have launched further initiatives to reduce its dividend rate by half;expenses, including a 12% workforce reduction that was completed in April of 2009, that we believe will improve our capital position and preserve profits. The restructuring costs associated with these layoffs are included in other expenses within Other Operations.Additional other-than-temporary impairments that will further reduce investment income for this segment. See below for further detail on this impact.20072008 Form 10-K, as updated byin “Part II – Item 1A. Risk Factors” below, and “Forward-Looking Statements – Cautionary Language” in this report.the holding company maintainswe maintain an inter-segment cash management accountprogram where other segmentscertain subsidiaries can borrow from or lend money to the holding company.company to meet short-term borrowing needs. The inter-segment cash management accountprogram affects net investment income for Other Operations, as all inter-segment eliminations are reported within Other Operations.Comparison of the Three Months Ended September 30, 2008 to 2007The decrease in net investment income was attributable to a decrease in invested assets that was driven by share repurchases, dividends paid to stockholders and transfers to other segments for other-than-temporary impairments. The decrease in invested assets from these items exceeded distributable earnings received from our insurance segments, dividends received from our other segments and issuances of debt. In addition, decreases in income on standby real estate equity commitments unfavorably impacted net investment income, partially offset by the favorable impact from decreases in collateral under securities loaned.92Comparison of the Nine Months Ended September 30, 2008 to 2007The increase in net investment income was attributable to an increase in invested assets that was driven by distributable earnings received from our insurance segments, dividends received from our other segments and issuances of debt. These items exceeded the amount of share repurchases, dividends paid to stockholders and transfers to other segments for other-than-temporary impairments. In addition, increases in our inter-segment cash management account payable and decreases in income on standby real estate commitments unfavorably impacted net investment income, partially offset by the favorable impact from decreases in collateral under securities loaned.products.Comparison of the Threeproducts and Nine Months Ended September 30, 2008 to 2007The decrease in benefits was a result of unfavorable mortality in our Institutional Pension business in the second and third quarters of 2007. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 13 $ 30 -57 % $ 44 $ 75 -41 % 8 8 0 % 27 24 13 % 4 3 33 % 9 6 50 % 2 4 -50 % 5 8 -38 % 6 7 -14 % 35 3 NM $ 33 $ 52 -37 % $ 120 $ 116 3 % For the Three Months Ended March 31, 2009 2008 Change Other Expenses Merger-related expenses $ 7 $ 15 -53 % Restructuring charges for expense initiatives 5 - NM Branding 5 8 -38 % Retirement Income Security Ventures 2 2 0 % Taxes, licenses and fees 2 2 0 % Other 13 8 63 % Total other expenses $ 34 $ 35 -3 % expenses for Other Operationsin the table above includes expenses that are corporate in nature such as merger-related expenses, restructuring costs, branding,including charitable contributions, certain litigation reserves, amortization of media intangible assets with a definite life, other expenses not allocated to our business segments and inter-segment expense eliminations, excluding those associated with our inter-segment investment advisory fees.Comparison of the Three Months Ended September 30, 2008 to 2007The decrease in other expenses was attributable primarily to the effect of decreased merger-related expenses because of higher system integration work related to our administrative systems in 2007, as well as a separation benefit related to the retirement of certain key executives in 2007. These decreases were partially offset by increases in litigation and facilities expense.Comparison of the Nine Months Ended September 30, 2008 to 2007The increase in other expenses was attributable primarily to the impact of the one-time curtailment gain recorded in the second quarter of 2007 related to our employee pension plan and relocation costs associated with the move of our corporate office and an increase in incentive compensation expense, strategic costs and facilities expense. These increases in other expenses were partially offset by a decrease in merger-related expenses as a result of higher system integration work related to our administrative systems in 2007 and a separation benefit related to the retirement of certain key executives recorded in the third quarter of 2007.byin the first half of 2009. Our current estimate of the cumulative integration expenses is approximately $215 million to $225 million, pre-tax, and excludes amounts capitalized or recorded as goodwill.goodwill.93ExpenseTheExpensesand/or discretionary nature of usesthe use of cash, for the repurchase of stock, incentive compensation and the availability of funds from our inter-company cash management account may result in changes in external financingprogram and volatility in interest expense.the future cost of capital. For additional information on our financing activities, see “Review of Consolidated Financial Condition – Liquidity and Capital Resources – Sources of Liquidity and Cash Flow – Financing Activities” below.Comparison of the Three and Nine Months Ended September 30, 2008 to 2007The increase in interest and debt expense was due primarily to an increase in our average outstanding debt balance in 2008 as compared to 2007, partially offset by decrease in interest rates on our variable rate borrowings. The increased debt was primarily the result of: $450 million issued in the third quarter of 2008 to repay maturing debt, to fund reductions in our outstanding commercial paper balances and for general corporate purposes; and $375 million issued in the fourth quarter of 2007 to fund a captive reinsurance company (calculated under AG38), which was created for the purpose of reinsuring liabilities of our existing insurance affiliates, related primarily to statutory reserves on UL products with secondary guarantees.Federal Income Tax BenefitComparison of the Three and Nine Months Ended September 30, 2008 to 2007The decrease in the federal income tax benefit was due to less favorable tax items that impacted the effective tax rate related primarily to changes in tax preferred investments.(1) (in millions) were as follows: For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change Pre-Tax 2008 2007 2008 2007 $ 2 $ — NM $ — $ 2 -100 % 11 2 NM 27 4 NM 39 (1 ) NM 47 (3 ) NM 52 1 NM 74 3 NM (314 ) (35 ) NM (480 ) (18 ) NM (2 ) (1 ) -100 % — 3 -100 % 89 (24 ) NM 85 (10 ) NM (33 ) — NM (41 ) 1 NM 2 (6 ) 133 % 9 (3 ) NM 2 — NM 6 — NM (256 ) (66 ) NM (421 ) (27 ) NM $ (204 ) $ (65 ) NM $ (347 ) $ (24 ) NM For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change After-Tax 2008 2007 2008 2007 $ 1 $ — NM $ — $ 1 -100 % 7 1 NM 18 3 NM 25 (1 ) NM 31 (2 ) NM 33 — NM 49 2 NM (203 ) (23 ) NM (311 ) (11 ) NM (1 ) — NM — 2 -100 % 58 (15 ) NM 54 (6 ) NM (22 ) — NM (27 ) 1 NM 1 (4 ) 125 % 6 (2 ) NM 1 — NM 4 — NM (166 ) (42 ) NM (274 ) (16 ) NM $ (133 ) $ (42 ) NM $ (225 ) $ (14 ) NM For the Three Months Ended March 31, Pre-Tax 2009 2008 Change Operating realized gain: Indexed annuity net derivatives results $ - $ (2 ) 100 % GLB 16 6 167 % GDB 81 6 NM Total operating realized gain 97 10 NM Realized loss related to certain investments (153 ) (41 ) NM Gain on certain reinsurance derivative/ trading securities 22 - NM GLB net derivatives results (130 ) (7 ) NM GDB derivatives results (32 ) (5 ) NM Indexed annuity forward-starting option 1 5 -80 % Gain on sale of subsidiaries/businesses 2 3 -33 % Total excluded realized loss (290 ) (45 ) NM Total realized loss $ (193 ) $ (35 ) NM For the Three Months Ended March 31, After-Tax 2009 2008 Change Operating realized gain: Indexed annuity net derivatives results $ - $ (1 ) 100 % GLB 10 4 150 % GDB 53 4 NM Total operating realized gain 63 7 NM Realized loss related to certain investments (99 ) (27 ) NM Gain on certain reinsurance derivative/ trading securities 14 1 NM GLB net derivatives results (84 ) (4 ) NM GDB derivative results (20 ) (4 ) NM Indexed annuity forward-starting option - 3 -100 % Gain on sale of subsidiaries/businesses 1 2 -50 % Total excluded realized loss (188 ) (29 ) NM Total realized loss $ (125 ) $ (22 ) NM of expense of DAC, VOBA, DSI and DFEL and changes in other contract holder funds and funds withheld reinsurance liabilities. For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 42 $ (4 ) NM $ 167 $ (37 ) NM (37 ) 4 NM (167 ) 42 NM (3 ) — NM — (3 ) 100 % 2 — NM — 2 -100 % 18 4 NM 51 10 NM 4 — NM 7 — NM (11 ) (2 ) NM (31 ) (6 ) NM 11 2 NM 27 4 NM 51 (2 ) NM 66 (5 ) NM 18 — NM 19 — NM (30 ) 1 NM (38 ) 2 NM 39 (1 ) NM 47 (3 ) NM $ 52 $ 1 NM $ 74 $ 3 NM For the Three Months Ended March 31, 2009 2008 Change Indexed Annuity Net Derivatives Results Change in fair value of S&P 500 call options $ 18 $ 94 81 % Change in fair value of embedded derivatives (18 ) (97 ) -81 % Associated amortization expense of DAC, VOBA, DSI and DFEL - 1 -100 % Total indexed annuity net derivatives results - (2 ) 100 % GLB 23 16 44 % Associated amortization expense of DAC, VOBA, DSI and DFEL: 9 - NM Amortization, excluding unlocking (16 ) (10 ) -60 % Total GLB 16 6 167 % GDB 96 12 NM Associated amortization expense of DAC, VOBA, DSI and DFEL: 43 - NM Amortization, excluding unlocking (58 ) (6 ) NM Total GDB hedge cost 81 6 NM Total Operating Realized Gain $ 97 $ 10 NM expense of DAC, VOBA, DSI and DFEL.• net derivative results – Represents the net difference between the change in the fair value of the S&P 500 Index® call options that we hold and the change in the fair value of the embedded derivative liabilities of our indexed annuities products. The change in the fair value of the liability for the embedded derivative represents the amount that is credited to the indexed annuity contract.indexed annuity contract.– Representsriders (the “attributed fees”). These attributed fees represent the present value of future claims expected to be paid for the GLB at the inception of the contract (the “net valuation premium”) plus a margin that a theoretical market participant would include for risk/profit (the “risk/profit margin”).calculated as the attributed fees in excess ofoperating realized gain and include the net valuation premium. Net valuation premium represents a level portion of the GLB attributed rider fees required to fund potential claims for living benefits. Thein excluded realized gain (loss). For our Retirement Solutions – Annuities and Retirement Solutions – Defined Contribution segments, the excess of total fees collected from the contract holders over the GLB attributed rider fees areis reported in insurance fees.fees usedchange in the calculationfair value of the embedded derivative.derivatives that offsets the benefit ratio unlocking of our SOP 03-1 reserves on our GLB riders. These changes in reserves attributable to Retirement Solutions’ benefit ratio unlocking of its SOP 03-1 reserves for GLB riders and associated amortization of DAC, VOBA, DSI and DFEL is offset in benefits within income from operations. This approach excludes the benefit ratio unlocking from income from operations according to our definition of income from operations and instead reflects it within GLB net derivatives results, a component of excluded realized gain (loss). On our Consolidated Statements of Income, the benefit ratio unlocking is reported within benefits.hedge cost – Representsrepresents the change in the fair value of the derivatives that offsets the benefit ratio unlocking of our SOP 03-1 reserves on our GDB riders, including our expected cost of the hedging instruments. These changes in reserves attributable to Retirement Solutions’ benefit ratio unlocking of its SOP 03-1 reserves for GDB riders and associated amortization of DAC, VOBA, DSI and DFEL is offset in benefits within income from operations. This approach excludes the benefit ratio unlocking from income from operations according to our definition of income from operations and instead reflects it within GDB derivatives results, a component of excluded realized gain (loss). On our Consolidated Statements of Income, the benefit ratio unlocking is reported within benefits.96Gain (Loss)Loss Related to Certain InvestmentsGain (Loss)Loss Related to Investments” below. Changes in the fair value of these derivatives are offset by the change in fair value of trading securities in the portfolios that support these arrangements.(dollars in(in millions) were as follows: For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 21 $ 13 62 % $ 58 $ 36 61 % 80 (6 ) NM 80 (6 ) NM — 8 -100 % — 8 -100 % (651 ) (123 ) NM (812 ) (49 ) NM 319 67 NM 388 (6 ) NM (252 ) (54 ) NM (344 ) (53 ) NM 372 — NM 481 — NM (31 ) — NM (31 ) — NM (69 ) (7 ) NM (59 ) (1 ) NM 48 24 100 % 14 8 75 % — — NM (34 ) — NM $ 89 $ (24 ) NM $ 85 $ (10 ) NM $ (51 ) $ 2 NM $ (67 ) $ 5 NM 8 (2 ) NM 10 (3 ) NM (16 ) — NM (17 ) — NM 26 — NM 33 (1 ) NM $ (33 ) $ — NM $ (41 ) $ 1 NM For the Three Months Ended March 31, 2009 2008 Change GLB Net Derivatives Results Net valuation premium, net of reinsurance $ 22 $ 17 29 % Change in reserves hedged 233 (375 ) 162 % Change in market value of derivative assets (310 ) 315 NM Hedge program ineffectiveness (77 ) (60 ) -28 % Change in reserves not hedged (NPR component) (55 ) 92 NM Change in SOP 03-1 reserve not hedged (6 ) - NM Associated amortization expense of DAC, VOBA, DSI and DFEL: (61 ) 10 NM Amortization, excluding unlocking 47 (33 ) 242 % Loss from the initial impact of adopting - (33 ) 100 % Total GLB net derivatives results $ (130 ) $ (7 ) NM GDB Derivatives Results Benefit ratio unlocking of SOP 03-1 reserves $ (96 ) $ (12 ) NM Change in fair value of derivatives, excluding expected cost of hedging instruments 57 1 NM Associated amortization expense of DAC, VOBA, DSI and DFEL: (17 ) - NM Amortization, excluding unlocking 24 6 300 % Total GDB derivatives results $ (32 ) $ (5 ) NM (1)DAC refers to the associated amortization of expense of DAC, VOBA, DSI and DFEL.(2)(2) DAC refers to the associated amortization of DAC, VOBA, DSI and DFEL GDB derivatives results represents the net difference between the benefit ratio unlockingGWB, GIB and 4LATER® features have elements of both insurance benefits accounted for under SOP 03-1 and embedded derivatives accounted for under SFAS 133 and SFAS 157. The SOP 03-1 component is calculated in a manner consistent with our GDB. We weight these features and their associated reserves accordingly based on our GDB riders andtheir hybrid nature. For the change in the fair value of the derivatives excluding our expected cost of the hedging instruments.97The GLB guarantees in our variable annuity products that are considered embedded derivatives, and are recordedwe record them on our Consolidated Balance Sheets at fair value under SFAS 133 and SFAS 157. We use derivative instruments to hedge our exposure to the risks and earnings volatility that result from the embedded derivatives for GLBs. The change in fair value of these derivative instruments tendsis designed to move in the opposite direction ofgenerally offset the change in fair value of the embedded derivatives. In the table above, we have presented the components of our GLB results, which can be volatile especially when sudden and significant changes in equity markets and/or interest rates occur. When we assess the effectiveness of our hedge program, we exclude the impact of the change in the liability not hedged. This reserve represents the portion of our GLB liabilities related to the NPR required byunder SFAS 157. ThisWe do not attempt to hedge the change in the NPR component of the liability is not included in our hedging program.liability. The impact of the change in NPR has had the effect of reducing our GLB liabilities on our balance sheet by $481$585 million since the adoption of SFAS 157 on January 1, 2008. See above for information regarding the effect of the NPR on the GLB net derivative results for first three months of 2009 and 2008. For additional information on our guaranteed benefits, see “Critical Accounting Policies and Estimates – Derivatives – Guaranteed Living Benefits” above. For additional information on our hedge program see “Reinsurance” below.ComparisonOur GLB net derivatives results also include the benefit ratio unlocking of the Three and Nine Months Ended September 30, 2008 to 2007The GLB hedge program ineffectiveness, excluding the impact of unlocking, in 2008 was attributable primarily to current period unfavorable fund performance of our hedges designed to mitigate our basis risk over the long-term, unfavorable and volatile capital market conditions that resulted in non-linear changes inSOP 03-1 reserves that our derivatives are not specifically designed to mitigate, and losses from the strengthening of the dollar as compared to the euro, pound and yen. A large portion of our third quarter hedge ineffectiveness was attributable to four days in September including the first market day after the Lehman bankruptcy and the day the House originally failed to pass the original EESA legislation. The ineffectiveness in the quarter can be attributed to a combination of basis risk, currency movements and the impact of extreme intra-day volatility. These same conditions have continued into the month of October. We are focused on managing the long-term performance of the hedge program recognizing that any material potential claims under the GLBs are approximately a decade in the future.The increased GLB hedge program ineffectiveness in 2008 was more than offset by the gains attributable to the SFAS 157 NPR adjustments attributable primarily to our widening credit spreads.The third quarter of 2008 had favorable GLB change in reserves hedged on our prospectiveGLB riders. The benefit ratio unlocking due to assumption changes reflecting primarily updates to implied ultimate volatility. The third quarter of 2007 had unfavorableSOP 03-1 reserves for GLB changeriders is offset in GLB. See “GLB” above for additional information.hedged prospective unlocking due to assumption changes reflecting improved persistency experience.The third quarter of 2008 had unfavorable GLB DAC, VOBA, DSIon our GDB riders and DFEL prospective unlocking reflecting the impact of incorporating the related GLB gross profits due to the change in reserves hedged prospectivethe fair value of the derivative instruments we own to hedge the benefit ratio unlocking, discussed above intoexcluding our expected cost of the DAC, VOBA, DSI and DFEL models.unfavorable GDB derivatives results, excluding the retrospectivebenefit ratio unlocking of DAC, VOBA, DSI and DFEL were driven primarily by current period unfavorable fund performance of our hedges designed to mitigate our basis risk over the long-term, losses from the strengthening of the dollar as compared to the euro, pound and yen, and unfavorable and volatile capital market conditions that resultedSOP 03-1 reserves for GDB riders is offset in non-linear changes in reserves that our derivatives are not specifically designed to mitigate.“Market Risk – Credit Risk”“GDB” above for information on our counterparty exposure.98A detailwaswere as follows: For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ — $ 1 -100 % $ — $ 1 -100 % 4 (14 ) 129 % (2 ) (8 ) 75 % (2 ) 7 NM 1 4 -75 % — — NM 10 — NM $ 2 $ (6 ) 133 % $ 9 $ (3 ) NM For the Three Months Ended March 31, 2009 2008 Change Indexed Annuity Forward-Starting Option $ 1 $ (10 ) 110 % Associated amortization expense of DAC, VOBA, DSI and DFEL - 5 -100 % Gain from the initial impact of adopting - 10 -100 % Total $ 1 $ 5 -80 % “Acquisitions and Dispositions – Fixed“Fixed Income Investment Management Business” in Note 3 of our 2008 Form 10-K for details.99 Percentage of
Total Investments As of
September 30,
2008 As of
December 31,
2007 As of
September 30,
2008 As of
December 31,
2007 $ 51,931 $ 56,276 76.5 % 78.2 % 493 518 0.7 % 0.7 % 2,393 2,730 3.5 % 3.8 % 7,688 7,423 11.3 % 10.3 % 127 258 0.2 % 0.4 % 2,870 2,885 4.2 % 4.0 % 1,262 807 1.9 % 1.1 % 826 799 1.2 % 1.1 % 367 276 0.5 % 0.4 % $ 67,957 $ 71,972 100.0 % 100.0 % Percentage of Total Investments As of As of As of As of March 31, December 31, March 31, December 31, 2009 2008 2009 2008 Investments AFS securities: Fixed maturity $ 49,349 $ 48,935 74.5 % 72.6 % Equity 205 288 0.3 % 0.4 % Trading securities 2,246 2,333 3.4 % 3.5 % Mortgage loans on real estate 7,616 7,715 11.5 % 11.5 % Real estate 129 125 0.2 % 0.2 % Policy loans 2,908 2,924 4.4 % 4.3 % Derivative instruments 2,226 3,397 3.4 % 5.0 % Alternative investments 771 776 1.2 % 1.2 % Other investments 705 848 1.1 % 1.3 % Total investments $ 66,155 $ 67,341 100.0 % 100.0 % sincebecause decisions can be made based upon both the economic and current investment income considerations affecting assets and liabilities. For a discussion on our risk management process, see “Item 3. Quantitative and Qualitative Disclosures About Market Risk.”available-for-saleAFS and trading. Mortgage-backed and private securities are included in both available-for-saleAFS and trading portfolios.available-for-saleAFS securities in Note 4;5; however, the categories below represent a more detailed breakout of the available-for-saleAFS portfolio; therefore, the investment classifications listed below do not agree to the investment categories provided in Note 4.100 As of March 31, 2009 Unrealized Amortized Unrealized Losses Fair % Fair Cost Gains and OTTI Value Value Fixed Maturity AFS Securities Corporate bonds: Financial services $ 8,512 $ 38 $ 1,484 $ 7,066 14.2 % Basic industry 2,205 11 348 1,868 3.8 % Capital goods 2,707 35 220 2,522 5.1 % Communications 2,662 41 208 2,495 5.1 % Consumer cyclical 2,867 26 360 2,533 5.1 % Consumer non-cyclical 4,879 88 166 4,801 9.7 % Energy 3,108 41 247 2,902 5.9 % Technology 1,038 13 65 986 2.0 % Transportation 1,231 15 120 1,126 2.3 % Industrial other 707 9 33 683 1.4 % Utilities 8,361 96 545 7,912 16.0 % Asset-backed securities ("ABS"): Collateralized debt obligations ("CDOs") and credit-linked notes ("CLNs") 796 4 625 175 0.4 % Commercial real estate ("CRE") CDOs 57 - 31 26 0.1 % Credit card 160 - 34 126 0.3 % Home equity 1,193 1 588 606 1.2 % Manufactured housing 145 - 35 110 0.2 % Other 192 9 15 186 0.4 % Commercial mortgage-backed securities ("CMBS"): Non-agency backed 2,517 11 621 1,907 3.9 % Collateralized mortgage obligations ("CMOs"): Agency backed 4,866 286 24 5,128 10.4 % Non-agency backed 1,954 2 756 1,200 2.4 % Mortgage pass-throughs ("MPTS"): Agency backed 1,374 65 - 1,439 2.9 % Non-agency backed 139 - 41 98 0.2 % Municipals: Taxable 110 5 1 114 0.2 % Tax-exempt 3 - - 3 0.0 % Government and government agencies: United States 1,047 131 29 1,149 2.3 % Foreign 1,482 67 126 1,423 2.9 % Hybrid and redeemable preferred stock 1,564 3 802 765 1.6 % Total fixed maturity AFS securities 55,876 997 7,524 49,349 100.0 % Equity AFS Securities 464 4 263 205 Total AFS securities 56,340 1,001 7,787 49,554 2,279 222 255 2,246 Total AFS and trading securities $ 58,619 $ 1,223 $ 8,042 $ 51,800 As of September 30, 2008 Amortized
Cost Unrealized
Gains Unrealized
Losses Fair
Value % Fair
Value $ 10,363 $ 52 $ 1,351 $ 9,064 17.4 % 2,339 14 155 2,198 4.2 % 2,675 24 116 2,583 5.0 % 2,637 22 170 2,489 4.8 % 2,954 15 273 2,696 5.2 % 4,269 37 166 4,140 8.0 % 2,937 47 143 2,841 5.5 % 737 4 32 709 1.4 % 1,271 25 72 1,224 2.4 % 680 7 26 661 1.3 % 8,374 71 471 7,974 15.3 % 797 7 460 344 0.7 % 61 — 12 49 0.1 % 165 — 23 142 0.3 % 1,183 1 316 868 1.7 % 151 4 9 146 0.3 % — — — — 0.0 % 204 1 9 196 0.4 % 2,588 10 280 2,318 4.5 % 4,902 50 54 4,898 9.3 % 2,146 — 568 1,578 3.0 % 1,756 20 6 1,770 3.4 % 147 — 26 121 0.2 % 113 4 1 116 0.2 % 5 — — 5 0.0 % 1,170 91 14 1,247 2.4 % 1,456 49 67 1,438 2.8 % 131 1 16 116 0.2 % 56,211 556 4,836 51,931 100.0 % 612 9 128 493 56,823 565 4,964 52,424 2,363 193 163 2,393 $ 59,186 $ 758 $ 5,127 $ 54,817 101 As of December 31, 2007 Amortized
Cost Unrealized
Gains Unrealized
Losses Fair
Value % Fair
Value $ 11,234 $ 187 $ 300 $ 11,121 19.8 % 2,148 52 35 2,165 3.8 % 2,665 66 16 2,715 4.8 % 2,903 123 46 2,980 5.3 % 3,038 56 94 3,000 5.3 % 3,898 101 25 3,974 7.1 % 2,688 121 14 2,795 5.0 % 660 15 5 670 1.2 % 1,409 39 19 1,429 2.5 % 710 22 6 726 1.3 % 8,051 195 77 8,169 14.5 % 996 8 205 799 1.4 % 42 — 4 38 0.1 % 1 — — 1 0.0 % 160 1 2 159 0.3 % 1,209 4 76 1,137 2.0 % 161 7 5 163 0.3 % 4 — — 4 0.0 % 235 4 1 238 0.4 % 2,711 48 70 2,689 4.8 % 4,547 74 19 4,602 8.2 % 2,347 10 110 2,247 4.0 % 933 18 2 949 1.7 % 153 1 4 150 0.3 % 133 5 — 138 0.2 % 6 — — 6 0.0 % 1,261 108 4 1,365 2.4 % 1,663 92 19 1,736 3.1 % 103 9 1 111 0.2 % 56,069 1,366 1,159 56,276 100.0 % 548 13 43 518 56,617 1,379 1,202 56,794 2,512 265 47 2,730 $ 59,129 $ 1,644 $ 1,249 $ 59,524 As of December 31, 2008 Unrealized Amortized Unrealized Losses Fair % Fair Cost Gains and OTTI Value Value Fixed Maturity AFS Securities Corporate bonds: �� Financial services $ 8,564 $ 75 $ 1,264 $ 7,375 15.1 % Basic industry 2,246 15 353 1,908 3.9 % Capital goods 2,668 34 222 2,480 5.1 % Communications 2,609 44 222 2,431 5.0 % Consumer cyclical 2,878 33 460 2,451 5.0 % Consumer non-cyclical 4,296 88 206 4,178 8.5 % Energy 2,972 48 246 2,774 5.7 % Technology 766 9 71 704 1.4 % Transportation 1,237 22 119 1,140 2.3 % Industrial other 718 16 38 696 1.4 % Utilities 8,207 104 678 7,633 15.6 % ABS: CDOs and CLNs 796 7 630 173 0.4 % CRE CDOs 60 - 23 37 0.1 % Credit card 165 - 73 92 0.2 % Home equity 1,108 1 411 698 1.4 % Manufactured housing 148 2 28 122 0.2 % Other 196 1 18 179 0.4 % CMBS: Non-agency backed 2,535 9 625 1,919 3.9 % CMOs: Agency backed 5,068 180 29 5,219 10.7 % Non-agency backed 1,996 1 746 1,251 2.6 % MPTS: Agency backed 1,619 55 - 1,674 3.4 % Non-agency backed 141 - 47 94 0.2 % Municipals: Taxable 110 4 1 113 0.2 % Tax-exempt 3 - - 3 0.0 % Government and government agencies: United States 1,148 167 25 1,290 2.6 % Foreign 1,377 97 135 1,339 2.7 % Redeemable preferred stock 1,563 6 607 962 2.0 % Total fixed maturity AFS securities 55,194 1,018 7,277 48,935 100.0 % Equity AFS Securities 466 9 187 288 Total AFS securities 55,660 1,027 7,464 49,223 2,307 255 229 2,333 Total AFS and trading securities $ 57,967 $ 1,282 $ 7,693 $ 51,556 below to our 2008 Form 10-K “Trading Securities” section for further details.102Available-for-SaleBecause theavailable-for-saleAFS accounting guidance is to reflect stockholders’ equity as if unrealized gains and losses were actually recognized, it is necessary that we consider all related accounting adjustments that would occur upon such a hypothetical recognition of unrealized gains and losses. Such related balance sheet effects include adjustments to the balances of DAC, VOBA, DFEL, other contract holder funds and deferred income taxes. Adjustments to each of these balances are charged or credited to accumulated other comprehensive income. For instance, DAC is adjusted upon the recognition of unrealized gains or losses sincebecause the amortization of DAC is based upon an assumed emergence of gross profits on certain insurance business. Deferred income tax balances are also adjusted sincebecause unrealized gains or losses do not affect actual taxes currently paid.As of September 30, 2008, and December 31, 2007, 92.3% and 90.7%, respectively, of total publicly traded and private securities in unrealized loss status were rated as investment grade. See Note 4 for ratings and maturity date information for our fixed maturity investment portfolio.As more fully described in Note 1 of our 2007 Form 10-K, we regularly review our investment holdings for other-than-temporary impairments. Based on this review, the cause of the $3.8 billion increase in our gross available-for-sale securities unrealized losses for the nine months ended September 30, 2008, was attributable primarily to a combination of reduced liquidity in several market segments and deterioration in credit fundamentals. We believe that the securities in an unrealized loss position as of September 30, 2008 were not other-than-temporarily impaired due to our ability and intent to hold for a period of time sufficient for recovery. For further information on our available-for-sales securities unrealized losses, see “Additional Details on our Unrealized Losses on Available-for-Sale Securities” below.available-for-saleAFS fixed maturity securities portfolio, as measured at estimated fair value and by the percentage of fixed maturity securities invested in various ratings categories, relative to the entire fixed maturity available-for-saleAFS security portfolio (in millions) was as follows: As of September 30, 2008 As of December 31, 2007 Amortized
Cost Fair
Value % of
Total Amortized
Cost Fair
Value % of
Total 1 Aaa / Aa / A $ 34,518 $ 32,178 62.0 % $ 34,648 $ 34,741 61.8 % 2 Baa 18,431 16,999 32.7 % 18,168 18,339 32.6 % 52,949 49,177 94.7 % 52,816 53,080 94.4 % 3 Ba 2,186 1,928 3.7 % 2,184 2,159 3.8 % 4 B 795 611 1.2 % 787 783 1.4 % 5 Caa and lower 240 175 0.3 % 270 238 0.4 % 6 In or near default 41 40 0.1 % 12 16 0.0 % 3,262 2,754 5.3 % 3,253 3,196 5.6 % $ 56,211 $ 51,931 100.0 % $ 56,069 $ 56,276 100.0 % 5.8 % 5.3 % 5.8 % 5.7 % Rating Agency As of March 31, 2009 As of December 31, 2008 NAIC Equivalent Amortized Fair % of Amortized Fair % of Designation Designation Cost Value Total Cost Value Total Investment Grade Securities 1 Aaa / Aa / A $ 31,466 $ 29,691 60.2 % $ 32,595 $ 30,386 62.0 % 2 Baa 19,716 16,733 33.9 % 19,240 16,111 32.9 % Total investment grade securities 51,182 46,424 94.1 % 51,835 46,497 94.9 % Below Investment Grade Securities 3 Ba 3,120 2,121 4.3 % 2,194 1,698 3.5 % 4 B 791 445 0.9 % 772 516 1.1 % 5 Caa and lower 532 257 0.5 % 251 131 0.3 % 6 In or near default 251 102 0.2 % 142 93 0.2 % Total below investment grade securities 4,694 2,925 5.9 % 3,359 2,438 5.1 % Total fixed maturity AFS securities $ 55,876 $ 49,349 100.0 % $ 55,194 $ 48,935 100.0 % Total securities below investment grade as a percentage of total fixed maturity AFS securities 8.4 % 5.9 % 6.1 % 5.1 % $7.5$7.1 billion as of September 30, 2008, compared to $7.8 billion as ofMarch 31, 2009, and December 31, 2007,2008, representing approximately 11% of total invested assets as of September 30, 2008,March 31, 2009, and December 31, 2007.Trading SecuritiesTrading securities, which support certain reinsurance funds withheld and our Modco reinsurance agreements, are carried at estimated fair value and changes in estimated fair value are recorded in net income as they occur. Investment results for these103portfolios, including gains and losses from sales, are passed directly to the reinsurers through the contractual terms of the reinsurance arrangements. Offsetting these amounts are corresponding changes in the fair value of the embedded derivative liability associated with the underlying reinsurance arrangement. See Note 1 in our 2007 Form 10-K for more information regarding our accounting for Modco.Mortgage-Backed Securities (Included in Available-for-Sale and Trading Securities)September 30, 2008,March 31, 2009, we did not have a significant amount of higher-risk, trust structured mortgage-backed securities. A significant amount of assets in our mortgage-backed securities portfolio are either guaranteed by U.S. government-sponsored enterprises or are supported in the securitization structure by junior securities enabling the assets to achieve high investment grade status.asset-backed securities collateralized debt obligations, asset-backed securities (“ABS”)ABS CDOs, ABS and residential mortgage-backed securities (“RMBS”). Mortgage-related ABS are backed by home equity loans and RMBS are backed by residential mortgages. These securities are backed by loans that are characterized by borrowers of differing levels of creditworthiness: prime, Alt-A and subprime. Prime lending is the origination of residential mortgage loans to customers with excellent credit profiles. Alt-A lending is the origination of residential mortgage loans to customers who have Primeprime credit profiles but lack documentation to substantiate income. Subprime lending is the origination of loans to customers with weak or impaired credit profiles. some originators of residential mortgage loans and home equity loans have recently led to higher delinquency rates, especially for loans originated in the past few years.loans. We expect delinquency rates and loss rates on residential mortgages and home equity loans to increase in the future; however, we continue to expect to receive payments in accordance with contractual terms for a significant amount of our securities, largely due to the seniority of the claims on the collateral of the securities that we own. The tranches of the securities will experience losses according to their seniority level with the least senior (or most junior), typically the unrated residual tranche, taking the initial loss. The credit ratings of our securities reflect the seniority of the securities that we own. Our RMBS had a market value of $9.4$8.6 billion and an unrealized loss of $923 million,$1.1 billion, or 10%13%, as of September 30, 2008.March 31, 2009. The unrealized loss was due primarily to deteriorating fundamentals and a general level of illiquidity in the market and resulting in price declines in many structured products.104$574$388 million and represented 1% of our total investment portfolio as of September 30, 2008.March 31, 2009. Investments rated A or above represented 91%73% of the subprime investments and $288$185 million in market value of our subprime investments was backed by loans originating in 2005 and forward. Available-for-saleAFS securities represent most$378 million, or 97%, of the subprime exposure withand trading securities being only $15represent $10 million, or 3%, as of September 30, 2008.March 31, 2009. The tables below summarize our investments in available-for-saleAFS securities backed by pools of residential mortgages (in millions): Fair Value as of September 30, 2008 Prime
Agency Prime/
Non -
Agency Alt-A Subprime Total $ 6,588 $ 1,146 $ 634 $ — $ 8,368 — — 309 559 868 $ 6,588 $ 1,146 $ 943 $ 559 $ 9,236 $ 6,549 $ 915 $ 645 $ 385 $ 8,494 20 125 119 104 368 19 46 44 19 128 — 47 91 47 185 — 13 44 4 61 $ 6,588 $ 1,146 $ 943 $ 559 $ 9,236 $ 3,183 $ 376 $ 337 $ 275 $ 4,171 865 225 243 201 1,534 361 186 310 83 940 2,179 359 53 — 2,591 $ 6,588 $ 1,146 $ 943 $ 559 $ 9,236 Fair Value as of March 31, 2009 Prime/ Prime Non - Agency Agency Alt-A Subprime Total Type CMOs and MPTS $ 6,495 $ 897 $ 473 $ - $ 7,865 ABS home equity - - 228 378 606 $ 6,495 $ 897 $ 701 $ 378 $ 8,471 Rating AAA $ 6,472 $ 586 $ 241 $ 221 $ 7,520 AA 5 104 91 34 234 A 18 105 6 19 148 BBB - 46 50 64 160 BB and below - 56 313 40 409 $ 6,495 $ 897 $ 701 $ 378 $ 8,471 Origination Year 2004 and prior $ 3,176 $ 330 $ 288 $ 195 $ 3,989 2005 912 185 185 129 1,411 2006 352 133 189 54 728 2007 1,397 249 39 - 1,685 2008 546 - - - 546 2009 112 - - - 112 $ 6,495 $ 897 $ 701 $ 378 $ 8,471 Total AFS securities $ 49,554 17.1 % (1)Does not include the fair value of trading securities totaling $196$173 million, which support our Modco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers. The $196$173 million in trading securities consisted of $158$148 million prime, $23$15 million Alt-A and $15$10 million subprime.105 Amortized Cost as of September 30, 2008 Prime
Agency Prime/
Non -
Agency Alt-A Subprime Total $ 6,565 $ 1,500 $ 885 $ — $ 8,950 — — 427 756 1,183 $ 6,565 $ 1,500 $ 1,312 $ 756 $ 10,133 $ 6,526 $ 1,103 $ 785 $ 469 $ 8,883 20 175 170 152 517 18 106 75 32 231 1 78 144 94 317 — 38 138 9 185 $ 6,565 $ 1,500 $ 1,312 $ 756 $ 10,133 $ 3,167 $ 430 $ 399 $ 340 $ 4,336 883 273 331 265 1,752 361 272 471 151 1,255 2,154 525 111 — 2,790 $ 6,565 $ 1,500 $ 1,312 $ 756 $ 10,133 (1)For the table above, credit ratings shown in the document are based on ratings provided by the major credit rating agencies (Fitch Ratings, Moody’s and S&P) or are based on internal ratings for those securities where external ratings are not available. For securities where the ratings assigned by the major rating agencies are not equivalent, the second highest of the three ratings assigned is used. Amortized Cost as of March 31, 2009 Prime/ Prime Non - Agency Agency Alt-A Subprime Total Type CMOs and MPTS $ 6,147 $ 1,411 $ 775 $ - $ 8,333 ABS home equity - - 428 765 1,193 $ 6,147 $ 1,411 $ 1,203 $ 765 $ 9,526 Rating AAA $ 6,123 $ 783 $ 311 $ 349 $ 7,566 AA 6 190 128 73 397 A 17 207 13 37 274 BBB - 90 88 140 318 BB and below 1 141 663 166 971 $ 6,147 $ 1,411 $ 1,203 $ 765 $ 9,526 Origination Year 2004 and prior $ 3,021 $ 410 $ 387 $ 330 $ 4,148 2005 860 272 317 265 1,714 2006 333 256 400 170 1,159 2007 1,307 473 99 - 1,879 2008 517 - - - 517 2009 109 - - - 109 $ 6,147 $ 1,411 $ 1,203 $ 765 $ 9,526 Total AFS securities $ 56,340 16.9 % (1) Does not include the amortized cost of trading securities totaling $221$203 million, which support our Modco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers. The $221$203 million in trading securities consisted of $167$156 million prime, $35$28 million Alt-A and $19 million subprime.(2) For the table above, credit ratings shown in the document are based on ratings provided by the major credit rating agencies (Fitch Ratings, Moody’s and S&P) or are based on internal ratings for those securities where external ratings are not available. For securities where the ratings assigned by the major rating agencies are not equivalent, the second highest of the three ratings assigned is used. available-for-saleAFS securities backed by pools of consumer loan asset-backed securities (in millions): As of September 30, 2008 Credit Card(1) Auto Loans Total Fair
Value Amortized
Cost Fair
Value Amortized
Cost Fair
Value Amortized
Cost $ 119 $ 139 $ — $ — $ 119 $ 139 — — — — — — 23 26 — — 23 26 $ 142 $ 165 $ — $ — $ 142 $ 165 As of March 31, 2009 Fair Amortized Value Cost Rating AAA $ 108 $ 134 BBB 18 26 $ 126 $ 160 Total AFS securities $ 49,554 $ 56,340 Total by rating as a percentage of total AFS securities 0.3 % 0.3 % (1)Additional indirect credit card exposure through structured securities is excluded from this table. See “Credit-Linked Notes” section below and in Note 4.5.(2)For the table above, credit ratings shown in the document are based on ratings provided by the major credit rating agencies (Fitch Ratings, Moody’s and S&P) or are based on internal ratings for those securities where external ratings are not available. For securities where the ratings assigned by the major rating agencies are not equivalent, the second highest of the three ratings assigned is used. (3) Does not include the fair value of trading securities totaling $3$2 million, which support our Modco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers. The $3$2 million in trading securities consisted of credit card securities.106available-for-saleAFS securities backed by pools of commercial mortgages (in millions): As of September 30, 2008 Multiple Property Single Property Commercial Real
Estate Collateralized
Debt Obligations Total Fair
Value Amortized
Cost Fair
Value Amortized
Cost Fair
Value Amortized
Cost Fair
Value Amortized
Cost $ 2,194 $ 2,422 $ 124 $ 166 $ — $ — $ 2,318 $ 2,588 — — — — 49 61 49 61 $ 2,194 $ 2,422 $ 124 $ 166 $ 49 $ 61 $ 2,367 $ 2,649 $ 1,553 $ 1,637 $ 68 $ 71 $ 27 $ 38 $ 1,648 $ 1,746 372 419 — — 3 3 375 422 151 187 51 72 19 20 221 279 95 140 5 23 — — 100 163 23 39 — — — — 23 39 $ 2,194 $ 2,422 $ 124 $ 166 $ 49 $ 61 $ 2,367 $ 2,649 $ 1,562 $ 1,647 $ 77 $ 80 $ 22 $ 23 $ 1,661 $ 1,750 310 370 40 61 10 15 360 446 192 242 7 25 17 23 216 290 130 163 — — — — 130 163 $ 2,194 $ 2,422 $ 124 $ 166 $ 49 $ 61 $ 2,367 $ 2,649 As of March 31, 2009 Multiple Property Single Property CRE CDOs Total Fair Amortized Fair Amortized Fair Amortized Fair Amortized Value Cost Value Cost Value Cost Value Cost Type CMBS $ 1,824 $ 2,371 $ 83 $ 146 $ - $ - $ 1,907 $ 2,517 CRE CDOs - - - - 26 57 26 57 $ 1,824 $ 2,371 $ 83 $ 146 $ 26 $ 57 $ 1,933 $ 2,574 Rating AAA $ 1,367 $ 1,536 $ 52 $ 68 $ 7 $ 15 $ 1,426 $ 1,619 AA 253 359 - - - - 253 359 A 85 185 25 44 18 39 128 268 BBB 93 165 5 29 1 3 99 197 BB and below 26 126 1 5 - - 27 131 $ 1,824 $ 2,371 $ 83 $ 146 $ 26 $ 57 $ 1,933 $ 2,574 Origination Year 2004 and prior $ 1,320 $ 1,563 $ 70 $ 77 $ 13 $ 19 $ 1,403 $ 1,659 2005 251 369 12 61 7 15 270 445 2006 139 255 1 8 6 23 146 286 2007 114 184 - - - - 114 184 $ 1,824 $ 2,371 $ 83 $ 146 $ 26 $ 57 $ 1,933 $ 2,574 Total AFS securities $ 49,554 $ 56,340 3.9 % 4.6 % $95$78 million, which support our Modco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers. The $95$78 million in trading securities consisted of $92$77 million commercial mortgage-backed securities and $3$1 million commercial real estate collateralized debt obligations.107(2) For the table above, credit ratings shown in the document are based on ratings provided by the major credit rating agencies (Fitch Ratings, Moody’s and S&P) or are based on internal ratings for those securities where external ratings are not available. For securities where the ratings assigned by the major rating agencies are not equivalent, the second highest of the three ratings assigned is used. As of September 30, 2008 Direct
Exposure Insured
Bonds (1) Total
Amortized
Cost Total
Unrealized
Gain Total
Unrealized
Loss Total
Fair
Value $ — $ 272 $ 272 $ 2 $ 49 $ 225 30 — 30 — — 30 3 100 103 — 31 72 — 68 68 1 5 64 12 125 137 1 20 118 11 7 18 1 4 15 27 — �� 27 — 12 15 19 — 19 — 9 10 1 — 1 1 — 2 73 73 146 1 27 120 $ 176 $ 645 $ 821 $ 7 $ 157 $ 671 As of March 31, 2009 Total Total Total Unrealized Total Direct Insured Amortized Unrealized Loss Fair Cost Gain and OTTI Value Monoline Name AMBAC $ - $ 266 $ 266 $ 1 $ 77 $ 190 ASSURED GUARANTY LTD 30 - 30 - 15 15 FGIC - 96 96 1 40 57 FSA - 68 68 1 11 58 MBIA 12 117 129 2 33 98 MGIC 12 7 19 - 8 11 PMI GROUP INC 27 - 27 - 15 12 RADIAN GROUP INC 19 - 19 - 10 9 XL CAPITAL LTD 72 72 144 1 37 108 $ 172 $ 626 $ 798 $ 6 $ 246 $ 558 Total AFS securities $ 56,340 $ 1,001 $ 7,787 $ 49,554 Total by Monoline insurer as a percentage of total AFS securities 1.4 % 0.6 % 3.2 % 1.1 % (2) Additional indirect insured exposure through structured securities is excluded from this table. See “Credit-Linked Notes” in Note 4.5.(2)$33$27 million, which support our Modco reinsurance agreements because investment results for these agreements are passed directly to the reinsurers. The $33$27 million in trading securities consisted of $10$8 million of direct exposure and $23$19 million of insured exposure. This table also excludes insured exposure totaling $15$14 million for a guaranteed investment tax credit partnership.As of September 30, 2008, and December 31, 2007, other contract holder funds on our Consolidated Balance Sheets included $600 million and $1.2 billion outstanding in funding agreements of the Lincoln National Life Insurance Company (“LNL”), respectively. LNL invested the proceeds of $850 million received for issuing three funding agreements in 2006 and 2007 into three separate credit-linked notes originated by third party companies. One of the credit linked notes totaling $250 million was paid off at par in September 2008 and as a result, the related structure, including the funding agreement, was terminated. The two remaining credit-linked notes are asset-backed securities classified as corporate bonds in the tables4, and are reported as fixed maturity securities on our Consolidated Balance Sheets. An additional $300 million funding agreement was assumed as a result of the merger of Jefferson-Pilot, but was not invested into credit-linked notes. This $300 million funding agreement matured on June 2, 2008.We earn a spread between the coupon received on the credit-linked notes and the interest credited on the funding agreement. Our credit-linked notes were created using a trust that combines highly rated assets with credit default swaps to produce a multi-class structured security. Our affiliate, Delaware Investments, actively manages the credit default swaps in the underlying portfolios. The high quality asset in these transactions is a AAA-rated asset-backed security secured by a pool of credit card receivables.Consistent with other debt market instruments, we are exposed to credit losses within the structure of the credit-linked notes, which could result in principal losses to our investments. However, we have attempted to protect our investments from credit losses through the multi-tiered class structure of the credit-linked note, which requires the subordinated classes of the investment pool to absorb all of the initial credit losses. LNL owns the mezzanine tranche of these investments. Generally, based upon our models, the transactions can sustain anywhere from 6-10 defaults, depending on the transaction, in the underlying collateral pools with no loss to LNL. However, if that number of defaults is realized, any additional defaults will significantly impact our recovery. Once the subordination is completely exhausted, losses will be incurred on LNL’s investment. In general, the entire investment can be lost with 4-5 additional defaults. To date, there has been one default in the underlying collateral pool of the $400 million credit-linked note and two defaults in the underlying collateral pool of the $200 million credit-linked note. There has not been an event of default on the credit linked notes themselves and we believe our subordination remains sufficient to absorb future initial credit losses. Similar to other debt market instruments our maximum principal loss is limited to our original investment of $600 million as of September 30, 2008.108As in the general markets, spreads on these transactions have widened, causing unrealized losses. As of September 30, 2008, we had unrealized losses of $421 million on the $600 million in credit-linked notes. As described more fully in Note 1 of our 2007 Form 10-K, we regularly review our investment holdings for other-than-temporary impairments. Based upon this review and the information in the paragraph above, we believe that these securities were not other-than-temporarily impaired as of September 30, 2008, and December 31, 2007. The following summarizes the fair value to amortized cost ratio of the credit-linked notes: As of
October 31,
2008 As of
September 30,
2008 As of
December 31,
2007 $ 104 $ 179 $ 660 600 600 850 17 % 30 % 78 % The following summarizes the exposure of the credit-linked notes’ underlying collateral by industry and rating as of September 30, 2008: AAA AA A BBB BB B Total 0 % 0 % 5 % 5 % 0 % 1 % 11 % 0 % 7 % 2 % 2 % 0 % 0 % 11 % 0 % 2 % 2 % 4 % 0 % 0 % 8 % 0 % 1 % 3 % 0 % 0 % 0 % 4 % 0 % 0 % 4 % 0 % 0 % 0 % 4 % 0 % 0 % 2 % 2 % 0 % 0 % 4 % 0 % 0 % 1 % 2 % 0 % 0 % 3 % 0 % 0 % 3 % 0 % 0 % 0 % 3 % 0 % 0 % 1 % 2 % 0 % 0 % 3 % 2 % 5 % 20 % 19 % 3 % 0 % 49 % 2 % 15 % 43 % 36 % 3 % 1 % 100 % Available-for-SaleAFS Securitiessincebecause the timing of the recognition of realized investment gains and losses through the selection of which securities are sold is largely at management’s discretion, it is important to consider the information provided below within the context of the overall unrealized gain or loss position of our investment portfolios. These are important considerations that should be included in any evaluation of the potential impact of unrealized loss securities on our future earnings.109 As of September 30, 2008 Fair
Value %
Fair
Value Amortized
Cost %
Amortized
Cost Unrealized
Loss %
Unrealized
Loss $ 92 23.7 % $ 194 32.0 % $ 102 47.2 % 178 45.6 % 222 36.5 % 44 20.4 % 15 3.8 % 43 7.1 % 29 13.4 % 30 7.7 % 50 8.3 % 20 9.2 % 18 4.6 % 28 4.6 % 9 4.2 % 3 0.8 % 7 1.2 % 4 1.9 % 6 1.5 % 9 1.5 % 3 1.4 % 5 1.3 % 7 1.2 % 2 0.9 % 2 0.5 % 3 0.5 % 2 0.9 % 6 1.5 % 8 1.3 % 1 0.5 % 9 2.3 % 9 1.5 % — 0.0 % 1 0.3 % 1 0.2 % — 0.0 % 13 3.3 % 13 2.1 % — 0.0 % 11 2.8 % 11 1.8 % — 0.0 % 1 0.3 % 1 0.2 % — 0.0 % $ 390 100.0 % $ 606 100.0 % $ 216 100.0 % As of December 31, 2007 Fair
Value %
Fair
Value Amortized
Cost %
Amortized
Cost Unrealized
Loss %
Unrealized
Loss $ 33 30.5 % $ 48 35.8 % $ 15 57.7 % 17 15.7 % 25 18.7 % 8 30.8 % 2 1.9 % 5 3.7 % 3 11.5 % 6 5.6 % 6 4.5 % — 0.0 % 37 34.3 % 37 27.6 % — 0.0 % 8 7.4 % 8 6.0 % — 0.0 % 5 4.6 % 5 3.7 % — 0.0 % $ 108 100.0 % $ 134 100.0 % $ 26 100.0 % 110 As of March 31, 2009 % % % Unrealized Unrealized Fair Fair Amortized Amortized Loss Loss Value Value Cost Cost and OTTI and OTTI Non-captive diversified $ 82 24.0 % $ 169 25.8 % $ 87 27.9 % CMOs 53 15.6 % 118 18.1 % 65 20.8 % ABS 21 6.2 % 85 13.0 % 64 20.5 % Property and casualty 34 10.0 % 70 10.7 % 36 11.5 % Gaming 13 3.8 % 31 4.8 % 18 5.8 % Media - non-cable 19 5.6 % 29 4.4 % 10 3.2 % Industrial-other 5 1.5 % 10 1.5 % 5 1.6 % Banking 18 5.3 % 23 3.5 % 5 1.6 % Building matierals 12 3.5 % 16 2.5 % 4 1.3 % Oil field services 1 0.3 % 5 0.8 % 4 1.3 % Automotive 13 3.8 % 16 2.5 % 3 1.0 % Entertainment 56 16.5 % 59 9.0 % 3 1.0 % CMBS - 0.0 % 3 0.5 % 3 1.0 % Refining 3 0.9 % 5 0.8 % 2 0.6 % Retailers - 0.0 % 1 0.2 % 1 0.3 % Financial-other 3 0.9 % 4 0.6 % 1 0.3 % Diversified manufacturing 1 0.3 % 2 0.3 % 1 0.3 % Media - cable 2 0.6 % 2 0.3 % - 0.0 % REITs 3 0.9 % 3 0.5 % - 0.0 % Chemicals 1 0.3 % 1 0.2 % - 0.0 % Total securities subject to enhanced analysis and monitoring $ 340 100.0 % $ 652 100.0 % $ 312 100.0 % Total AFS securities $ 49,554 $ 56,340 $ 7,787 Total securities subject to enhanced analysis and monitoring as a percentage of total AFS securities 0.7 % 1.2 % 4.0 % As of December 31, 2008 % % % Unrealized Unrealized Fair Fair Amortized Amortized Loss Loss Value Value Cost Cost and OTTI and OTTI Non-captive diversified $ 83 30.6 % $ 140 31.4 % $ 57 32.4 % Automotive 34 12.6 % 70 15.7 % 36 20.5 % Gaming 10 3.7 % 43 9.7 % 33 18.8 % Property and casualty 27 10.0 % 51 11.4 % 24 13.5 % Non-captive consumer 10 3.7 % 20 4.5 % 10 5.7 % ABS 9 3.4 % 16 3.7 % 7 4.0 % Entertainment 56 20.8 % 59 13.2 % 3 1.7 % Refining 2 0.7 % 5 1.1 % 3 1.7 % CMBS 2 0.7 % 4 0.9 % 2 1.1 % Banking 23 8.5 % 24 5.4 % 1 0.6 % Retailers 1 0.4 % 1 0.2 % - 0.0 % CMOs 6 2.2 % 6 1.3 % - 0.0 % Media - non-cable 5 1.9 % 5 1.1 % - 0.0 % Paper 1 0.4 % 1 0.2 % - 0.0 % Pharmaceuticals 1 0.4 % 1 0.2 % - 0.0 % Total securities subject to enhanced analysis and monitoring $ 270 100.0 % $ 446 100.0 % $ 176 100.0 % Total AFS securities $ 49,223 $ 55,660 $ 7,464 Total securities subject to enhanced analysis and monitoring as a percentage of total AFS securities 0.5 % 0.8 % 2.4 % As of September 30, 2008 Fair
Value %
Fair
Value Amortized
Cost %
Amortized
Cost Unrealized
Loss %
Unrealized
Loss $ 1,651 4.7 % $ 2,481 6.2 % $ 830 16.7 % 3,851 11.0 % 4,603 11.5 % 752 15.1 % 3,393 9.7 % 4,014 10.0 % 621 12.5 % 1,874 5.3 % 2,153 5.4 % 279 5.6 % 3,340 9.5 % 3,587 8.9 % 247 5.0 % 375 1.1 % 532 1.3 % 157 3.2 % 1,504 4.3 % 1,638 4.1 % 134 2.7 % 864 2.5 % 993 2.5 % 129 2.6 % 531 1.5 % 654 1.6 % 123 2.5 % 302 0.9 % 391 1.0 % 89 1.8 % 1,148 3.3 % 1,233 3.1 % 85 1.7 % 822 2.3 % 900 2.2 % 78 1.6 % 870 2.5 % 945 2.4 % 75 1.5 % 654 1.9 % 727 1.8 % 73 1.5 % 742 2.1 % 814 2.0 % 72 1.5 % 444 1.3 % 513 1.3 % 69 1.4 % 482 1.4 % 543 1.4 % 61 1.2 % 594 1.7 % 654 1.6 % 60 1.2 % 632 1.8 % 692 1.7 % 60 1.2 % 245 0.7 % 304 0.8 % 59 1.2 % 575 1.6 % 633 1.6 % 58 1.2 % 496 1.4 % 550 1.4 % 54 1.1 % 704 2.0 % 757 1.9 % 53 1.1 % 256 0.7 % 309 0.8 % 53 1.1 % 392 1.1 % 434 1.1 % 42 0.8 % 518 1.5 % 556 1.4 % 38 0.8 % 442 1.3 % 478 1.2 % 36 0.7 % 245 0.7 % 281 0.7 % 36 0.7 % 388 1.1 % 422 1.1 % 34 0.7 % 484 1.4 % 518 1.3 % 34 0.7 % 572 1.6 % 605 1.5 % 33 0.7 % 483 1.4 % 515 1.3 % 32 0.6 % 219 0.6 % 251 0.6 % 32 0.6 % 216 0.6 % 243 0.6 % 27 0.5 % 296 0.8 % 322 0.8 % 26 0.5 % 287 0.8 % 313 0.8 % 26 0.5 % 257 0.7 % 283 0.7 % 26 0.5 % 111 As of March 31, 2009 % % % Unrealized Unrealized Fair Fair Amortized Amortized Loss Loss Value Value Cost Cost and OTTI and OTTI Banking $ 3,383 11.9 % $ 4,801 13.3 % $ 1,418 18.3 % ABS 1,064 3.8 % 2,392 6.6 % 1,328 17.2 % CMOs 1,349 4.8 % 2,130 5.9 % 781 10.1 % CMBS 1,569 5.5 % 2,190 6.1 % 621 8.1 % Property and casualty insurers 781 2.8 % 1,077 3.0 % 296 3.8 % Electric 2,772 9.8 % 3,037 8.4 % 265 3.4 % Real estate investment trusts 684 2.4 % 902 2.5 % 218 2.8 % Pipelines 1,472 5.2 % 1,667 4.6 % 195 2.5 % Life 572 2.0 % 739 2.0 % 167 2.1 % Non-captive diversified 340 1.2 % 494 1.4 % 154 2.0 % Metals and mining 538 1.9 % 685 1.9 % 147 1.9 % Paper 398 1.4 % 539 1.5 % 141 1.8 % Financial - other 362 1.3 % 478 1.3 % 116 1.5 % Retailers 454 1.6 % 568 1.6 % 114 1.5 % Media - non-cable 734 2.6 % 839 2.3 % 105 1.3 % Building materials 441 1.6 % 528 1.5 % 87 1.1 % Diversified manufacturing 626 2.2 % 711 2.0 % 85 1.1 % Independent 488 1.7 % 572 1.6 % 85 1.1 % Non-captive consumer 171 0.6 % 253 0.7 % 81 1.0 % Food and beverage 1,009 3.6 % 1,089 3.0 % 80 1.0 % Distributors 663 2.3 % 740 2.0 % 78 1.0 % Integrated 473 1.7 % 544 1.5 % 70 0.9 % Gaming 227 0.8 % 296 0.8 % 69 0.9 % Owned no guarantee 236 0.8 % 305 0.8 % 69 0.9 % Transportation services 403 1.4 % 469 1.3 % 67 0.9 % Technology 495 1.7 % 560 1.6 % 65 0.8 % Wirelines 485 1.7 % 544 1.5 % 59 0.8 % Chemicals 401 1.4 % 459 1.3 % 58 0.7 % Oil field services 549 1.9 % 606 1.7 % 57 0.7 % Home construction 242 0.9 % 296 0.8 % 54 0.7 % Entertainment 531 1.9 % 582 1.6 % 51 0.7 % Wireless 148 0.5 % 196 0.5 % 48 0.6 % Refining 244 0.9 % 290 0.8 % 47 0.6 % Sovereigns 146 0.5 % 193 0.5 % 46 0.6 % Non-agency 98 0.3 % 139 0.4 % 41 0.5 % Automotive 131 0.5 % 165 0.5 % 34 0.4 % Industrial other 363 1.3 % 394 1.1 % 32 0.4 % As of September 30, 2008 Fair
Value %
Fair
Value Amortized
Cost %
Amortized
Cost Unrealized
Loss %
Unrealized
Loss 395 1.1 % 420 1.0 % 25 0.5 % 121 0.3 % 146 0.4 % 25 0.5 % 366 1.0 % 388 1.0 % 22 0.4 % 231 0.7 % 253 0.6 % 22 0.4 % 360 1.0 % 379 0.9 % 19 0.4 % 357 1.0 % 376 0.9 % 19 0.4 % 71 0.2 % 88 0.2 % 17 0.3 % 112 0.3 % 126 0.3 % 14 0.3 % 111 0 % 125 0.3 % 14 0.3 % 65 0 % 76 0.2 % 11 0.2 % 168 0.5 % 179 0.4 % 11 0.2 % 1,638 4.6 % 1,710 4.2 % 72 1.6 % $ 35,143 100.0 % $ 40,107 100.0 % $ 4,964 100.0 % As of December 31, 2007 Fair
Value %
Fair
Value Amortized
Cost %
Amortized
Cost Unrealized
Loss %
Unrealized
Loss $ 1,946 9.4 % $ 2,239 10.2 % $ 293 24.4 % 3,147 15.0 % 3,328 15.1 % 181 15.1 % 2,881 13.8 % 3,010 13.7 % 129 10.8 % 1,083 5.2 % 1,153 5.2 % 70 5.8 % 1,406 6.8 % 1,440 6.5 % 34 2.9 % 494 2.4 % 528 2.4 % 34 2.8 % 314 1.5 % 347 1.6 % 33 2.7 % 287 1.4 % 319 1.5 % 32 2.7 % 223 1.1 % 254 1.2 % 31 2.6 % 443 2.1 % 469 2.1 % 26 2.2 % 258 1.2 % 284 1.3 % 26 2.2 % 593 2.9 % 614 2.8 % 21 1.7 % 572 2.8 % 593 2.7 % 21 1.7 % 273 1.3 % 291 1.3 % 18 1.5 % 354 1.7 % 371 1.7 % 17 1.4 % 434 2.1 % 449 2.0 % 15 1.2 % 126 0.6 % 140 0.6 % 14 1.2 % 429 2.1 % 442 2.0 % 13 1.1 % 419 2.0 % 431 2.0 % 12 1.0 % 328 1.6 % 338 1.5 % 10 0.8 % 226 1.1 % 236 1.1 % 10 0.8 % 184 0.9 % 194 0.9 % 10 0.8 % 4,370 21.0 % 4,522 20.6 % 152 12.6 % $ 20,790 100.0 % $ 21,992 100.0 % $ 1,202 100.0 % 112 As of March 31, 2009 % % % Unrealized Unrealized Fair Fair Amortized Amortized Loss Loss Value Value Cost Cost and OTTI and OTTI (Continued from Above) Consumer products 357 1.3 % 390 1.1 % 33 0.4 % Brokerage 175 0.6 % 206 0.6 % 31 0.4 % Health insurance 349 1.2 % 375 1.0 % 27 0.3 % Airlines 60 0.2 % 87 0.2 % 26 0.3 % Lodging 88 0.3 % 114 0.3 % 26 0.3 % Railroads 230 0.8 % 257 0.7 % 26 0.3 % Healthcare 426 1.5 % 451 1.2 % 25 0.3 % Packaging 157 0.6 % 183 0.5 % 25 0.3 % Local authorities 58 0.2 % 76 0.2 % 18 0.2 % Construction machinery 190 0.7 % 207 0.6 % 17 0.2 % Media - cable 157 0.6 % 174 0.5 % 17 0.2 % Supermarkets 108 0.4 % 119 0.3 % 12 0.2 % Industries with unrealized losses less than $10 million 943 3.2 % 1,018 2.9 % 75 0.9 % Total by industry $ 28,340 100.0 % $ 36,126 100.0 % $ 7,787 100.0 % Total AFS securities $ 49,554 $ 56,340 $ 7,787 Total by indsutry as a percentage of total AFS securities 57.2 % 64.1 % 100.0 % As of December 31, 2008 % % % Unrealized Unrealized Fair Fair Amortized Amortized Loss Loss Value Value Cost Cost and OTTI and OTTI ABS $ 1,198 4.0 % $ 2,380 6.4 % $ 1,182 15.7 % Banking 3,657 12.2 % 4,714 12.5 % 1,057 14.1 % CMOs 1,636 5.5 % 2,411 6.3 % 775 10.4 % CMBSs 1,632 5.5 % 2,257 6.0 % 625 8.4 % Electric 2,916 9.7 % 3,242 8.7 % 326 4.4 % Pipelines 1,501 5.0 % 1,763 4.7 % 262 3.5 % Real estate investment trusts 662 2.2 % 918 2.5 % 256 3.4 % Property and casualty insurers 746 2.5 % 999 2.7 % 253 3.4 % Metals and mining 604 2.0 % 772 2.1 % 168 2.3 % Life 585 2.0 % 716 1.9 % 131 1.8 % Paper 397 1.3 % 528 1.4 % 131 1.8 % Retailers 549 1.8 % 678 1.8 % 129 1.7 % Media - non-cable 750 2.5 % 867 2.3 % 117 1.6 % Food and beverage 1,205 4.0 % 1,310 3.5 % 105 1.4 % Gaming 205 0.7 % 303 0.8 % 98 1.3 % Diversified manufacturing 686 2.3 % 774 2.1 % 88 1.2 % Non-captive diversified 217 0.7 % 304 0.8 % 87 1.2 % Financial - other 395 1.3 % 479 1.3 % 84 1.1 % Building materials 467 1.6 % 549 1.5 % 82 1.1 % Owned no guarantee 208 0.7 % 290 0.8 % 82 1.1 % Home construction 227 0.8 % 308 0.8 % 81 1.1 % Independent 533 1.8 % 615 1.6 % 82 1.1 % Distributors 890 3.0 % 971 2.6 % 81 1.1 % Non-captive consumer 181 0.6 % 253 0.7 % 72 1.0 % Technology 511 1.7 % 582 1.6 % 71 1.0 % Automotive 174 0.6 % 241 0.6 % 67 0.9 % Integrated 424 1.4 % 490 1.3 % 66 0.9 % Transportation services 376 1.3 % 442 1.2 % 66 0.9 % Wirelines 566 1.9 % 627 1.7 % 61 0.8 % Refining 285 1.0 % 340 0.9 % 55 0.7 % Oil field services 550 1.8 % 604 1.6 % 54 0.7 % Wireless 225 0.8 % 278 0.7 % 53 0.7 % Chemicals 473 1.6 % 522 1.4 % 49 0.7 % Non-agency 94 0.3 % 141 0.4 % 47 0.6 % Healthcare 431 1.4 % 477 1.3 % 46 0.6 % Entertainment 487 1.6 % 531 1.4 % 44 0.6 % Sovereigns 146 0.5 % 190 0.5 % 44 0.6 % As of December 31, 2008 % % % Unrealized Unrealized Fair Fair Amortized Amortized Loss Loss Value Value Cost Cost and OTTI and OTTI (Continued from Above) Health insurance 334 1.1 % 376 1.0 % 42 0.6 % Industrial other 368 1.2 % 407 1.1 % 39 0.5 % Brokerage 186 0.6 % 223 0.6 % 37 0.5 % Consumer products 434 1.4 % 469 1.3 % 35 0.5 % Airlines 72 0.2 % 101 0.3 % 29 0.4 % Lodging 85 0.3 % 112 0.3 % 27 0.4 % Packaging 161 0.5 % 187 0.5 % 26 0.3 % Railroads 232 0.8 % 257 0.7 % 25 0.3 % Local authorities 31 0.2 % 45 0.1 % 14 0.2 % Construction machinery 238 0.8 % 250 0.7 % 12 0.2 % Utility - other 87 0.3 % 98 0.3 % 11 0.1 % Government sponsored 15 0.0 % 26 0.1 % 11 0.1 % Media - cable 156 0.5 % 167 0.4 % 11 0.1 % Industries with unrealized losses less than $10 million 747 2.5 % 815 2.2 % 68 0.9 % Total by industry $ 29,935 100.0 % $ 37,399 100.0 % $ 7,464 100.0 % Total AFS securities $ 49,223 $ 55,660 $ 7,464 Total by industry as a percentage of total AFS securities 60.8 % 67.2 % 100.0 % Below-Investment-Grade Available-for-SaleBelow Investment Grade AFS Fixed Maturity Securitiesavailable-for-sale below-investment-gradeAFS fixed maturity securities below investment grade fixed maturity securities represented 11.0%23.1% and 12.1%12.8% of total gross unrealized losses on all available-for-saleAFS securities as of September 30, 2008,March 31, 2009, and December 31, 2007,2008, respectively. Generally, below-investment-gradebelow investment grade fixed maturity securities are more likely than investment-gradeinvestment grade securities to develop credit concerns. The remaining 89.0%76.9% and 87.9%87.2% of the gross unrealized losses as of September 30, 2008,March 31, 2009, and December 31, 2007,2008, respectively, relate to investment grade available-for-saleAFS securities. The ratios of estimated fair value to amortized cost reflected in the table below were not necessarily indicative of the market value to amortized cost relationships for the securities throughout the entire time that the securities have been in an unrealized loss position nor are they necessarily indicative of these ratios subsequent to September 30, 2008.
Amortized
Cost to
Fair Value As of September 30, 2008 Fair
Value Amortized
Cost Unrealized
Loss 70% to 100% $ 481 $ 505 $ 24 40% to 70% — — — Below 40% 2 10 8 483 515 32 70% to 100% 478 520 42 40% to 70% 12 19 7 Below 40% 1 12 11 491 551 60 70% to 100% 156 180 24 40% to 70% 19 30 11 Below 40% 2 9 7 177 219 42 70% to 100% 139 160 21 40% to 70% 23 39 16 Below 40% 20 65 45 182 264 82 70% to 100% 796 930 134 40% to 70% 126 196 70 Below 40% 31 156 125 953 1,282 329 $ 2,286 $ 2,831 $ 545 113 Ratio of As of March 31, 2009 Amortized Unrealized Cost to Fair Amortized Loss Aging Category Fair Value Value Cost and OTTI < or = 90 days 70% to 100% $ 148 $ 161 $ 13 40% to 70% 70 150 80 Below 40% 57 211 154 Total < or = 90 days 275 522 247 >90 days but < or = 180 days 70% to 100% 115 123 8 40% to 70% 13 20 7 Below 40% - - - Total >90 days but < or = 180 days 128 143 15 >180 days but < or = 270 days 70% to 100% 273 317 44 40% to 70% 53 90 37 Below 40% 6 20 14 Total >180 days but < or = 270 days 332 427 95 >270 days but < or = 1 year 70% to 100% 369 438 69 40% to 70% 152 257 105 Below 40% 37 131 94 Total >270 days but < or = 1 year 558 826 268 >1 year 70% to 100% 664 799 135 40% to 70% 441 804 363 Below 40% 181 853 672 Total >1 year 1,286 2,456 1,170 Total below investment grade $ 2,579 $ 4,374 $ 1,795 Total AFS securities $ 49,554 $ 56,340 $ 7,787 Total below investment grade as a percentage of total AFS securities 5.2 % 7.8 % 23.1 %
Amortized
Cost to
Fair Value As of December 31, 2007 Fair
Value Amortized
Cost Unrealized
Loss 70% to 100% $ 446 $ 468 $ 22 40% to 70% — 1 1 446 469 23 70% to 100% 218 231 13 40% to 70% 1 1 — 219 232 13 70% to 100% 378 408 30 378 408 30 70% to 100% 121 135 14 121 135 14 70% to 100% 328 362 34 40% to 70% 52 84 32 380 446 66 $ 1,544 $ 1,690 $ 146 114 Ratio of As of December 31, 2008 Amortized Unrealized Cost to Fair Amortized Loss Aging Category Fair Value Value Cost and OTTI < or = 90 days 70% to 100% $ 253 $ 268 $ 15 40% to 70% 17 31 14 Below 40% 1 5 4 Total < or = 90 days 271 304 33 >90 days but < or = 180 days 70% to 100% 291 336 45 40% to 70% 41 66 25 Below 40% - - - Total >90 days but < or = 180 days 332 402 70 >180 days but < or = 270 days 70% to 100% 311 349 38 40% to 70% 83 140 57 Below 40% 10 40 30 Total >180 days but < or = 270 days 404 529 125 >270 days but < or = 1 year 70% to 100% 116 143 27 40% to 70% 35 66 31 Below 40% 9 28 19 Total >270 days but < or = 1 year 160 237 77 >1 year 70% to 100% 501 606 105 40% to 70% 339 604 265 Below 40% 98 376 278 Total >1 year 938 1,586 648 Total below investment grade $ 2,105 $ 3,058 $ 953 Total AFS securities $ 49,223 $ 55,660 $ 7,464 Total below investment grade as a percentage of total AFS securities 4.3 % 5.5 % 12.8 % Unrealized Loss on Fixed Maturity and Equity Securities Available-for-Sale in Excess of $10 millionAs of September 30, 2008, available-for-sale fixed maturity and equity securities with gross unrealized losses greater than $10 million (in millions) for investment grade securities were as follows: As of September 30, 2008 Fair
Value Amortized
Cost Unrealized
Loss >1 year $ 122 $ 400 $ 278 >1 year 57 200 143 >270 days but < = 1 year 420 522 102 >180 days but < or = 270 days 127 195 68 >180 days but < or = 270 days 101 148 47 >270 days but < = 1 year 138 179 41 >1 year 74 113 39 >180 days but < or = 270 days 43 82 39 >180 days but < or = 270 days 163 198 35 >1 year 117 145 28 >180 days but < or = 270 days 117 144 27 >180 days but < or = 270 days 170 196 26 >1 year 43 67 24 >1 year 22 46 24 >90 days but < or = 180 days 181 203 22 >180 days but < or = 270 days 139 161 22 >180 days but < or = 270 days 54 76 22 >1 year 77 98 21 >1 year 23 44 21 >270 days but < = 1 year 21 42 21 >270 days but < = 1 year 42 62 20 >1 year 175 194 19 >270 days but < = 1 year 25 44 19 >1 year 35 54 19 >270 days but < = 1 year 40 59 19 >1 year 131 149 18 >1 year 97 115 18 >1 year 19 37 18 >1 year 22 40 18 >1 year 29 46 17 >1 year 8 25 17 >1 year 56 72 16 >1 year 86 102 16 >1 year 82 98 16 >1 year 13 29 16 >1 year 60 76 16 >1 year 69 85 16 >1 year 52 68 16 >90 days but < or = 180 days 56 72 16 >1 year 65 80 15 >180 days but < or = 270 days 88 103 15 >1 year 40 55 15 >180 days but < or = 270 days 111 126 15 >90 days but < or = 180 days 97 111 14 >180 days but < or = 270 days 49 63 14 115 As of September 30, 2008 Fair
Value Amortized
Cost Unrealized
Loss Mortgage related MBS >1 year 3 17 14 Mortgage related ABS >1 year 26 40 14 International bank and finance >180 days but < or = 270 days 16 30 14 Mortgage related ABS >180 days but < or = 270 days 19 33 14 International energy >270 days but < = 1 year 147 160 13 Domestic bank and finance >90 days but < or = 180 days 58 71 13 International bank and finance >1 year 49 62 13 Domestic communications >90 days but < or = 180 days 132 145 13 Mortgage related MBS >1 year 21 34 13 Domestic energy >90 days but < or = 180 days 120 133 13 International energy >1 year 76 89 13 Mortgage related ABS >1 year 44 57 13 International energy >1 year 95 108 13 International bank and finance >1 year 35 48 13 International energy >1 year 27 40 13 Professional services >270 days but < = 1 year 68 80 12 Mortgage related MBS >180 days but < or = 270 days 22 34 12 Domestic energy >1 year 81 93 12 Mortgage related ABS >270 days but < = 1 year 17 29 12 Domestic insurance >1 year 15 27 12 International bank and finance >270 days but < = 1 year 82 94 12 International metals and mining >1 year 76 88 12 International bank and finance >1 year 8 19 11 Mortgage related MBS >1 year 9 20 11 International investment company >270 days but < = 1 year 46 57 11 Mortgage related ABS >1 year 5 16 11 Automotive rentals >1 year 46 57 11 Domestic healthcare >180 days but < or = 270 days 129 140 11 Domestic energy >270 days but < = 1 year 99 110 11 Property and casualty insurance >270 days but < = 1 year 29 40 11 Domestic energy >1 year 114 125 11 Domestic healthcare >180 days but < or = 270 days 113 124 11 Domestic energy >1 year 65 75 10 Mortgage related MBS >1 year 28 38 10 Domestic energy >180 days but < or = 270 days 111 121 10 Mortgage related MBS >1 year 15 25 10 $ 5,802 $ 7,703 $ 1,901 116As of September 30, 2008, available-for-sale fixed maturity and equity securities with gross unrealized losses greater than $10 million (in millions) for non investment grade securities were as follows: As of September 30, 2008 Fair
Value Amortized
Cost Unrealized
Loss >270 days but < = 1 year $ 24 $ 70 $ 46 > 1 year 15 44 29 >1 year 4 19 15 > 1 year 38 51 13 > 1 year 77 91 14 >1 year 2 15 13 >1 year 1 15 14 >1 year 2 14 12 >270 days but < = 1 year 15 27 12 > 1 year 48 60 12 >90 days but < or = 180 days 1 12 11 > 1 year 51 61 10 >1 year 10 20 10 $ 288 $ 499 $ 211 The information above is presented by investment grade and length of time in a loss position on an issuer basis. These investments are subject to rapidly changing conditions. As such, we expect that the level of securities with overall unrealized losses will fluctuate, as will the level of unrealized loss securities that are subject to enhanced analysis and monitoring. The volatility of financial market conditions results in increased recognition of both investment gains and losses, as portfolio risks are adjusted through sales and purchases. As discussed above, this is consistent with the classification of our investment portfolios as available-for-sale.117 As of September 30, 2008 Amount % $ 2,568 33 % 2,020 26 % 1,839 24 % 727 9 % 293 4 % 135 2 % 106 2 % $ 7,688 100 % $ 191 2 % 482 6 % 822 11 % 433 6 % 1,824 24 % 464 5 % 676 9 % 746 10 % 2,050 27 % $ 7,688 100 % As of September 30, 2008 Amount % State Exposure CA $ 1,610 21 % TX 626 8 % MD 442 6 % FL 337 4 % TN 326 4 % NC 324 4 % VA 316 4 % AZ 315 4 % WA 299 4 % IL 287 4 % GA 257 3 % PA 242 3 % OH 221 3 % NV 215 3 % IN 195 3 % MN 161 2 % NJ 147 2 % SC 138 2 % MA 133 2 % Other states 1% and under 1,097 14 % $ 7,688 100 % As of March 31, 2009 As of March 31, 2009 Amount % Amount % Property Type State Exposure Office building $ 2,598 34 % CA $ 1,600 21 % Industrial 1,981 26 % TX 643 8 % Retail 1,807 24 % MD 436 6 % Apartment 710 9 % FL 335 4 % Hotel/Motel 283 4 % TN 319 4 % Mixed use 134 2 % AZ 315 4 % Other commercial 103 1 % VA 309 4 % $ 7,616 100 % NC 305 4 % WA 294 4 % IL 281 4 % Geographic Region GA 248 3 % Pacific $ 2,032 27 % PA 234 3 % South Atlantic 1,778 23 % NV 213 3 % East North Central 791 10 % OH 200 3 % Mountain 738 10 % IN 190 2 % West South Central 691 9 % MA 158 2 % Middle Atlantic 509 7 % MN 156 2 % East South Central 453 6 % NJ 145 2 % West North Central 410 5 % SC 134 2 % New England 214 3 % NY 130 2 % $ 7,616 100 % Other states under 2% 971 13 % $ 7,616 100 % September 30 2008,December 31, 2008. As of March 31, 2009, there were two commercial mortgage loans that were two or more payments delinquent and December 31, 2007. As of September 30, 2008, there were no commercial mortgage loans that were two or more payments delinquent. As of December 31, 2007, we had one commercial mortgage loan that was two or more payments delinquent. The total principal and interest due on thesethe mortgage loans as of DecemberMarch 31, 2007,2009, was less than $1 million. See Note 4 for additional detail regarding impaired mortgage loans. See Note 1 in our 20072008 Form 10-K for more information regarding our accounting policy relating to the impairment of mortgage loans.118werewas as follows: As of
September 30,
2008 As of
December 31,
2007 $ 97 $ 108 76 130 606 526 36 2 11 33 $ 826 $ 799 Income As of As of March 31, December 31, 2009 2008 Retirement Solutions: Annuities $ 102 $ 89 Defined Contribution 60 72 Insurance Solutions: Life Insurance 560 603 Group Protection 37 8 Other Operations 12 4 Total alternative investments $ 771 $ 776 For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 2 $ 1 100 % $ 1 $ 15 -93 % 1 (1 ) 200 % (2 ) 15 NM 23 — NM 36 58 -38 % 1 — NM 1 — — — NM — 2 -100 % $ 27 $ — NM $ 36 $ 90 -60 % For the Three Months Ended March 31, 2009 2008 Change Retirement Solutions: Annuities $ (1 ) $ (1 ) 0 % Defined Contribution - (2 ) 100 % Insurance Solutions: Life Insurance (5 ) (1 ) NM Group Protection - - NM Other Operations - (1 ) 100 % $ (6 ) $ (5 ) -20 % when comparing the first nine months of 2008 to the corresponding period in 2007 was due to continued deterioration of the financial markets during 2008, as compared to exceptionally strong returns in the first half of 2007.markets. This weakness was spread across the various categories of investments withinconcentrated primarily in our alternative investment portfolio.September 30, 2008,March 31, 2009, and December 31, 2007,2008, alternative investments includeincluded investments in approximately 102 different partnerships. The partnerships respectively, that allow us to gain exposure torepresent a broadly diversified portfolio of asset classes suchclasses. The investment strategy of the alternative investment portfolio is to provide incremental investment income compared to the traditional fixed-income and equity markets over a long term investment horizon. In addition, the portfolio represents approximately 1.6% of our overall invested assets. The portfolio is actively monitored to minimize the likelihood of material investment income losses.venture capital, hedge funds, oil and gas and real estate. follows: As of As of March 31, December 31, 2009 2008 Venture capital $ 354 $ 341 Hedge funds 199 223 Real estate 113 110 Oil & gas 105 102 Total alternative investments $ 771 $ 776 September 30, 2008,March 31, 2009, and December 31, 2007,2008, the carrying amount of fixed maturity securities, mortgage loans on real estate and real estate that were non-income producing was $17$19 million and $21$15 million, respectively.119 For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 849 $ 854 -1 % $ 2,558 $ 2,539 1 % 7 10 -30 % 24 31 -23 % 41 44 -7 % 126 134 -6 % 120 114 5 % 354 347 2 % 5 11 -55 % 17 34 -50 % 1 5 -80 % 3 9 -67 % 46 43 7 % 134 130 3 % 12 14 -14 % 46 52 -12 % 8 11 -27 % 28 42 -33 % 27 — NM 36 90 -60 % 2 1 100 % 4 9 -56 % — 4 -100 % (5 ) 8 NM 1,118 1,111 1 % 3,325 3,425 -3 % (29 ) (49 ) 41 % (94 ) (140 ) 33 % $ 1,089 $ 1,062 3 % $ 3,231 $ 3,285 -2 % For the Three Months Ended March 31, 2009 2008 Change Net Investment Income Fixed maturity AFS securities $ 836 $ 857 -2 % Equity AFS securities 2 9 -78 % Trading securities 40 42 -5 % Mortgage loans on real estate 118 117 1 % Real estate 4 7 -43 % Standby real estate equity commitments - 1 -100 % Policy loans 44 45 -2 % Invested cash 10 19 -47 % 1 6 -83 % (6 ) (5 ) -20 % Other investments 4 2 100 % Investment income 1,053 1,100 -4 % Investment expense (26 ) (35 ) 26 % Net investment income $ 1,027 $ 1,065 -4 % For the Three
Months Ended
September 30, Basis
Point
Change For the Nine
Months Ended
September 30, Basis
Point
Change 2008 2007 2008 2007 5.91 % 5.92 % (1 ) 5.92 % 5.94 % (2 ) 0.04 % 0.06 % (2 ) 0.05 % 0.08 % (3 ) 0.15 % 0.00 % 15 0.07 % 0.17 % (10 ) 0.01 % 0.01 % — 0.01 % 0.02 % (1 ) 0.01 % 0.03 % (2 ) 0.01 % 0.02 % (1 ) 6.12 % 6.02 % 10 6.06 % 6.23 % (17 ) For the Three
Months Ended
September 30, Change For the Nine
Months Ended
September 30, Change 2008 2007 2008 2007 $ 71,218 $ 70,575 1 % $ 71,142 $ 70,291 1 % For the Three Months Ended Basis March 31, Point 2009 2008 Change Interest Rate Yield Fixed maturity securities, mortgage loans on real estate and other, net of investment expenses 5.85% 5.97% (12) Commercial mortgage loan prepayment and bond makewhole premiums 0.01% 0.03% (2) Alternative investments -0.03% -0.03% - Standby real estate equity commitments 0.00% 0.01% (1) Net investment income yield on invested assets 5.83% 5.98% (15) For the Three Months Ended March 31, 2009 2008 Change Average invested assets at amortized cost $ 70,421 $ 71,195 -1 % 120ninethree months of 20082009 to the same period in 20072008 was attributable largely to our liquidity strategy of maintaining higher cash balances during the recent volatile markets which has reduced our portfolio yield and a decline in investment income on alternative investments,investments.an extraordinarily strong first halfstandby real estate equity commitments totaling $263 million and $267 million, respectively. During the three months ended March 31, 2009, we funded commitments of 2007.ninethree months ended September 30,March 31, 2009 to 2008 to 2007 was attributable primarily to the generalcontinued tightening of credit conditions in the market resulting in less refinancing activity and less prepayment income.gain (loss)loss related to investments (in millions) was as follows: For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 Change 2008 2007 Change $ 27 $ 26 4 % $ 58 $ 108 -46 % (380 ) (44 ) NM (618 ) (97 ) NM 1 1 0 % 4 7 -43 % (26 ) — NM (33 ) — NM (1 ) 6 NM 27 7 286 % 95 (14 ) NM 144 (36 ) NM (284 ) (25 ) NM (418 ) (11 ) NM (30 ) (11 ) NM (62 ) (7 ) NM — 1 -100 % — — NM $ (314 ) $ (35 ) NM $ (480 ) $ (18 ) NM $ (312 ) $ (34 ) NM $ (523 ) $ (68 ) NM For the Three Months Ended March 31, 2009 2008 Change Fixed maturity AFS securities: Gross gains $ 55 $ 9 NM Gross losses (244 ) (100 ) NM Equity AFS securities: Gross gains 3 3 0 % Gross losses (3 ) - NM Gain on other investments (2 ) 25 NM Associated amortization expense of DAC, VOBA, DSI and DFEL and changes in other contract holder funds and funds withheld reinsurance liabilities 55 25 120 % Total realized loss on investments, excluding trading securities (136 ) (38 ) NM Loss on certain derivative instruments (17 ) (3 ) NM Total realized loss on investments and certain derivative instruments, excluding trading securities $ (153 ) $ (41 ) NM Write-downs for OTTI included in realized loss on AFS securities above $ (170) $ % gain (loss)loss reflecting the incremental impact of actual versus expected credit-related investment losses. These actual to expected amortization adjustments could create volatility in net realized gains (loss).and losses. The write-down for impairments includes both credit-related and interest-rate related impairments.ninethree months of 20082009 and 2007, respectively,2008, we sold securities for gains and losses. In the process of evaluating whether a security with an unrealized loss reflects declines that are other-than-temporary, we consider our ability and intent to hold the security until its value recovers. However, subsequent decisions on securities sales are made within the context of overall risk monitoring, assessing value relative to other comparable securities and overall portfolio maintenance. Although our portfolio managers may, at a given point in time, believe that the preferred course of action is to hold securities with unrealized losses that121available-for-sale.AFS. We expect to continue to manage all non-trading invested assets within our portfolios in a manner that is consistent with the available-for-saleAFS classification.20072008 Form 10-K for additional information on our portfolio management strategy.other-than-temporary impairmentsOTTIs (in millions) that were recognized in earnings were as follows: For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, 2008 2007 Change 2008 2007 Change $ 210 $ 32 NM $ 336 $ 66 NM 1 — NM 1 — NM 76 2 NM 154 2 NM 287 34 NM 491 68 NM 25 — NM 32 — NM $ 312 $ 34 NM $ 523 $ 68 NM For the Three Months Ended March 31, 2009 2008 Change Fixed Maturity Securities Corporate bonds $ 85 $ 90 -6 % MBS: CMOs 81 1 NM ABS: CDOs - 1 -100 % Hybrid and redeemable preferred stock 1 - NM Total fixed maturity securities 167 92 82 % Equity Securities Other financial services securities 3 - NM Total equity securities 3 - NM Total OTTI losses on AFS $ 170 $ 92 85 % $523$170 million of impairments taken during the first ninethree months of 20082009 are split between $424$166 million of credit related impairments and $99$4 million on non-credit related impairments. The credit related impairments are largely attributable to our financialAutomotive and Gaming sector holdings, RMBS, and mortgage related ABS holdings that have suffered from continued deterioration in housing fundamentals. The non-credit related impairments were incurred due to declines in values of securities for which we are uncertain of ourhave an intent to hold until recovery or maturity.122September 30, 2008,March 31, 2009, the reserves associated with these reinsurance arrangements totaled $1.2$1.1 billion. To cover products other than life insurance, we acquire other insurance coverage with retentions and limits that management believes are appropriate for the circumstances. The consolidated financial statements included in Item 1 reflect premiums, benefits and DAC, net of insurance ceded. Our insurance companies remain liable if their reinsurers are unable to meet contractual obligations under applicable reinsurance agreements.September 30, 2008,March 31, 2009, and December 31, 2007,2008, the amounts recoverable from reinsurers were $8.2 billion.$8.0 billion and $8.5 billion, respectively. We obtain reinsurance from a diverse group of reinsurers, and we monitor concentration and financial strength ratings of our principal reinsurers. Swiss Re represents our largest exposure. In 2001, we sold our reinsurance business to Swiss Re primarily through indemnity reinsurance arrangements. Because we are not relieved of our liability to the ceding companies for this business, the liabilities and obligations associated with the reinsured policies remain on our Consolidated Balance Sheets with a corresponding reinsurance receivable from the business sold to Swiss Re, which totaled $4.5$3.3 billion and $4.3$4.5 billion as of September 30, 2008,March 31, 2009, and December 31, 2007,2008, respectively. Swiss Re has funded a trust with a balance of $1.8$1.9 billion as of September 30, 2008,March 31, 2009, to support this business. In addition to various remedies that we would have in the event of a default by Swiss Re, we continue to hold assets in support of certain of the transferred reserves. These assets consist of those reported as trading securities and certain mortgage loans. Our liabilitiesliability for funds withheld and our asset for embedded derivatives included $2.0$1.2 billion and less than $1$63 million, respectively, as of September 30, 2008,March 31, 2009, related to the business sold to Swiss Re.Included in the sold to Swiss Re throughas part of several indemnity reinsurance transactions executed in 2001, as discussed above. On January 24, 2009, an award of rescission was disability income business.declared related to an ongoing dispute between us and Swiss Re is disputing its obligationfor this treaty, which requires us to pay approximately $47 million ofbe fully responsible for all claims incurred and liabilities supporting this block as if the reinsurance recoverables on this disability income business. We are currently arbitrating this dispute with Swiss Re. Although the outcometreaty never existed. See Note 11 for a discussion of the arbitration is uncertain, we currently believe that it is probable that we will ultimately collect the full amountaffects of the reinsurance recoverable from Swiss Re and that Swiss Re will ultimately remain at risk on all of its obligations on the disability income business that it acquired from us in 2001. In addition, we are disputing with Swiss Re the contractual terms for interest crediting rates under two funds withheld reinsurance arrangements. One of these disputed arrangements is part of the current arbitration, and any action on the other disputed arrangement is pending the decision of the current arbitration results. Our estimate of the maximum loss exposure on these open matters is $45 million (pre-tax) as of September 30, 2008. Although the outcome of these open disputes is uncertain, we currently believe that the ultimate resolution will not result in a material financial impact to us.JulyMarch 31, 2007,2009, we entered into a reinsurance arrangement with Swiss Re covering55% coinsurance agreement whereby we ceded a closed block of business consisting of certain UL and VUL insurance products to a third party reinsurer. See “Results of Insurance Solutions – Insurance Solutions – Life Insurance” and “Review of Consolidated Financial Condition” for more information. our rider related to our Retirement Solutions’ variable annuity products. Under the arrangement,annuities. Swiss Re providesprovided 50% quota share coinsurance of theour lifetime GWB,Lincoln SmartSecurity® Advantage, for business written in 2007 and 2008, up to a total of $3.8 billion in rider sales. The sales level covered under this arrangement was achieved in the second quarter of 2008. The arrangement will not be renewed for new business, but this will not affect our ability to continue to write new business.deposits.During the third quarter of 2006, one of our reinsurers, Scottish Re Group Ltd (“Scottish Re”), received rating downgrades from various rating agencies. Of the $706 million of fixed annuity business that we reinsure with Scottish Re, approximately 78% is reinsured through the use of modified coinsurance treaties, in which we possess the investments that support the reserves ceded to Scottish Re. For our annuity business ceded on a coinsurance basis, Scottish Re had previously established an irrevocable investment trust supporting the reserves for the benefit of LNC. In addition to fixed annuities, we have approximately $122 million of policy liabilities on the life insurance business that we have reinsured with Scottish Re. Scottish Re continues to perform under its contractual responsibilities to us. We continue to evaluate the impact of these rating downgrades with respect to our existing exposures to Scottish Re. Based on current information, we do not believe that Scottish Re’s rating downgrades will have a material adverse effect on our results of operations, liquidity or financial condition.As of September 30, 2008, we had reinsurance recoverables of $703 million and policy loans of $46 million that were related to the businesses of Jefferson-Pilot that are coinsured with Household International (“HI”) affiliates. HI has provided payment, performance and capital maintenance guarantees with respect to the balances receivable. We regularly evaluate the financial condition of our reinsurers and monitor concentrations of credit risk related to reinsurance activities.aanother subsidiary of LNC, Lincoln National Reinsurance Company (Barbados) Limited (“LNBAR”) under which LNL reinsures certain guarantees associated with the GDB and GLB riders on its variable annuity productproducts. In early January 2008, we entered into a reinsurance treaty between LLANY and LNBAR under which LLANY reinsures certain guarantees including GDB andassociated with the GLB riders. This treaty is ariders on its variable annuity products. These treaties are traditional reinsurance programprograms where LNL paysand LLANY pay premiums to LNBAR, and LNBAR assumes the associated variable annuity guarantee reserves. LNBAR has arider guarantees. The hedge program that is designed to mitigate selected risk and income statement volatility from changes in123products. In addition to mitigating selected risk and income statement volatility, the hedge programproducts is also focused on long-term performance of the hedge program recognizing that any material potential claims under the GLBs are approximately a decadeconducted in the future.The LNBAR hedge program uses put options to hedge a portion of the liability related to our variable annuity products with a GLB feature. 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. Variance swaps are used to hedge the liability exposure on certain options in variable annuity products. Variance swaps are contracts entered into at no cost and whose payoff is the difference between the realized variance of an underlying index and the fixed variance rate determined at inception. Equity futures are used to hedge a portion of the liability related to our variable annuity products with GLB and GDB features. These futures contracts require payment between us and our counterparty on a daily basis for changes in the futures index price.subsidiary. For more information on the results of our hedge program, see “Realized Loss” above.124$811$98 million and $2.1 billion for the first ninethree months of 2008 and 2007, respectively. The decline in cash provided by operating activities was related primarily to the timing of federal income tax payments.2008. When considering our liquidity and cash flow, it is important to distinguish between the needs of our insurance subsidiaries and the needs of the holding company, LNC. As a holding company with no operations of its own, LNC derives its cash primarily from its operating subsidiaries. For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30, For the
Year Ended
December 31,
2007 2008 2007 2008 2007 $ 100 $ 175 $ 400 $ 469 $ 769 — — 50 150 150 3 14 656 36 86 15 15 43 45 55 — 395 — 395 395 — 16 24 48 75 22 20 63 59 82 $ 140 $ 635 $ 1,236 $ 1,202 $ 1,612 $ 1 $ 25 $ 15 $ 101 $ 107 For the Three For the Months Ended Year Ended March 31, December 31, 2009 2008 2008 Dividends from Subsidiaries LNL $ - $ 200 $ 400 First Penn-Pacific - - 50 - 658 659 Delaware Investments 3 15 51 Lincoln UK - - 24 Other - - 54 Loan Repayments and Interest from Subsidiary 22 22 83 $ 25 $ 895 $ 1,321 Other Cash Flow and Liquidity Items Net capital received from stock option exercises $ - $ 7 $ 15 the nine months ended September 30, 2008, amount includes proceeds on the sale of certain discontinued media operations. For more information, see Note 3.For the year ended December 31, 2007, amountPrimarily represents a dividend of Bank of America shares to LNC from a subsidiary occurring in September 2007.(3)Represents primarily interest on the holding company’s $1.3 billion in surplus note investments in LNL.accountprogram (discussed below). Taxes have been eliminated from the analysis due to a tax sharing agreement among our primary subsidiaries resulting in a modest impact on net cash flows at the holding company. Also excluded from this analysis is the modest amount of investment income on short-term investments of the holding company.125Lincoln Life & Annuity Company of New York,LLANY, has similar restrictions, except that in New York it is the lesser of 10% of surplus to contract holders as of the immediately preceding calendar year or net gain from operations for the immediately preceding calendar year, not including realized capital gains. well above current regulatory required levels. As mentioned earlier, more than 69%73% of our life sales consist of products containing secondary guarantees, which require reserving practices under AG38. Our insurance subsidiaries are employing strategies to lessen the burden of increased AG38 and Valuation of Life Insurance Policies Model Regulation (“XXX”) statutory reserves associated with certain UL products and other products with secondary guarantees subject to these statutory reserving requirements. See “Financing Activities” below for additional details. LNC will guarantee that its wholly-owned subsidiary, which reinsures a portion of the XXX reserves, will maintain a minimum level of capital and surplus as required under the insurance laws of South Carolina, its state of domicile. The surplus maintenance agreement will remain in effect until such time that we securitize the reserves, transfer the business to an unrelated party, sell or dissolve the wholly-owned subsidiary or receive notification from the state insurance department permitting the rescission of the guarantee.September 30, 2008,March 31, 2009, reported in the revolving credit facilities table in “Financing Activities,” was approximately $1.2$1.5 billion of LOCs supporting the reinsurance obligations of LNBAR on UL business with secondary guarantees. Recognizing that LOCs are generally one to five years in duration, it is likely that our insurance companies will apply a mix of LOCs, reinsurance and capital market strategies in addressing long-term AG38 and XXX needs. LOCs and related capital market alternatives lower the RBC impact of the UL business with secondary guarantee products. An inability to obtain the necessary LOC capacity or other capital market alternatives could impact our returns on UL business with secondary guarantee products.In the fourth quarter of 2007,As mentioned above in “Reinsurance,” we issued $375 million of 6.30% senior notes, whichentered into a coinsurance agreement on March 31, 2009. The transaction resulted in the release of approximately $300$240 million of statutory capital previously supporting oura closed block of business of certain UL products with secondary guarantees. See “Results of Other Operations” for additional information. We are targeting to complete another transaction during the fourth quarter of 2008 that will finance a portion of statutory reserves related to ourand VUL insurance products with secondary guarantees.and an RBC benefit of approximately 20 percentage points in 2009. See “Part I – Item 1A. Risk Factors – Attempts to mitigate the impact of Regulation XXX and Actuarial Guideline 38 may fail in whole or in part resulting in an adverse effect on our financial condition and results of operations” in our 2008 Form 10-K for further information on XXX reserves. In addition, a portion of our term life insurance business is reinsured with a domestic reinsurance captive as part of our overall strategy of managing the statutory capital of our insurance subsidiaries. There are no outstanding LOCs related to this business.On August 20,Actuarial Guidelinea new statutory reserving standard, VACARVM, which will be effective as of December 31, 2009. VACARVMWe are currently in the process of evaluating the impact of adopting VACARVM. This reserving requirement will replace current statutory reserving practices for variable annuities with guaranteed benefits and has the potential to require statutory reserves well in excess of current levels for certain variable annuity riders sold by us. The actual impact of the adoption will be dependent upon several factors including account values and market conditions that exist as December 31, 2009, the value of derivative and other assets supporting reserves whose change in value may be uncorrelated with the new reserving requirements, and the use of captive or third-party reinsurance. We plan to utilizeare analyzing the current use of existing captive reinsurance structures, as well as pursue additional third-party reinsurance arrangements, and hedging strategies relative to lessen anymanaging the negative impact on the level and volatility of statutory capital and dividend capacity in our life insurance subsidiaries. However,Depending on market conditions, reinsurance solutions and hedging strategies, additional statutory reserves could lead to lower risk-based capitalRBC ratios and potentially reduce future dividend capacity fromof our insurance subsidiaries. We are currently in the process of evaluating the impact of adopting VACARVM. For a discussion of RBC ratios, see “Part I – Item 1. Business – Regulatory – Risk-Based Capital” in our 2007 Form 10-K.thirdfirst quarter of 2008,2009, we recognized higher reserves under Commissioners Annuity Reserve Valuation Method (“CARVM”) for our annuity products and higher reserves for GDB riders, which are only partially reinsured. CARVM is the current statutory actuarial method used for determining reserves for the base annuity contract. The impact of these items reduced the statutory surplus of LNL by approximately $110$75 million in the thirdfirst quarter of 2008.2009. We estimate that an S&P level of 700, a 30%12.5% drop infrom the equity markets from September 30, 2008, levels couldMarch 31, 2009, level, would require an increase in statutory reserves, and thereby, further reduce statutory surplus of LNL by $275-$300$80 million to $100 million at the end of the fourthsecond quarter of 2008,2009, related primarily to CARVM. As a result, we estimate that LNL’s estimated RBC ratio at the end of SeptemberJune 30, 2008,2009, would be reduced by approximately 2510 percentage points. The estimated potential increase to statutory reserves is based on the current statutory reserve formulas and does not take into account the reserve and asset adequacy analysis performed by our actuaries on an annual basis to determine appropriateness of the reserves at year-end.year end. This analysis incorporates the adequacy of assets in LNBAR, our captive reinsurance company, supporting the liabilities that it assumes from LNL. The outcome of this analysis may result in an additional reserve increase and could further reduce the RBC ratio.126also be affected by the level of account values relative to the level of guaranteed amounts, product design and reinsurance. Because the calculation of statutoryStatutory reserves for variable annuities dependsdepend upon the cumulative equity market impacts on the business in-force, the reserves do not move in a linear relationshipforce and therefore result in non-linear relationships with respect to the level of equity market performance within any given reporting period. The RBC ratio is also affected by the product mix of the in-force book of business; i.e.business (i.e. the amount of business without guarantees is not subject to the same level of reserves as the business with guarantees. All of these factors affect theguarantees). The RBC ratio of LNL which is an important factor in the determination of the credit and financial strength ratings of LNC and its subsidiaries.including GDB and between LLANY and LNBAR under which LLANY reinsures certain guarantees associated with the GLB riders.riders on its variable annuity products. We also entered into a reinsurance arrangement wherereinsured with Swiss Re provideson a 50% quota share coinsurance of thebasis rider sales on certain GLB business written infrom July 2007 and 2008, up to a total of $3.8 billion in rider sales.markets.markets; however, the reinsurance treaty between LNL and LNBAR does not limit our exposure to mortality losses. Both LNBAR and Swiss Re have established reserves for the business assumed and hold assets to support both the reserves and capital required by the respective regulatory agencies. For more details on LNBAR, see “Reinsurance” above. of the planned dividends to the holding company in the first and third quarters of 2008, which did not negatively impact our liquidity. A dividend of $24 million was paid by Lincoln UK to LNC in the second quarter of 2008, and we anticipate that Lincoln UK will again resume the payment of dividends when market conditions ease.127activityactivities (in millions) were as follows: For the Nine Months Ended September 30, 2008 Beginning
Balance Issuance Maturities
and
Repayments Change
in Fair
Value
Hedges Other
Changes (1) Ending
Balance $ 265 $ — $ — $ — $ (145 ) $ 120 285 — (285 ) — 515 515 $ 550 $ — $ (285 ) $ — $ 370 $ 635 $ 2,892 $ 450 $ — $ 14 $ (513 ) $ 2,843 155 — — — — 155 1,571 — — — — 1,571 $ 4,618 $ 450 $ — $ 14 $ (513 ) $ 4,569 For the Three Months Ended March 31, 2009 Change Maturities in Fair Beginning and Value Other Ending Balance Issuance Repayments Hedges Balance Short-Term Debt Commercial paper $ 315 $ - $ - $ - $ 371 $ 686 Current maturities of long-term debt 500 - - 250 750 Total short-term debt $ 815 $ - $ - $ - $ 621 $ 1,436 Long-Term Debt Senior notes $ 2,555 $ - $ - $ (50 ) $ (250 ) $ 2,255 Bank borrowing 200 - - - - 200 Federal Home Loan Bank of Indianapolis ("FHLBI") advance 250 - - - - 250 Junior subordinated debentures issued to affiliated trusts 155 - - - - 155 Capital securities 1,571 - (87 ) - 1 1,485 Total long-term debt $ 4,731 $ - $ (87 ) $ (50 ) $ (249 ) $ 4,345 Other changes includesIncludes the net increase (decrease) in commercial paper, non-cash reclassification of long-term debt to current maturities of long-term debt, accretion of discounts and (amortization) of premiums. As of September 30, 2008
Date Maximum
Available Borrowings
Outstanding Not Applicable $ 378 $ 378 July 2013 200 200 March 2011 1,750 — February 2011 1,350 — November 2008 20 — $ 3,698 $ 578 $ 1,794 As of March 31, 2009 Expiration Maximum Borrowings Date Available Outstanding Revolving Credit Facilities Not Applicable $ 378 $ 250 Five-year revolving credit facility March 2011 1,750 - Five-year revolving credit facility February 2011 1,350 - Total $ 3,478 $ 250 Letters of credit issued $ 2,095 former Reinsurance segment.business sold through reinsurance. LOCs are used primarily used to satisfy the U.S. regulatory requirements of our domestic clients of the former Reinsurance segment who have contracted with the reinsurance subsidiaries not domiciled in the U.S. and, as discussed above,insurance companies for thewhich reserve credit is provided by our affiliated offshore reinsurance company, toas discussed above, and our domestic insurance companies for ceded business.September 30, 2008,March 31, 2009, we were in compliance with all such covenants. All of our credit agreements are unsecured.claims payingclaims-paying ratings were downgraded in the future, terms in LFG’sour derivative agreements may be triggered, which could negatively impact overall liquidity. For the majority of our counterparties, there is a termination event should long-term debt ratings of LNC drop below BBB-/Baa3. As noted in “Sources of Liquidity and Cash Flow” above, our long-term debt currently holds a rating of BBB/Baa2. In addition, contractual selling agreements with intermediaries could be negatively impacted, which could have an adverse impact on overall sales of annuities, life insurance and128AsSee “Part I – Item 1A. Risk Factors – A decrease in the capital and surplus of September 30, 2008, we maintained adequate currentour insurance subsidiaries may result in a downgrade to our insurer financial strength ratings” and senior debt“Part I – Item 1A. Risk Factors – A downgrade in our financial strength or credit ratings and do not anticipate any ratings-based impactcould limit our ability to future liquidity.market products, increase the number or value of policies being surrendered and/or hurt our relationships with creditors” in our 2008 Form 10-K for more information. See “Part I – Item 1. Business – Ratings” in our 20072008 Form 10-K and “Sources of Liquidity and Cash Flow” above for additional information on our current bond ratings. This relationship provides the company with another source of liquidity as an alternative to commercial paper and repurchase agreements as well as provides funding at comparatively low borrowing rates. We are allowed to borrow up to 20 times the amount of our common stock investment in FHLBI. All borrowings from the FHLBI are required to be secured by certain investments owned by LNL. On December 4, 2008, the LNC and LNL Boards of Directors approved an additional common stock investment of $56 million, which would increase our total borrowing capacity up to $1.5 billion. As of September 30, 2008,March 31, 2009, based on our common stock investment, we had borrowing capacity of up to approximately $378 million from FHLBI. We also had a $250 million floating-rate term loan outstanding under the facility due June 20, 2017, which may be prepaid beginning June 20, 2010.1. LNL’s RBC ratio is less than 175% (based on the most recent annual financial statement filed with the State of Indiana); or 2. (i) the sum of our consolidated net income for the four trailing fiscal quarters ending on the quarter that is two quarters prior to the most recently completed quarter prior to the determination date is zero or negative, and (ii) our consolidated shareholders’ equity (excluding accumulated other comprehensive income and any increase in shareholders’ equity resulting from the issuance of preferred stock during a quarter) (“adjusted shareholders’ equity”) as of (x) the most recently completed quarter and (y) the end of the quarter that is two quarters before the most recently completed quarter, has declined by 10% or more as compared to the quarter that is ten fiscal quarters prior to the last completed quarter (the “benchmark quarter”). alsowould have to utilize the ACSM until the trigger events above no longer existed. If we were required to utilize the ACSM and were successful in selling sufficient common shares or warrants to satisfy the interest payment, we would dilute the current holders of our common stock. Furthermore, while a trigger event is occurring and if we do not pay accrued interest in full, we may not, among other things, pay dividends on or repurchase our capital stock.90-day variable rate note outstanding (due December 16, 2008)trailing four quarter consolidated net loss of $128$811 million. Accordingly, we have triggered test 2(i) looking forward to the quarter ending September 30, 2009. Also, looking forward to the quarter ending September 30, 2009, we have triggered test 2(ii)(y) above as our adjusted shareholders’ equity as of March 31, 2009, as compared to the benchmark quarter (March 31, 2007) has declined by 10% or more. If our adjusted shareholders’ equity as of September 30, 2009, increases by less than $29 million which may be prepaid at any time. On October 2, 2008, our Board of Directors approved an additional common stock investment of $31 million,or further declines, then we would also trigger test 2(ii)(x) above, which would increasetrigger the ACSM for at least our total borrowing capacity upinterest payments due on November 17, 2009, and January 20, 2010, of approximately $33 million.$1.0 billion.maximize the use of available cash, the holding company maintainsmanage our capital more efficiently, we have an inter-company cash management accountprogram where certain subsidiaries can lend to or borrow from the holding company to meet their short-term needsborrowing needs. The cash management program is essentially a series of demand loans, which are permitted under applicable insurance laws, among LNC and can invest their short-term funds withits affiliates that reduces overall borrowing costs by allowing LNC and its subsidiaries to access internal resources instead of incurring third-party transaction costs. For our Indiana-domiciled insurance subsidiaries, the holding company. The holding company finances this program fromborrowing and lending limit is currently the lesser of 3% of the insurance company’s admitted assets and 25% of its primary sourcessurplus, in both cases, as of cash flow discussed above. Depending on the overall cash availability or need, the holding company invests excess cash in short-term investments or borrows funds in the financial markets.$162$423 million from the cash management accountprogram during the thirdfirst quarter of 2008.2009. The holding company had a maximum and minimum amount of financing that is used from the cash management accountprogram during this period of $334$603 million and none,$250 million, respectively.September 30, 2008,March 31, 2009, our insurance subsidiaries had securities with a carrying value of $463$311 million out on loan under the securities lending program and $280$460 million carrying value subject to reverse-repurchase agreements. The cash received in our securities lending program is typically invested in cash equivalents, short-term investments or fixed maturity securities.A-1,A-2, P-2 and F1.F2. We believe that a further downgrade of our short-term debt ratings will make it more expensive to sell additional commercial paper, and it may make it more likely that we will have to utilize other sources of liquidity, including our credit facilities, for liquidity purposes. The commercial paper program is backed by a bank line of credit. During the thirdfirst quarter of 2008,2009, LNC had an average of $257$532 million in commercial paper outstanding with a maximum amount of $394$776 million outstanding at any time. LNC had $120$686 million of commercial paper outstanding as of September 30, 2008.The Federal Reserve Board authorizedMarch 31, 2009.on October 7, 2008,program. We are not currently eligible to issue new commercial paper under Section 13(3)the CPFF. As of the Federal Reserve Act to provide a liquidity backstop to U.S. issuersMay 8, 2009, we had $70 million of commercial paper. Thepaper remaining under the CPFF, which is intendedscheduled to improve liquiditymature in short-term funding markets by increasingMay of 2009.availabilityOffice of term commercial paper fundingThrift Supervision approved LNC’s application to issuersbecome a savings and by providing greater assuranceloan holding company and its acquisition of Newton County Loan & Savings, FSB, a federally regulated savings bank, located in Indiana. LNC contributed $10 million to both issuersthe capital of Newton County Loan & Savings, FSB, and investors that firms will be able to roll over their maturing commercial paper. The commercial paper must be U.S. dollar-denominated and rated A-1/P-1/F1 by at least two rating agencies to be eligible forclosed on the program. On October 29, 2008, we were granted approvalpurchase on January 15, 2009. LNC also previously filed an application to participate in the CPFF, under whichCPP. LNC’s application to participate in the CPP is subject to approval from the U.S. Treasury. Accordingly, there can be no assurance that our application will be approved or that we may issue upwill participate in the CPP if approved.$575 million of commercial paper. Access to the CPFF is scheduled to terminate on April 30, 2009, unless such date is extended by the Federal Reserve.“Introduction – Acquisitions and Dispositions.”129 For the Three
Months Ended
September 30, For the Nine
Months Ended
September 30,
December 31, 2008 2007 Change 2008 2007 Change 2007 $ 106 $ 107 -1 % $ 323 $ 324 0 % $ 430 50 175 -71 % 476 686 -31 % 986 $ 156 $ 282 -45 % $ 799 $ 1,010 -21 % $ 1,416 1.010 3.092 -67 % 9.091 10.307 -12 % 15.381 $ 49.55 $ 56.45 -12 % $ 52.31 $ 66.58 -21 % $ 64.13 For the Three For the Months Ended Year Ended March 31, December 31, 2009 2008 Change 2008 Dividends to stockholders $ 54 $ 110 -51 % $ 429 Repurchase of common stock - 286 -100 % 476 Total cash returned to stockholders $ 54 $ 396 -86 % $ 905 Number of shares repurchased - 5.450 -100 % 9.091 Average price per share $ - $ 52.42 -100 % $ 52.31 above is calculated using whole dollars instead of dollars rounded to millionsOctober 10, 2008,February 24, 2009, the Board of Directors approved a decrease inreduction of the quarterly dividend on our common stock from $0.21 to stockholders from $0.415$0.01 per share, to $0.21 per share effective in 2009, which, along with a prior reduction, is expected to add approximately $50$100 million to capital each quarter. Additionally, we have suspended further stock repurchase activity. BothWe expect that both of these changes will favorably impact our capital position prospectively.
As stated above, LNC’s cash flow, as a holding company, is largely dependent upon the dividend capacity and surplus note interest payments of its insurance company subsidiaries. The insurance company subsidiaries’ dividend capacity issubsidiaries as well as their ability to otherwise forward funds to it through inter-company borrowing arrangements, which may be impacted by factors influencing their risk-based capitalthe insurance subsidiaries’ RBC and statutory earnings performance. Although we currentlyWe expect to be able to meet the holding company’s ongoing cash needs with a combination of commercial paper as available and our inter-company cash management program. We also have sufficientaccess to $1.0 billion in bank credit lines, as noted above, none of which are currently drawn. We are continuing to explore our options with regard to managing our liquidity and capital resourcespositions and expect that the available holding company borrowing sources combined with the previously mentioned dividend reductions, suspension of share repurchases and enterprise-wide restructuring program that is expected to meetgenerate $250 million, pre-tax, in annual savings will satisfy reduced holding company cash requirements for the foreseeable future. In addition, we are exploring our obligations in 2008,options with regard to protecting and building capital at the insurance company subsidiaries. Note, a continuation of or an acceleration of poor capital market conditions, which reduces our insurance subsidiaries’ statutory surplus and RBC, may require usthem to retain more capital in our insurance company subsidiaries and may pressure our subsidiaries’ dividends to the holding company, which may lead us to take steps to preserve or raise additional capital. For factors that could cause actual results to differ materially from those set forth in this section,affect our expectations for liquidity and capital, see “Part I – Item 1A. Risk Factors” in our 20072008 Form 10-K, as updated byin “Part II – Item 1A. Risk Factors” in this report.subsidiaries, to make permanent recent reductions in individual tax rates, to permanently repeal the estate tax and to increase regulation of our annuity and investment management businesses.subsidiaries. Although the eventual effect on us of the changing environment in which we operate remains uncertain, these factors and others could have a material effect on our results of operations, liquidity and capital resources. For factors that could cause actual results to differ materially from those set forth in this section, see “Part I – Item 1A. Risk Factors” in our 20072008 Form 10-K, as updated byin “Part II – Item 1A. Risk Factors” below, and “Forward-looking“Forward-Looking Statements – Cautionary Language” in this report. to our consolidated financial statements for a discussion of recent accounting pronouncements that have been implemented during the periods presented or that have been issued and are to be implemented in the future.130Item 3.Quantitative and Qualitative Disclosures About Market Riskrisk, foreign currency exchange, risk, equity market, risk, default, risk, basis risk and credit risk.credit. The exposuresexposure of financial instruments to market risks, and the related risk management processes,process, are most important to theour Retirement Solutions and Insurance Solutions businesses, where most of the invested assets support accumulation and investment-oriented insurance products. As an important element of our integrated asset-liability management process, we use derivatives to minimize the effects of changes in interest levels, and the shape of the yield curve.curve, currency movements and volatility. In this context, derivatives are designated as a hedge and serve to reduceminimize interest rate risk by mitigating the effect of significant increases in interest rates on our earnings. Additional market exposures exist in our other general account insurance products and in our debt structure and derivatives positions. TheOur primary sources of market risk are: substantial, relatively rapid and sustained increases or decreases in interest rates; fluctuations in currency exchange rates; or a sharp drop in equity market values. These market risks are discussed in detail in the following pages.Interest Rate RiskWith respect to accumulationpages and investment-oriented products, we seek to earn a stableshould be read in conjunction with, our consolidated financial statements and profitable spread, or margin, between investment income and interest credited to account values. If we have adverse experience on investments that cannot be passed on to customers, our spreads are reduced. Provided interest rates continue to gradually return to levels that are more typical from a long-term perspective, we do not view the near term risk to spreads over the next twelve months to be material. The combination of a probable range of interest rate changes over the next twelve months, asset-liability management strategies, flexibility in adjusting policy crediting rate levels and protection afforded by policy surrender charges and other switching costs all work together to mitigate this risk. The interest rate scenarios of concern are those in which there is a substantial, relatively rapid increase or decrease in interest rates that is then sustained over a long period.131Interest Rate Risk – Falling RatesThe spreads on our fixed annuity and interest-sensitive whole life, universal life (“UL”) and fixed portion of variable universal life (“VUL”) insurance policies are at risk if interest rates decline and remain low for a period of time, which has generally been the case in recent years. Should interest rates remain at current levels that are significantly lower than those existing prioraccompanying notes to the declines of recent years, the average earned rate of return on our annuityconsolidated financial statements (“Notes”) presented in “Item 1. Financial Statements and UL investment portfolios will continue to decline. Declining portfolio yields may cause the spreads between investment portfolio yields and the interest rate credited to contract holders to deteriorate as our ability to manage spreads can become limited by minimum guaranteed rates on annuity and UL policies. Minimum guaranteed rates on annuity and UL policies generally range from 1.5% to 5.0%, with an average guaranteed rate of approximately 4%. The following table provides detail on the percentage differences between the current interest rates being credited to contract holders and the respective minimum guaranteed policy rate, broken out by contract holder account values reported within the Retirement Solutions and Insurance Solutions businesses (in millions): As of September 30, 2008 Account Values Retirement Solutions Insurance
Solutions - Percent
of Total Annuities Defined
Contribution Life
Insurance Total Account
Values $ 1,606 $ — $ 10,422 $ 12,028 21.95 % 8,787 11,660 3,238 23,685 43.23 % — 4,641 1,518 6,159 11.24 % 2 2,638 848 3,488 6.37 % 79 947 161 1,187 2.17 % 1 572 144 717 1.31 % 191 1,262 62 1,515 2.77 % 80 1,016 33 1,129 2.06 % — 442 281 723 1.32 % 1 471 4 476 0.87 % — 356 9 365 0.67 % 36 631 7 674 1.23 % 149 282 52 483 0.88 % 189 636 426 1,251 2.28 % — 207 479 686 1.25 % 13 — — 13 0.02 % 184 22 — 206 0.38 % 9,712 25,783 7,262 42,757 78.05 % $ 11,318 $ 25,783 $ 17,684 $ 54,785 100.00 % (1)Contracts currently within new money rate bands are grouped according to the corresponding portfolio rate band in which they will fall upon their first anniversary.The maturity structure and call provisions of the related portfolios are structured to afford protection against erosion of investment portfolio yields during periods of declining interest rates. We devote extensive effort to evaluating the risks associated with falling interest rates by simulating asset and liability cash flows for a wide range of interest rate scenarios. We seek to manage these exposures by maintaining a suitable maturity structure and by limiting our exposure to call risk in each respective investment portfolio.Interest Rate Risk – Rising RatesFor both annuities and UL, a rapid and sustained rise in interest rates poses risks of deteriorating spreads and high surrenders. The portfolios supporting these products have fixed-rate assets laddered over maturities generally ranging from one to ten years or more. Accordingly, the earned rate on each portfolio lags behind changes in market yields. As rates rise, the lag may be increased132by slowing mortgage-backed securities prepayments. The greater and faster the rise in interest rates, the more the earned rate will tend to lag behind market rates. If we set renewal crediting rates to earn the desired spread, the gap between our renewal crediting rates and competitors’ new money rates may be wide enough to cause increased surrenders that could cause us to liquidate a portion of our portfolio to fund these surrenders. If we credit more competitive renewal rates to limit surrenders, our spreads will narrow. We devote extensive effort to evaluating these risks by simulating asset and liability cash flows for a wide range of interest rate scenarios. Such analysis has led to adjustments in the target maturity structure and to hedging the risk of rising rates by buying out-of-the-money interest rate cap agreements and swaptions. With these instruments in place, the potential adverse impact of a rapid and sustained rise in rates is kept within our risk tolerances.DebtWe manage the timing of maturities and the mixture of fixed-rate and floating-rate debt as part of the process of integrated management of interest rate risk for the entire enterprise.DerivativesWe have entered into derivative transactions to reduce our exposure to rapid changes in interest rates. The derivative programs are used to help us achieve more stable margins while providing competitive crediting rates to policyholders during periods when interest rates are changing. Such derivatives include interest rate swaps, interest rate futures, interest rate caps and treasury locks. During the first nine months of 2008, the more significant changes in our derivative positions were as follows:We entered into and terminated interest rate swap agreements hedging floating rate bond coupon payments with a notional amount of $17 million and $492 million, respectively, resulting in a remaining notional amount of $544 million. A loss of $6 million was recognized on the terminations. We also entered into $3.0 billion notional amount of interest rate swap agreements hedging a portion of the liability exposure on certain options in our variable annuity products, resulting in a total notional amount of $7.8 billion. These interest rate swap agreements convert floating rate bond coupon payments into a fixed rate of return.We entered into and terminated interest rate swap agreements hedging fixed rate bond coupon payments with a notional amount of $6 million and $14 million, resulting in a remaining notional amount of $295 million. A loss of $1 million was recognized on the terminations. These interest rate swap agreements are used to hedge our exposure to fixed rate bond coupon payments and the change in underlying asset values as interest rates fluctuate.Interest rate cap agreements with a notional amount of $1.3 billion matured, resulting in a remaining notional amount of $2.9 billion. These interest rate cap agreements are used to hedge our annuity business against a negative impact of a significant and sustained rise in interest rates.We entered into and terminated forward-starting interest rate swap agreements with a notional amount of $365 million and $355 million, respectively, resulting in a remaining notional amount of $60 million. These swaps are used to hedge interest rate risk associated with assets that support our annuity liabilities. A loss of $2 million was recognized on certain terminations and was reported in other comprehensive income (“OCI”). The loss will be reclassified from accumulated OCI recognized in income over the life of the purchased assets. A loss of $1 million was recognized on other terminations and was recorded in net income as benefits.In addition to continuing existing programs, we may use derivative instruments in other strategies to limit risk and enhance returns, particularly in the management of investment spread businesses. We have established policies, guidelines and internal control procedures for the use of derivatives as tools to enhance management of the overall portfolio of risks assumed in our operations. Annually, our Board of Directors reviews our derivatives policy.Foreign Currency Exchange RiskForeign Currency Denominated InvestmentsWe invest in foreign currency securities for incremental return and risk diversification relative to United States Dollar-Denominated (“USD”) securities. We use foreign currency swaps and foreign currency forwards to hedge some of the foreign exchange risk related to our investment in securities denominated in foreign currencies. The currency risk is hedged using foreign currency derivatives of the same currency as the bonds.We use foreign currency swaps to convert the cash flow of foreign currency securities to U.S. dollars. 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.133We use foreign currency forward contracts to hedge dividends received from our U.K. based subsidiary, Lincoln UK. The foreign currency forward contracts obligate us to deliver a specified amount of currency at a future date and a specified exchange rate.During the first nine months of 2008, a significant change in our foreign currency derivative positions was as follows:We entered into and terminated foreign exchange forward contracts with a notional amount of $231 million and $48 million, respectively, resulting in $183 million remaining notional amount. These contracts are hedging the net investment inSupplementary Data,” as well as dividends received from our Lincoln UK subsidiary. A loss“Item 2. Management’s Discussion and Analysis of less than $1 million was recognized on the terminations.Our revenues, assets, liabilities and derivatives are exposed to equity market risk. we expect that, in general, short-term fluctuations in the equity markets should not have a significant impact on our quarterly earnings from unlocking of assumptions for deferred acquisition costs (“DAC”), deferred sales inducements (“DSI”), value of business acquired (“VOBA”) and deferred front-end sales loads (“DFEL”). However, there is an impact to earnings from the effects of equity market movements on account values and assets under management and the related fees we earn on those assets. Refer to our Critical Accounting Policy – DAC, VOBA, DSI and DFEL for further discussion on the impact of equity markets on our RTM.Fee RevenuesThe fee revenues of our Investment Management segment and fees earned from variable annuities and variable life insurance products are exposed to the risk of a decline in equity market values. These fees are generally a fixed percentage of the market value of assets under management. In a severe equity market decline, fee income could be reduced by not only reduced market valuations but also by customer withdrawals and redemptions. Such withdrawals and redemptions from equity funds and accounts might be partially offset by transfers to our fixed-income accounts and the transfer of funds to us from our competitors’ customers.Assets and LiabilitiesWhile we invest in equity assets with the expectation of achieving higher returns than would be available in our core fixed-income investments, the returns on, and values of, these equity investments are subject to somewhat greater market risk than our fixed-income investments. These investments, however, add diversification benefits to our fixed-income investments.We have exposure to changes in our stock price through stock appreciation rights issued. This program is being hedged with equity derivatives.Derivatives Hedging Equity Market RiskDuring the first nine months of 2008, the more significant changes in our derivative positions hedging equity market risk were as follows:We had less than one million call options on an equal number of shares of Lincoln National Corporation (“LNC”) stock hedging the increase in liabilities arising from stock appreciation rights granted on LNC stock;We entered into and terminated variance swaps used to hedge the liability exposure on certain options in variable annuity products with a notional amount of $28 million and $3 million, respectively, resulting in a remaining notional amount of $31 million. A gain of $1 million was recognized on the terminations.We entered into Standard & Poor’s (“S&P”) 500 Index® call options with a notional amount of $2.1 billion, call options with a notional amount of $2.0 billion expired and terminated, resulting in a remaining notional amount of $3.0 billion to hedge the impact of the equity-index interest credited to our equity annuity products. A loss of $10 million was recognized on the terminations;We entered into and terminated put option agreements with a notional amount of $1.3 billion and $650 million, respectively, resulting in a remaining notional amount of $4.7 billion to hedge a portion of the liability exposure on certain options in our variable annuity products. A loss of $12 million was recognized on the terminations; andWe had net purchases and terminations in financial futures with a notional amount of $2.5 billion, resulting in a remaining notional amount of $3.0 billion to hedge a portion of the liability exposure on certain options in variable annuity products.134Impact of Equity Market SensitivityDue to the use of our RTM process and our hedging strategies as described in “MD& A—&A – Critical Accounting Policies and Estimates” in Item 2 above and in Item 7 of our 20072008 Form 10-K, we expect that, in general, short-term fluctuations in the equity markets should not have a significant impact on our quarterly earnings from unlocking of assumptions for DAC, VOBA, DSI and DFEL, as we do not unlock our long-term equity market assumptions based upon short-term fluctuations in the equity markets. However, there is an impact to earnings from the effects of equity market movements on account values and assets under management and the related asset-based fees we earn on those assets net of related expenses we incur based upon the level of assets. The following table below presents our estimate of the annual, after-tax, after-DAC, impact on income from operations from both a 1% and 10% decline in the equity markets (in millions), from the change in asset-based fees and related expenses, if the level of the S&P 500 were to remain at 800 from March 31, 2009, through the remainder of 2009 or dropped to 700 immediately after March 31, 2009, and remain at that level through the remainder of 2009, excluding any impact related to sales, prospective and retrospective unlocking, persistency, hedge program performance or customer behavior caused by the equity market change: Impact per
1% Change Impact per
10% ChangeInvestment Management Composite of Equity Assets (1) $ 1 $ 12 Retirement Solutions – Annuities Average daily change in the S&P 500 3 25 Retirement Solutions – Defined Contribution Average daily change in the S&P 500 1 8 Lincoln UK Average daily change in the FTSE 100 — 4 S&P 500 S&P 500 Segment $ (32 ) $ (10 ) (8 ) (4 ) Investment Management (6 ) - The Investment Management segment manages equity-based assets of varying styles (growth, value, blend and international) and underlying products (mutual funds, institutional accounts, insurance separate accounts, etc.). No single equity benchmark is an accurate predictorIf the level of the changeS&P 500 index dropped to 700 immediately after March 31, 2009, and remained at that level in earningssubsequent periods we project that we would have a RTM prospective unlocking of approximately $255 million to $315 million, after-tax, for this segment andRetirement Solutions around mid-2010. If the earnings impact summarized above includeslevel of the return on seed capital.(2) The baseline for these impacts assumes 2.25% growth per quarter beginning with the first quarter of 2009 earnings, when excluding the impacts of retrospective unlocking and federal tax return true-ups. The baseline is then compared to scenarios of S&P 500 at 700 and 800, which assume the index stays at those levels for the remainder of 2009. The difference between the baseline and S&P 500 at 700 and 800 scenarios is presented in the table. annual effect. The resulteffect for the remainder of the above factors should be multiplied by 25% to arrive at an estimated quarterly effect.2009. The effect of quarterly equity market changes upon fee revenues and asset-based expenses will not be fully recognized in the current quarter due to the fact thatbecause fee revenues are earned and related expenses are incurred based upon daily variable account values. The difference between the current period average daily variable account values compared to the end of period variable account values impacts fee revenues in subsequent periods. Additionally, the impact on earnings may not necessarily be symmetrical with comparable increases in the equity markets. This discussion concerning the estimated effects of ongoing equity market volatility on the fees we earn from account values and assets under management is intended to be illustrative. Actual effects may vary depending on a variety of factors, many of which are outside of our control, such as changing customer behaviors that might result in changes in the mix of our business between variable and fixed annuity contracts, switching among investment alternatives available within variable products, changes in sales production levels or changes in policy persistency. For purposes of this guidance, the change in account values is assumed to correlate with the change in the relevant index.Default RiskOur portfolio of invested assets was $68.0 billion and $71.9 billion as of September 30, 2008, and December 31, 2007, respectively. Of this total, $41.7 billion and $46.1 billion consist of corporate bonds and $7.7 billion and $7.4 billion consist of commercial mortgages as of September 30, 2008, and December 31, 2007, respectively. We manage the risk of adverse default experience on these investments by applying disciplined credit evaluation and underwriting standards, prudently limiting allocations to lower-quality, higher-yielding investments and diversifying exposures by issuer, industry, region and property type. For each counterparty or borrowing entity and its affiliates, our exposures from all transactions are aggregated and managed in relation to formal limits set by rating quality. Additional diversification limits, such as limits per industry, are also applied. We remain exposed to occasional adverse cyclical economic downturns during which default rates may be significantly higher than the long-term historical average used in pricing.We are depending on the ability of derivative product dealers and their guarantors to honor their obligations to pay the contract amounts under varioususe credit-related derivatives agreements. In order to minimize the risk of default losses, we diversify our exposures among several dealers and limit the amount of exposure to each in accordance with thecredit-related events and we also sell credit rating of each dealer or its guarantor. We generally limitdefault swaps to offer credit protection to our selection of counterparties that are obligated under these derivative contracts to those with an A credit rating or above.135Credit-Related DerivativesSeptember 30, 2008,March 31, 2009, and December 31, 2007,2008, we had no purchased credit default swaps outstanding. On a limited basis we also sell credit default swaps to offer credit protection to investors through trades that replicate the purchase of a fixed maturity security. When credit protection is sold, it is typically to replicate the purchase of a bond, similar to other investing activities. As of September 30, 2008,March 31, 2009, and December 31, 2007,2008, we had credit default swaps with a notional amount of $82$164 million and $60$149 million, which expire in 2010 through 2017.By usingthe Company.September 30, 2008,March 31, 2009, and December 31, 2007,2008, our counterparty risk exposure, net of collateral, was $429$448 million and $781$562 million, respectively. Of this exposure, $300$163 million and $567$145 million, respectively was related to our program to hedge our variable annuity guaranteed benefits. We have exposure to 1718 counterparties, with a maximum exposure of $88$182 million, net of collateral, to a single counterparty. The credit risk associated with such agreements is minimized by purchasing such agreements from financial institutions with long-standing, superior performance records. For the majority of LNC counterparties, there is a termination event should long-term debt ratings of LNC rating drop below BBB-/Baa3. Additionally, we maintain a policy of requiring all derivative contracts to be governed by an International SwapsISDA Master Agreement.Derivatives Association (“ISDA”) Master Agreement.Item 4.Controls and Procedures As of As of March 31, December 31, 2009 2008 Rating AAA $ 5 $ 20 AA 290 333 A 153 209 Total $ 448 $ 562 September 30, 2008,March 31, 2009, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.136Item 1.Legal Proceedings2007.2008. Item 1A.Risk Factorsfactorsfactor set forth below updateupdates those set forth in our Form 10-K for the year ended December 31, 2007. 2008. You should carefully consider the risks described below before investing in our securities. The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations. If any of these risks actually occur, our business, financial condition and results of operations could be materially affected. In that case, the value of our securities could decline substantially.Adverse capital and credit market conditions may significantly affect our ability to meet liquidity needs, access to capital and cost of capital.The capital and credit markets have been experiencing extreme volatility and disruption for more than twelve months. Over the last month, the volatility and disruption have reached unprecedented levels. In some cases, the markets have exerted downward pressure on availability of liquidity and credit capacity for certain issuers.We need liquidity to pay our operating expenses, interest on our debt and dividends on our capital stock, maintain our securities lending activities and replace certain maturing liabilities. Without sufficient liquidity,will be forced to curtail our operations, and our business will suffer. Asare a holding company with no direct operations, the inability of our subsidiaries to pay dividends to us in sufficient amounts would harm our ability to meet our obligations.asset isassets are the capital stock of our insurance subsidiaries.investment management subsidiaries. Ourlong-term instruments, including credit facilities, commercial paper and medium-term and long-term debt. However, our ability to meet our obligations for payment of interest and principal on outstanding debt obligations and to pay dividends to shareholders, repurchase our securities and pay corporate expenses depends significantly upon the surplus and earnings of our subsidiaries andprimarily on the ability of our subsidiaries to pay dividends or to advance or repay funds to us. PaymentsUnder Indiana laws and regulations, our Indiana insurance subsidiaries, including our primary insurance subsidiary, The Lincoln National Life Insurance Company, may pay dividends to us without prior approval of the Indiana Insurance Commissioner (the “Commissioner”) up to a certain threshold, or must receive prior approval of the Commissioner to pay a dividend if such dividend, along with all other dividends paid within the preceding twelve consecutive months exceed the statutory limitation. The current Indiana statutory limitation is the greater of 10% of the insurer’s contract holders’ surplus, as shown on its last annual statement on file with the Commissioner or the insurer’s statutory net gain from operations for the prior calendar year.including laws establishingrequiring that our insurance subsidiaries hold a specified amount of minimum solvencyreserves in order to meet future obligations on their outstanding policies. These regulations specify that the minimum reserves shall be calculated to be sufficient to meet future obligations, giving consideration for required future premiums to be received, are based on certain specified mortality and liquidity thresholds. morbidity tables, interest rates and methods of valuation, which are subject to change. In order to meet their claims-paying obligations, our insurance subsidiaries regularly monitor their reserves to ensure we hold sufficient amounts to cover actual or expected contract and claims payments. At times, we may determine that reserves in excess of the minimum may be needed to ensure sufficiency.principalholding company.our liquidityearnings are insurance premiums and fees, annuity considerations, investment advisory fees, and cash flowincome from our investment portfolio and assets, consisting mainly of cash or assets that are readily convertible into cash. AtRecent economic conditions have resulted in lower earnings in our insurance subsidiaries. Lower earnings constrain the growth in the insurance subsidiaries’ capital, and therefore, the payment of dividends and advances or repayment of funds to us.level, sourceswe believe that the holding company’s ongoing cash needs will continued to be met with a combination of liquidity in normal markets also include a variety of short- and long-term instruments, including repurchase agreements, credit facilities, commercial paper as available and medium-a contractual inter-company borrowing facility of up to $1 billion as well as access, if necessary, to $1 billion in bank credit lines, none of which are currently drawn. However, a further downgrade of our short-term credit ratings by Standard & Poor’s, Moody’s or Fitch may limit our ability to access the commercial paper market and long-term debt.financing. The availability of additional financing, will depend on a variety of factors such as market conditions, the general availability of credit, the volume of trading activities, the overall availability of credit to the financial services industry, our credit ratings and credit capacity, as well as the possibility that customers or lenders could develop a negative perception of our long- or short-term financial prospects if we incur large investment losses or if the level of our business activity decreased due to a market downturn. Similarly, our access to funds may be impaired if regulatory authorities or rating agencies take negative actions against us. Our internal sources of liquidity may prove to be insufficient, and in such case, wewhich may not be able to successfully obtain additional financing on favorableavailable or only available with unfavorable terms or at all.Disruptions, uncertainty or volatility in the capital and credit markets may also limit our access to capital required to operate our business, most significantly our insurance operations. Such market conditions may limit our ability to replace, inconditions. For a timely manner, maturing liabilities; satisfy statutory capital requirements; generate fee income and market-related revenue to meetfurther discussion of liquidity, needs; and access the capital necessary to grow our business. As such, we may be forced to delay raising capital, issue shorter tenor securities than we prefer, or bear an unattractive cost of capital which could decrease our profitability and significantly reduce our financial flexibility. Recently, our credit spreads have widened considerably which increases the interest rate we must pay on any new debt obligation we may issue. Our results of operations, financial condition, cash flows and statutory capital position could be materially adversely affected by disruptions in the financial markets.Difficult conditions in the global capital markets and the economy generally may materially adversely affect our business and results of operations and we do not expect these conditions to improve in the near future.Our results of operations are materially affected by conditions in the global capital markets and the economy generally, both in the U.S. and elsewhere around the world. The stress experienced by global capital markets that began in the second half of 2007137continued and substantially increased during the third quarter of 2008. Recently, concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. These factors, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown and fears of a possible recession. In addition, the fixed-income markets are experiencing a period of extreme volatility which has negatively impacted market liquidity conditions. Initially, the concerns on the part of market participants were focused on the subprime segment of the mortgage-backed securities market. However, these concerns have since expanded to include a broad range of mortgage-and asset-backed and other fixed income securities, including those rated investment grade, the U.S. and international credit and interbank money markets generally, and a wide range of financial institutions and markets, asset classes and sectors. As a result, the market for fixed income instruments has experienced decreased liquidity, increased price volatility, credit downgrade events, and increased probability of default. Securities that are less liquid are more difficult to value and may be hard to dispose of. Domestic and international equity markets have also been experiencing heightened volatility and turmoil, with issuers (such as our company) that have exposure to the real estate, mortgage and credit markets particularly affected. These events and the continuing market upheavals may have an adverse effect on us, in part because we have a large investment portfolio and are also dependent upon customer behavior. Our revenues are likely to decline in such circumstances and our profit margins could erode. In addition, in the event of extreme prolonged market events, such as the global credit crisis, we could incur significant losses. Even in the absence of a market downturn, we are exposed to substantial risk of loss due to market volatility.We are a significant writer of variable annuity products. The account values of these products will be affected by the downturn in capital markets. Any decrease in account values will decrease the fees generated by our variable annuity products.Factors such as consumer spending, business investment, government spending, the volatility and strength of the capital markets, and inflation all affect the business and economic environment and, ultimately, the amount and profitability of our business. In an economic downturn characterized by higher unemployment, lower family income, lower corporate earnings, lower business investment and lower consumer spending, the demand for our financial and insurance products could be adversely affected. In addition, we may experience an elevated incidence of claims and lapses or surrenders of policies. Our policyholders may choose to defer paying insurance premiums or stop paying insurance premiums altogether. Adverse changes in the economy could affect earnings negatively and could have a material adverse effect on our business, results of operations and financial condition. The current mortgage crisis has also raised the possibility of future legislative and regulatory actions in addition to the recent enactment of the Emergency Economic Stabilization Act of 2008 (the “EESA”) that could further impact our business. We cannot predict whether or when such actions may occur, or what impact, if any, such actions could have on our business, results of operations and financial condition. A further material deterioration in economic conditions may require us to raise additional capital or consider other transactions to manage our capital position or our liquidity.There can be no assurance that actions of the U.S. Government, Federal Reserve and other governmental and regulatory bodies for the purpose of stabilizing the financial markets will achieve the intended effect.In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, President Bush signed the EESA into law. Pursuant to the EESA, the U.S. Treasury has the authority to, among other things, purchase up to $700 billion of mortgage-backed and other securities from financial institutions for the purpose of stabilizing the financial markets. The Federal Government, Federal Reserve and other governmental and regulatory bodies have taken or are considering taking other actions to address the financial crisis. There can be no assurance as to what impact such actions will have on the financial markets, including the extreme levels of volatility currently being experienced. As of September 30, 2008 our residential mortgage-backed securities balance was $9.2 billion, of which 96% was rated AA or above, and our unrealized loss was $897 million. Such continued volatility could materially and adversely affect our business, financial condition and results of operations, or the trading price of our common stock. Seesee “Item 7–2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Review of Consolidated InvestmentsFinancial Condition – Fixed MaturityLiquidity and Capital Resources.”Portfolios” for additional information on our investment portfolio.The impairmentand Use of other financial institutions could adversely affect us.ProceedsWe have exposure to many different industries and counterparties, and routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, and other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty. In addition, with respect to secured transactions, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due to it. We also may have exposure to these financial institutions in the form of unsecured debt instruments, derivative transactions and/or equity investments. There can be no assurance that any such losses or impairments to the carrying value of these assets would not materially and adversely affect our business and results of operations.138Our participation in a securities lending program subjects us to potential liquidity and other risks.We participate in a securities lending program for our general account whereby fixed income securities are loaned by our agent bank to third parties, primarily major brokerage firms and commercial banks. The borrowers of our securities provide us with collateral, typically in cash, which we separately maintain. We invest such cash collateral in other securities, primarily in commercial paper and money market or other short term funds. Securities with a cost or amortized cost of $481 million and $612 million and an estimated fair value of $435 million and $634 million were on loan under the program at September 30, 2008, and December 31, 2007, respectively. Securities loaned under such transactions may be sold or repledged by the transferee. We were liable for cash collateral under our control of $463 million and $655 million at September 30, 2008, and December 31, 2007, respectively.As of September 30, 2008, approximately all securities on loan under the program could be returned to us by the borrowers at any time. Returns of loaned securities would require us to return the cash collateral associated with such loaned securities. In addition, in some cases, the maturity of the securities held as invested collateral (i.e., securities that we have purchased with cash received from the third parties) may exceed the term of the related securities loan and the market value may fall below the amount of cash received as collateral and invested. If we are required to return significant amounts of cash collateral on short notice and we are forced to sell securities to meet the return obligation, we may have difficulty selling such collateral that is invested in securities in a timely manner, be forced to sell securities in a volatile or illiquid market for less than we otherwise would have been able to realize under normal market conditions, or both. In addition, under stressful capital market and economic conditions, such as those conditions we have experienced recently, liquidity broadly deteriorates, which may further restrict our ability to sell securities.Our reserves for future policy benefits and claims related to our current and future business as well as businesses we may acquire in the future may prove to be inadequate.Our reserves for future policy benefits and claims may prove to be inadequate. We establish and carry, as a liability, reserves based on estimates of how much we will need to pay for future benefits and claims. For our life insurance and annuity products, we calculate these reserves based on many assumptions and estimates, including estimated premiums we will receive over the assumed life of the policy, the timing of the event covered by the insurance policy, the lapse rate of the policies, the amount of benefits or claims to be paid and the investment returns on the assets we purchase with the premiums we receive. The assumptions and estimates we use in connection with establishing and carrying our reserves are inherently uncertain. Accordingly, we cannot determine with precision the ultimate amounts that we will pay, or the timing of payment of, actual benefits and claims or whether the assets supporting the policy liabilities will grow to the level we assume prior to payment of benefits or claims. If our actual experience is different from our assumptions or estimates, our reserves may prove to be inadequate in relation to our estimated future benefits and claims. As a result, we would incur a charge to our earnings in the quarter in which we increase our reserves.Because the equity markets and other factors impact the profitability and expected profitability of many of our products, changes in equity markets and other factors may significantly affect our business and profitability.The fee revenue that we earn on equity-based variable annuities, unit-linked accounts, VUL insurance policies and investment advisory business is based upon account values. Because strong equity markets result in higher account values, strong equity markets positively affect our net income through increased fee revenue. Conversely, a weakening of the equity markets results in lower fee income and may have a material adverse effect on our results of operations and capital resources.The increased fee revenue resulting from strong equity markets increases the expected gross profits (“EGPs”) from variable insurance products as do better than expected lapses, mortality rates and expenses. As a result, the higher EGPs may result in lower net amortized costs related to deferred acquisition costs (“DAC”), deferred sales inducements (“DSI”), value of business acquired (“VOBA”), and deferred front-end sales loads (“DFEL”). However, a decrease in the equity markets as well as worse than expected increases in lapses, mortality rates and expenses depending upon their significance, may result in higher net amortized costs associated with DAC, DSI, VOBA and DFEL and may have a material adverse effect on our results of operations and capital resources. For example, if equity markets continued to decline by 20% and remained at those levels during the fourth quarter of 2008, we may have to reset our “reversion to the mean” (RTM) process that we use to compute our best estimate of long-term gross growth rate assumption. We estimate that such a reset would result in a cumulative unfavorable prospective unlocking in the range of approximately $200-$300 million, after-tax. For more information on DAC, DSI, VOBA and DFEL amortization, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operation – Critical Accounting Policies and Estimates” on page 40 of our Annual Report on Form 10-K for the year ended December 31, 2007, and “Part I. Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operation – Critical Accounting Policies and Estimates” above.139Changes in the equity markets, interest rates and/or volatility affects the profitability of our products with guaranteed benefits; therefore, such changes may have a material adverse effect on our business and profitability.Certain of our variable annuity products include guaranteed minimum benefit riders. These include guaranteed minimum death benefit (“GDB”), guaranteed minimum withdrawal benefit (“GWB”) and guaranteed minimum income benefit (“GIB”) riders. The amount of reserves related to GDB for variable annuities is tied to the difference between the value of the underlying accounts and the guaranteed death benefit, calculated using a benefit ratio approach. The GDB reserves take into account the present value of total expected GDB payments and the present value of total expected assessments over the life of the contract and claims and assessments to date. The amount of reserves related to GWB and GIB for variable annuities is based on the fair value of the underlying benefit. Both the level of expected GDB payments and expected total assessments used in calculating the benefit ratio are affected by the equity markets. The liabilities related to GWB and GIB benefits valued at fair value are impacted by changes in equity markets, interest rates and volatility. Accordingly, strong equity markets will decrease the amount of GDB reserves that we must carry, and strong equity markets, increases in interest rates and decreases in volatility will generally decrease the fair value of the liabilities underlying the GWB and GIB benefits.Conversely, a decrease in the equity markets will increase the net amount at risk under the GDB benefits we offer as part of our variable annuity products, which has the effect of increasing the amount of GDB reserves that we must carry. Also, a decrease in the equity market along with a decrease in interest rates and an increase in volatility will generally result in an increase in the fair value of the liabilities underlying GWB and GIB benefits, which has the effect of increasing the amount of GWB and GIB reserves that we must carry. Such an increase in reserves would result in a charge to our earnings in the quarter in which we increase our reserves. We maintain a customized dynamic hedge program that is designed to mitigate the risks associated with income volatility around the change in reserves on guaranteed benefits. However, the hedge positions may not be effective to exactly offset the changes in the carrying value of the guarantees due to, among other things, the time lag between changes in their values and corresponding changes in the hedge positions, high levels of volatility in the equity markets and derivatives markets, extreme swings in interest rates, contract holder behavior different than expected, and divergence between the performance of the underlying funds and hedging indices. For example, the quarter ended September 30, 2008, we experienced a breakage between the change in our guaranteed benefit reserve and the value of our hedges of $252 million. Breakage is defined as the difference between the change in the fair value of the liabilities, excluding the amount related to the non-performance risk component and the change in the fair value of the derivatives. The breakage also excludes the amount we determine to be the cost of hedging. In addition, we remain liable for the guaranteed benefits in the event that derivative counterparties are unable or unwilling to pay, and we are also subject to the risk that the cost of hedging these guaranteed benefits increases, resulting in a reduction to net income. We also must consider our own credit standing, which is not hedged, in the valuation of certain of these liabilities. A decrease in our own credit spread could cause the value of these liabilities to increase, resulting in a reduction to net income. For more information on our hedging program, see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operation – Critical Accounting Policies and Estimates – Future Contract Benefits and Other Contract Holder Funds” on page 47 of our Annual Report on Form 10-K for the year ended December 31, 2007. These, individually or collectively, may have a material adverse effect on net income, financial condition or liquidity.Changes in interest rates may cause interest rate spreads to decrease and may result in increased contract withdrawals.Because the profitability of our fixed annuity and interest-sensitive whole life, universal life (“UL”) and fixed portion of variable universal life (“VUL”) insurance business depends in part on interest rate spreads, interest rate fluctuations could negatively affect our profitability. Changes in interest rates may reduce both our profitability from spread businesses and our return on invested capital. Some of our products, principally fixed annuities and interest-sensitive whole life, universal life and the fixed portion of variable universal life insurance, have interest rate guarantees that expose us to the risk that changes in interest rates will reduce our “spread,” or the difference between the amounts that we are required to pay under the contracts and the amounts we are able to earn on our general account investments intended to support our obligations under the contracts. Declines in our spread or instances where the returns on our general account investments are not enough to support the interest rate guarantees on these products could have a material adverse effect on our businesses or results of operations.In periods of increasing interest rates, we may not be able to replace the assets in our general account with higher yielding assets needed to fund the higher crediting rates necessary to keep our interest sensitive products competitive. We therefore may have to accept a lower spread and thus lower profitability or face a decline in sales and greater loss of existing contracts and related assets. In periods of declining interest rates, we have to reinvest the cash we receive as interest or return of principal on our investments in lower yielding instruments then available. Moreover, borrowers may prepay fixed-income securities, commercial mortgages and mortgage-backed securities in our general account in order to borrow at lower market rates, which exacerbates this risk. Because we are entitled to reset the interest rates on our fixed rate annuities only at limited, pre-established intervals, and since many of our contracts have guaranteed minimum interest or crediting rates, our spreads could decrease and potentially become negative.140Increases in interest rates may cause increased surrenders and withdrawals of insurance products. In periods of increasing interest rates, policy loans and surrenders and withdrawals of life insurance policies and annuity contracts may increase as contract holders seek to buy products with perceived higher returns. This process may lead to a flow of cash out of our businesses. These outflows may require investment assets to be sold at a time when the prices of those assets are lower because of the increase in market interest rates, which may result in realized investment losses. A sudden demand among consumers to change product types or withdraw funds could lead us to sell assets at a loss to meet the demand for funds.Our requirements to post collateral or make payments related to declines in market value of specified assets may adversely affect our liquidity and expose us to counterparty credit risk.Many of our transactions with financial and other institutions specify the circumstances under which the parties are required to post collateral. The amount of collateral we may be required to post under these agreements may increase under certain circumstances, which could adversely affect our liquidity. In addition, under the terms of some of our transactions we may be required to make payment to our counterparties related to any decline in the market value of the specified assets.Defaults on our mortgage loans and volatility in performance may adversely affect our profitability.Our mortgage loans face default risk and are principally collateralized by commercial and residential properties. Mortgage loans are stated on our balance sheet at unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or expenses, and are net of valuation allowances. We establish valuation allowances for estimated impairments as of the balance sheet date based information such as the market value of the underlying real estate securing the loan, any third party guarantees on the loan balance or any cross collateral agreements and their impact on expected recovery rates. At September 30, 2008, no loans were either delinquent or in the process of foreclosure for our mortgage loan investments. The performance of our mortgage loan investments, however, may fluctuate in the future. In addition, some of our mortgage loan investments have balloon payment maturities. An increase in the default rate of our mortgage loan investments could have a material adverse effect on our business, results of operations and financial condition.Further, any geographic or sector exposure in our mortgage loans may have adverse effects on our investment portfolios and consequently on our consolidated results of operations or financial condition. While we seek to mitigate this risk by having a broadly diversified portfolio, events or developments that have a negative effect on any particular geographic region or sector may have a greater adverse effect on the investment portfolios to the extent that the portfolios are exposed.Our investments are reflected within the consolidated financial statements utilizing different accounting basis and accordingly we may not have recognized differences, which may be significant, between cost and fair value in our consolidated financial statements.Our principal investments are in fixed maturity and equity securities, mortgage loans on real estate, real estate (either wholly owned or in joint ventures), policy loans, short-term investments, derivative instruments and limited partnerships and other invested assets. The carrying value of such investments is as follows:Fixed maturity and equity securities are classified as available-for-sale, except for those designated as trading securities, and are reported at their estimated fair value. The difference between the estimated fair value and amortized cost of such securities, i.e., unrealized investment gains and losses, are recorded as a separate component of other comprehensive income or loss, net of policyholder related amounts and deferred income taxes.Fixed maturity and equity securities designated as trading securities, which support certain reinsurance arrangements, are recorded at fair value with subsequent changes in fair value recognized in realized gains and losses. However, offsetting the changes to fair value of the trading securities are corresponding changes in the fair value of the embedded derivative liability associated with the underlying reinsurance arrangement. In other words, the investment results for the trading securities, including gains and losses from sales, are passed directly to the reinsurers through the contractual terms of the reinsurance arrangements.Short-term investments include investments with remaining maturities of one year or less, but greater than three months, at the time of acquisition and are stated at amortized cost, which approximates fair value.Mortgage loans are stated at unpaid principal balance, adjusted for any unamortized premium or discount, deferred fees or expenses, net of valuation allowances.Policy loans are stated at unpaid principal balances.Real estate joint ventures and other limited partnership interests are carried using the equity method of accounting.Other invested assets consist principally of derivatives with positive fair values. Derivatives are carried at fair value with changes in fair value reflected in income from non-qualifying derivatives and derivatives in fair value hedging relationships. Derivatives in cash flow hedging relationships are reflected as a separate component of other comprehensive income or loss.141Investments not carried at fair value in our consolidated financial statements — principally, mortgage loans, policy loans and real estate — may have fair values which are substantially higher or lower than the carrying value reflected in our consolidated financial statements. In addition, unrealized losses are not reflected in net income unless we realize the losses by either selling the security at below amortized cost or determine that the decline in fair value is deemed to be other than temporary, i.e., impaired. Each of such asset classes is regularly evaluated for impairment under the accounting guidance appropriate to the respective asset class.Our valuation of fixed maturity, equity and trading securities may include methodologies, estimations and assumptions which are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations or financial condition.Fixed maturity, equity, trading securities and short-term investments which are reported at fair value on the consolidated balance sheet represented the majority of our total cash and invested assets. Pursuant to Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”) “Fair Value Measurements,” we have categorized these securities into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). An asset or liability’s classification within the fair value hierarchy is based of the lowest level of significant input to its valuation. SFAS No. 157 defines the input levels as follows:Level 1 – inputs to the valuation methodology are quoted prices available in active markets for identical investments as of the reporting date. “Blockage discounts” for large holdings of unrestricted financial instruments where quoted prices are readily and regularly available for an identical asset or liability in an active market are prohibited;Level 2 – inputs to the valuation methodology are other than quoted prices in active markets, which are either directly or indirectly observable as of the reporting date, and fair value can be determined through the use of models or other valuation methodologies; andLevel 3 – inputs to the valuation methodology are unobservable inputs in situations where there is little or no market activity for the asset or liability and the reporting entity makes estimates and assumptions related to the pricing of the asset or liability, including assumptions regarding risk.At September 30, 2008, approximately .5%, 90.4%, and 9.1% of these securities represented Level 1, Level 2 and Level 3, respectively. The Level 1 securities primarily consist of certain U.S. Treasury and agency fixed maturity securities and exchange-traded common stock. The Level 2 assets include fixed maturity securities priced principally through independent pricing services including most U.S. Treasury and agency securities as well as the majority of U.S. and foreign corporate securities, residential mortgage-backed securities, commercial mortgage-backed securities, state and political subdivision securities, foreign government securities, and asset-backed securities as well as equity securities, including non-redeemable preferred stock, priced by independent pricing services. Management reviews the valuation methodologies used by the pricing services on an ongoing basis and ensures that any valuation methodologies are justified. Level 3 assets include fixed maturity securities priced principally through independent broker quotes or market standard valuation methodologies. This level consists of less liquid fixed maturity securities with very limited trading activity or where less price transparency exists around the inputs to the valuation methodologies including: U.S. and foreign corporate securities — including below investment grade private placements; residential mortgage-backed securities; asset backed securities; and other fixed maturity securities such as structured securities. Equity securities classified as Level 3 securities consist principally of common stock of privately held companies and non-redeemable preferred stock where there has been very limited trading activity or where less price transparency exists around the inputs to the valuation.Prices provided by independent pricing services and independent broker quotes can vary widely even for the same security.The determination of fair values in the absence of quoted market prices is based on: (i) valuation methodologies; (ii) securities we deem to be comparable; and (iii) assumptions deemed appropriate given the circumstances. The fair value estimates are made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty. Factors considered in estimating fair value include: coupon rate, maturity, estimated duration, call provisions, sinking fund requirements, credit rating, industry sector of the issuer, and quoted market prices of comparable securities. The use of different methodologies and assumptions may have a material effect on the estimated fair value amounts.During periods of market disruption including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities, if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, more securities may fall to Level 3 and thus require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater142estimation as well as valuation methods which are more sophisticated or require greater estimation thereby resulting in values which may be less than the value at which the investments may be ultimately sold. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of securities as reported within our consolidated financial statements and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on our results of operations or financial condition.Some of our investments are relatively illiquid and are in asset classes that have been experiencing significant market valuation fluctuations.We hold certain investments that may lack liquidity, such as privately placed fixed maturity securities; mortgage loans; policy loans; and equity real estate, including real estate joint venture; and other limited partnership interests. These asset classes represented 27% of the carrying value of our total cash and invested assets as of September 30, 2008. Even some of our very high quality assets have been more illiquid as a result of the recent challenging market conditions.If we require significant amounts of cash on short notice in excess of normal cash requirements or are required to post or return collateral in connection with our investment portfolio, derivatives transactions or securities lending activities, we may have difficulty selling these investments in a timely manner, be forced to sell them for less than we otherwise would have been able to realize, or both.The reported value of our relatively illiquid types of investments, our investments in the asset classes described in the paragraph above and, at times, our high quality, generally liquid asset classes, do not necessarily reflect the lowest current market price for the asset. If we were forced to sell certain of our assets in the current market, there can be no assurance that we will be able to sell them for the prices at which we have recorded them and we may be forced to sell them at significantly lower prices.We invest a portion of our invested assets in investment funds, many of which make private equity investments. The amount and timing of income from such investment funds tends to be uneven as a result of the performance of the underlying investments, including private equity investments. The timing of distributions from the funds, which depends on particular events relating to the underlying investments, as well as the funds’ schedules for making distributions and their needs for cash, can be difficult to predict. As a result, the amount of income that we record from these investments can vary substantially from quarter to quarter. Recent equity and credit market volatility may reduce investment income for these types of investments.The determination of the amount of allowances and impairments taken on our investments is highly subjective and could materially impact our results of operations or financial position.The determination of the amount of allowances and impairments vary by investment type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects changes in allowances and impairments in operations as such evaluations are revised. There can be no assurance that our management has accurately assessed the level of impairments taken and allowances reflected in our financial statements. Furthermore, additional impairments may need to be taken or allowances provided for in the future. Historical trends may not be indicative of future impairments or allowances.For example, the cost of our fixed maturity and equity securities is adjusted for impairments in value deemed to be other-than-temporary in the period in which the determination is made. The assessment of whether impairments have occurred is based on management’s case-by-case evaluation of the underlying reasons for the decline in fair value. In evaluating whether a decline in value is other-than-temporary, we consider several factors including, but not limited to: 1) our ability and intent to hold the security for a sufficient period of time to allow for a recovery in value; 2) the cause of the decline; 3) fundamental analysis of the liquidity, business prospects and overall financial condition of the issuer; and 4) severity of the decline in value.Additionally, our management considers a wide range of factors about the security issuer and uses their best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Another key factor in whether determining an other-than-temporary impairment has occurred is our “intent or ability to hold to recovery or maturity.” In the event that we determine that we do not have the intent or ability to hold to recovery or maturity, we are required to write down the security. A write-down is necessary even in situations where the unrealized loss is not due to an underlying credit issue, but may be solely related to the impact of changes in interest rates on the fair value of the security. Where such analysis results in a conclusion that declines in fair values are other-than-temporary, the security is written down to fair value.143Our gross unrealized losses on fixed maturity securities available-for-sale at September 30, 2008, were $4.8 billion pre-tax and the component of gross unrealized losses for securities trading down 20% or more for six months is approximately $2.4 billion pre-tax. Related to our unrealized losses we establish deferred tax assets for the tax benefit we may receive in the event that losses are realized. The realization of significant realized losses could result in an inability to recover the tax benefits and may result in the establishment of valuation allowances against our deferred tax assets. Realized losses or impairments may have a material adverse impact on our results of operation and financial position.A downgrade in our financial strength or credit ratings could limit our ability to market products, increase the number or value of policies being surrendered and/or hurt our relationships with creditors.Nationally recognized rating agencies rate the financial strength of our principal insurance subsidiaries and rate our debt. Ratings are not recommendations to buy our securities. Each of the rating agencies reviews its ratings periodically, and our current ratings may not be maintained in the future. Please see “Item 1 – Business – Ratings” on page 20 of our Annual Report on Form 10-K for the year ended December 31, 2007, for a complete description of our ratings.Our financial strength ratings, which are intended to measure our ability to meet contract holder obligations, are an important factor affecting public confidence in most of our products and, as a result, our competitiveness. A downgrade of the financial strength rating of one of our principal insurance subsidiaries could affect our competitive position in the insurance industry and make it more difficult for us to market our products as potential customers may select companies with higher financial strength ratings. This could lead to a decrease in fees as outflows of assets increase, and therefore, result in lower fee income. Furthermore, sales of assets to meet customer withdrawal demands could also result in losses, depending on market conditions. The interest rates we pay on our borrowings are largely dependent on our credit ratings. A downgrade of our debt ratings could affect our ability to raise additional debt, including bank lines of credit, with terms and conditions similar to our current debt, and accordingly, likely increase our cost of capital. In addition, a downgrade of these ratings could make it more difficult to raise capital to refinance any maturing debt obligations, to support business growth at our insurance subsidiaries and to maintain or improve the current financial strength ratings of our principal insurance subsidiaries described above.Our businesses are heavily regulated and changes in regulation may reduce our profitability.Our insurance subsidiaries are subject to extensive supervision and regulation in the states in which we do business. The supervision and regulation relate to numerous aspects of our business and financial condition. The primary purpose of the supervision and regulation is the protection of our insurance contract holders, and not our investors. The extent of regulation varies, but generally is governed by state statutes. These statutes delegate regulatory, supervisory and administrative authority to state insurance departments. This system of supervision and regulation covers, among other things:Standards of minimum capital requirements and solvency, including risk-based capital measurements;Restrictions of certain transactions between our insurance subsidiaries and their affiliates;Restrictions on the nature, quality and concentration of investments;Restrictions on the types of terms and conditions that we can include in the insurance policies offered by our primary insurance operations;Limitations on the amount of dividends that insurance subsidiaries can pay;The existence and licensing status of the company under circumstances where it is not writing new or renewal business;Certain required methods of accounting;Reserves for unearned premiums, losses and other purposes; andAssignment of residual market business and potential assessments for the provision of funds necessary for the settlement of covered claims under certain policies provided by impaired, insolvent or failed insurance companies.In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending on a variety of factors – the amount of statutory income or losses generated by our insurance subsidiaries (which itself is sensitive to equity market and credit market conditions), the amount of additional capital our insurance subsidiaries must hold to support business growth, changes in equity market levels, the value of certain fixed-income and equity securities in our investment portfolio, the value of certain derivative instruments that do not get hedge accounting, changes in interest rates and foreign currency exchange rates, as well as changes to the NAIC RBC formulas. Most of these factors are outside of our control. LNC’s credit ratings are significantly influenced by the statutory surplus amounts and RBC ratios of our insurance company subsidiaries. In addition, rating agencies may implement changes to their internal models that have the effect of increasing or decreasing the amount of statutory capital we must hold in order to maintain our current ratings. In addition, in extreme scenarios of equity market declines, the amount of additional statutory reserves that we are required to hold for our variable annuity products increases at a greater than linear rate. This reduces the statutory surplus used in calculating our RBC ratios. To the extent that our statutory capital resources are deemed144to be insufficient to maintain a particular rating by one or more rating agencies, we may seek to raise additional capital. Alternatively, if we were not to raise additional capital in such a scenario, either at our discretion or because we were unable to do so, our financial strength and credit ratings might be downgraded by one or more rating agencies.We may be unable to maintain all required licenses and approvals and our business may not fully comply with the wide variety of applicable laws and regulations or the relevant authority’s interpretation of the laws and regulations, which may change from time to time. Also, regulatory authorities have relatively broad discretion to grant, renew or revoke licenses and approvals. If we do not have the requisite licenses and approvals or do not comply with applicable regulatory requirements, the insurance regulatory authorities could preclude or temporarily suspend us from carrying on some or all of our activities or impose substantial fines. Further, insurance regulatory authorities have relatively broad discretion to issue orders of supervision, which permit such authorities to supervise the business and operations of an insurance company. As of 2008, no state insurance regulatory authority had imposed on us any substantial fines or revoked or suspended any of our licenses to conduct insurance business in any state or issued an order of supervision with respect to our insurance subsidiaries, which would have a material adverse effect on our results of operations or financial condition.In addition, LFN and LFD, as well as our variable annuities and variable life insurance products, are subject to regulation and supervision by the SEC and FINRA. Our Investment Management segment, like other investment management companies, is subject to regulation and supervision by the SEC, FINRA, the Municipal Securities Rulemaking Board, the Pennsylvania Department of Banking and jurisdictions of the states, territories and foreign countries in which they are licensed to do business. Lincoln UK is subject to regulation by the FSA in the U.K. These laws and regulations generally grant supervisory agencies and self-regulatory organizations broad administrative powers, including the power to limit or restrict the subsidiaries from carrying on their businesses in the event that they fail to comply with such laws and regulations. Finally, our radio operations require a license, subject to periodic renewal, from the Federal Communications Commission to operate. While management considers the likelihood of a failure to renew remote, any station that fails to receive renewal would be forced to cease operations.Many of the foregoing regulatory or governmental bodies have the authority to review our products and business practices and those of our agents and employees. In recent years, there has been increased scrutiny of our businesses by these bodies, which has included more extensive examinations, regular “sweep” inquiries and more detailed review of disclosure documents. These regulatory or governmental bodies may bring regulatory or other legal actions against us if, in their view, our practices, or those of our agents or employees, are improper. These actions can result in substantial fines, penalties or prohibitions or restrictions on our business activities and could have a material adverse effect on our business, results of operations or financial condition.For further information on regulatory matters relating to us, see “Item 1. Business – Regulatory,” beginning on page 21 of our Annual Report on Form 10-K for the year ended December 31, 2007.145Item 2.Unregistered Sales(c) The following table summarizes purchases of Equity Securities and Use of Proceedsequity securities by the issuer during the quarter ended March 31, 2009 (dollars in millions, except per share data):(c) The following table summarizes purchases of equity securities by the issuer during the quarter ended September 30, 2008 (dollars in millions, except per share data): (a) Total
Number
of Shares
(or Units)
Purchased (1) (b) Average
Price Paid
per Share
(or Unit) (c) Total Number
of Shares (or Units)
Purchased as Part of
Publicly Announced
Plans or Programs (2) (d) Approximate Dollar
Value of Shares (or
Units) that May Yet Be
Purchased Under the
Plans or Programs(3) 3,439 $ 44.41 — $ 1,238.2 684,227 48.76 665,000 1,205.8 344,659 50.93 344,644 1,204.0 (a) Total (c) Total Number (d) Approximate Dollar Number (b) Average of Shares (or Units) Value of Shares (or of Shares Price Paid Purchased as Part of Units) that May Yet Be (or Units) per Share Publicly Announced Purchased Under the Period Purchased (or Unit) 1/1/09 - 1/31/09 - $ - - $ 1,204 2/1/09 - 2/28/09 64 9.08 - 1,204 3/1/09 - 3/31/09 158 (1) 5.62 - 1,204 22,681222 shares were withheld for taxes on the vesting of restricted stock. For the quarter ended September 30, 2008,March 31, 2009, there were 1,009,644no shares purchased as part of publicly announced plans or programs.September 30, 2008,March 31, 2009, our security repurchase authorization was $1.2 billion. The security repurchase authorization does not have an expiration date. The amount and timing of share repurchase depends on key capital ratios, rating agency expectations, the generation of free cash flow and an evaluation of the costs and benefits associated with alternative uses of capital. The shares repurchased in connection with the awards described in footnote (1)Note 12 are not included in our security repurchase. 5.Other Information(a) (1) On November 6 2008, J. Patrick Barrett, a director and the non-executive Chairman of the Board of Directors, informed the Board that pursuant to the retirement age policy set forth in Lincoln National Corporation’s (the “Company”) corporate governance guidelines, he would be retiring and resigning from the board at the end of the second day immediately preceding the 2009 annual meeting of shareholders, or May 12, 2009.(2) Effective November 6, 2008, the board of directors approved amendments to the Company’s Bylaws. The amendments made the following substantive changes:(i)Article I, Section 3. Place of Meetings. We have deleted reference to the principal office of the Company in Philadelphia.(ii)Article I, Section 10. Notice of Shareholder Business. The changes provide for additional requirements for shareholders desiring to bring business before an annual meeting. Such shareholders must now disclose, among other things, (a) other shareholder(s) controlling, controlled by or acting in concert with such shareholder (“Shareholder Associated Person”), (b) the number of shares beneficially owned or held of record by the shareholder or any Shareholder Associated Person and any derivative instruments entered into by such persons with respect to the Company’s shares, (c) whether any hedging or other transaction or series of transactions to mitigate potential stock losses or to increase or decrease voting power or pecuniary or economic interests has been made by or on behalf of such persons, and (d) a description of any interest of such shareholder or any Shareholder Associated Person in the business desired to be brought before the meeting. The changes also clarify that except for a proposal properly made pursuant to Rule 14a-8 under the Securities Exchange Act of 1934, as amended, Section 10 is the exclusive means for shareholders to propose business to be brought before an annual meeting and further clarifies that shareholder may not propose business to be brought before a special meeting of shareholders. The changes require the proposing shareholder to update any information given, if necessary, so it is true and correct as of the record date for the annual meeting and provide that if any information submitted is materially inaccurate, then such information may be deemed not to have been properly given in accordance with Section 10.(iii)Article I, Section 11. Notice of Shareholder Nominees. The changes set forth the requirement for timely notice, which has not changed, and restates the information required with respect to shareholders (or any Shareholder146Associated Person) who wish to nominate persons for election to the board of directors at an annual meeting or special meeting called for such purpose, rather than, in both cases, as before, cross-referencing to Section 10 above. As described in subparagraph (3) above, nominating shareholders must now disclose, among other things, (a) other shareholder(s) controlling, controlled by or acting in concert with such shareholder (“Shareholder Associated Person”), (b) the number of shares beneficially owned or held of record by the shareholder or any Shareholder Associated Person and any derivative instruments entered into by such persons with respect to the Company’s shares, (c) whether any hedging or other transaction or series of transactions to mitigate potential stock losses or to increase or decrease voting power or pecuniary or economic interests has been made by or on behalf of such persons, and (d) to the extent known by the shareholder giving notice, the name and address of any other shareholder supporting the nominee for election as a director. The changes also require additional information regarding the person whom the shareholder proposes to nominate as a director, including (a) the number of shares beneficially owned or held of record by such person and any derivative instruments entered into by such person with respect to the Company’s shares and (b) whether any hedging or other transaction or series of transactions to mitigate potential stock losses or to increase or decrease voting power or pecuniary or economic interests has been made by or on behalf of such person. The changes require the nominating shareholder to update any information given, if necessary, so it is true and correct as of the record date for the meeting and provide that if any information submitted is materially inaccurate, then such information may be deemed not to have been properly given in accordance with Section 11. The changes also give the board of directors the right to request that a nominee furnish the information required to be set forth in the notice of nomination which pertains to the nominee.(iv)Article II, Section 2. Additional Provisions. We have deleted this section and renumbered the sections that follow and have made conforming changes to other section of the Bylaws. This section included certain corporate governance provisions adopted in connection with our merger with Jefferson-Pilot Corporation and have expired by their terms.(v)Article VIII, Section 6. Amendment or Repeal. We have added this section to make it clear that no amendment or repeal of the indemnification provisions of Article VIII will adversely affect the rights of any persons under Article VIII with respect to acts or omission occurring prior to the amendment or repeal.The foregoing is merely a summary of the material amendments to the Company’s by-laws and is qualified in its entirety by the Amended and Restated Bylaws, a copy of which is included as Exhibit 3.1 to this Form 10-Q and is incorporated into this Item 5(a) by reference.(b) The description in (a)(2)(iii) above is incorporated herein by reference in answer to this Item 5(b). The description in (a)(2)(iii) is merely a summary of the material changes to the procedures by which shareholders may propose nominees for election to the Company’s board of directors at a shareholder’s meeting and is qualified in its entirety by Article I, Section 11 of the Amended and Restated Bylaws, a copy of which is included as part of Exhibit 3.1 to this Form 10-Q and is incorporated into this Item 5(b) by reference.Item 6.Exhibits147LINCOLN NATIONAL CORPORATION By: By: /s/ FREDERICK J. CRAWFORD By: By: /s/ DOUGLAS N. MILLER Date: May 8, 2009 Date: November 10, 2008148September 30, 2008March 31, 20094.1 3.110.1 Amended and Restated Bylawseffective November 6, 2008 (marked to show changes),is filed herewith.10.1Amended and Restated Lincoln National Corporation Executives’ Severance Benefit Plan is incorporated by reference to10.3 of99.1 to LNC’s10-Q for8-K (File No. 1-6028) filed with the quarter ended June 30, 2008.SEC on March 19, 2009.10.2 10.2Amendment No. 3 to Employment Agreement of Dennis R. Glass, effective as of August 6, 2008,2009 Executive Compensation Matters dated March 30, 2009 is filed herewith.Historical Ratio of Earnings to Fixed Charges. Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.