form10k.htm
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM
10-K
_________________
(Mark
One)
x
|
Annual Report Pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934
|
For the fiscal year
ended December 31, 2009
OR
¨
|
Transition Report Pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934
|
For
the transition period from
to .
Commission File Number 1-6028
LINCOLN
NATIONAL CORPORATION
(Exact name of registrant as
specified in its charter)
_________________
|
|
Indiana
|
35-1140070
|
(State
or other jurisdiction of
incorporation
or organization)
|
(I.R.S.
Employer
Identification
No.)
|
|
|
150 N. Radnor Chester Road, Suite A305, Radnor,
Pennsylvania
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19087
|
(Address
of principal executive offices)
|
(Zip
Code)
|
Registrant’s telephone number,
including area code: (484)
583-1400
_________________
Securities
registered pursuant to Section 12(b) of the Act:
|
|
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Title
of each class
|
|
Name
of each exchange on which registered
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Common
Stock
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New
York and Chicago
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$3.00
Cumulative Convertible Preferred Stock, Series A
|
|
New
York and Chicago
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6.75%
Capital Securities
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|
New
York
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6.75%
Trust Preferred Securities, Series F (1)
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|
New
York
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(1)
|
Issued
by Lincoln National Capital VI. Payments of distributions and
payments on liquidation or redemption are guaranteed by Lincoln National
Corporation.
|
Securities
registered pursuant to Section 12(g) of the Act: None
_________________
Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No ¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files). Yes x No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. Large accelerated filer x Accelerated
filer ¨
Non-accelerated filer (Do not check if a smaller reporting
company) ¨ Smaller
reporting company ¨
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes ¨ No x
The
aggregate market value of the shares of the registrant’s common stock held by
non-affiliates (based upon the closing price of these shares on the New York
Stock Exchange) as of the last business day of the registrant’s most recently
completed second fiscal quarter was $5.2 billion.
As of
February 19, 2010, 302,261,792 shares of common stock of the registrant were
outstanding.
Documents Incorporated by Reference:
Selected portions of the Proxy
Statement for the Annual Meeting of Shareholders, scheduled for May 27, 2010,
have been incorporated by reference into Part III of this Form 10-K.
Lincoln
National Corporation
Table
of Contents
Item
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Page
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PART
I
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1.
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Business
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1
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Overview
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1
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Business
Segments and Other Operations
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3
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|
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Retirement
Solutions
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3
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|
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Retirement
Solutions – Annuities
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3
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Retirement
Solutions – Defined Contribution
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8
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|
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Insurance
Solutions
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10
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|
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Insurance
Solutions – Life Insurance
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10
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|
|
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Insurance
Solutions – Group Protection
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14
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|
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Other
Operations
|
15
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|
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Reinsurance
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16
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Reserves
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16
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Investments
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17
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Ratings
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17
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Regulatory
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18
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Employees
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25
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Available
Information
|
25
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1A.
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Risk
Factors
|
26
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1B.
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Unresolved
Staff Comments
|
42
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2.
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Properties
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43
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|
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3.
|
Legal
Proceedings
|
43
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|
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4.
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Submission
of Matters to a Vote of Security Holders
|
43
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Executive
Officers of the Registrant
|
44
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PART
II
|
|
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5.
|
Market
for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
|
45
|
|
|
|
6.
|
Selected
Financial Data
|
46
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|
|
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7.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
47
|
|
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Forward-Looking
Statements – Cautionary Language
|
48
|
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|
Introduction
|
49
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Executive Summary
|
49
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Critical Accounting Policies and Estimates
|
54
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Acquisitions and Dispositions
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72
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Results
of Consolidated Operations
|
74
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Results
of Retirement Solutions
|
79
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Retirement Solutions – Annuities
|
79
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Retirement Solutions – Defined Contribution
|
87
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Results
of Insurance Solutions
|
94
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Insurance Solutions – Life Insurance
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94
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Insurance Solutions – Group Protection
|
103
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Item
|
|
Page
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Results
of Other Operations
|
106
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|
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Realized
Loss
|
110
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|
|
Consolidated
Investments
|
116
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|
|
Reinsurance
|
139
|
|
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Review
of Consolidated Financial Condition
|
140
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Liquidity and Capital Resources
|
140
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Other
Matters
|
149
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Other Factors Affecting Our Business
|
149
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Recent Accounting Pronouncements
|
149
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|
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7A.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
150
|
|
|
|
8.
|
Financial
Statements and Supplementary Data
|
159
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|
|
|
9.
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
|
262
|
|
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9A.
|
Controls
and Procedures
|
263
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|
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9B.
|
Other
Information
|
263
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PART
III
|
|
|
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10.
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Directors,
Executive Officers and Corporate Governance
|
264
|
|
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11.
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Executive
Compensation
|
264
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|
|
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12.
|
Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
|
264
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|
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13.
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Certain
Relationships and Related Transactions, and Director
Independence
|
265
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|
|
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14.
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Principal
Accounting Fees and Services
|
265
|
|
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PART
IV
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15.
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Exhibits,
Financial Statement Schedules
|
266
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Signatures
|
267
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Index
to Financial Statement Schedules
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FS-1
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Index
to Exhibits
|
E-1
|
PART
I
The
“Business” section and other parts of this Form 10-K contain forward-looking
statements that involve inherent risks and uncertainties. Statements
that are not historical facts, including statements about our beliefs and
expectations, and containing words such as “believes,” “estimates,”
“anticipates,” “expects” or similar words are forward-looking
statements. Our actual results may differ materially from the
projected results discussed in the forward-looking
statements. Factors that could cause such differences include, but
are not limited to, those discussed in “Item 1A. Risk Factors” and in the
“Forward-Looking Statements – Cautionary Language” in “Part II – Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations” (“MD&A”) of the Form 10-K. Our consolidated financial
statements and the accompanying notes to the consolidated financial statements
(“Notes”) are presented in “Part II – Item 8. Financial Statements and
Supplementary Data.”
Item
1. Business
OVERVIEW
Lincoln
National Corporation (“LNC,” which also may be referred to as “Lincoln,” “we,”
“our” or “us”) is a holding company, which operates multiple insurance and
retirement businesses through subsidiary companies. Through our
business segments, we sell a wide range of wealth protection, accumulation and
retirement income products and solutions. These products include
fixed and indexed annuities, variable annuities, universal life insurance
(“UL”), variable universal life insurance (“VUL”), linked-benefit UL, term life
insurance, mutual funds and group life insurance. LNC was organized
under the laws of the state of Indiana in 1968. We currently maintain
our principal executive offices in Radnor, Pennsylvania. “Lincoln Financial
Group” is the marketing name for LNC and its subsidiary companies. As of
December 31, 2009, LNC had consolidated assets of $177.4 billion and
consolidated stockholders’ equity of $11.7 billion.
We
provide products and services in two operating businesses and report results
through four segments as follows:
Business
|
|
Corresponding
Segments
|
Retirement
Solutions
|
|
Annuities
|
|
|
Defined
Contribution
|
|
|
|
Insurance
Solutions
|
|
Life
Insurance
|
|
|
Group
Protection
|
We also
have Other Operations, which includes the financial data for operations that are
not directly related to the business segments, unallocated corporate items and
the ongoing amortization of deferred gain on the indemnity reinsurance portion
of the sale of our former reinsurance segment to Swiss Re Life & Health
America Inc. (“Swiss Re”) in the fourth quarter of 2001. Unallocated
corporate items include investment income on investments related to the amount
of statutory surplus in our insurance subsidiaries that is not allocated to our
business units and other corporate investments, interest expense on short-term
and long-term borrowings and certain expenses, including restructuring and
merger-related expenses. Other Operations also includes our run-off
institutional pension business, the results of certain disability income
business due to the rescission of a reinsurance agreement with Swiss Re and the
results of our remaining media businesses.
As a
result of entering agreements of sale for Lincoln National (UK) plc (“Lincoln
UK”) and Delaware Management Holdings, Inc. (“Delaware”) during 2009, we have
reported the results of these businesses as discontinued operations on our
Consolidated Statements of Income (Loss) and the assets and liabilities as held
for sale on our Consolidated Balance Sheets for all periods
presented. For further information, see “Acquisitions and
Dispositions” below.
The
results of Lincoln Financial Network (“LFN”) and Lincoln Financial Distributors
(“LFD”), our retail and wholesale distributors, respectively, are included in
the segments for which they distribute products. LFD distributes our
individual products and services, defined contribution (“DC”) plans and
corporate-owned UL and VUL (“COLI”) and bank-owned UL and VUL (“BOLI”) products
and services. The distribution occurs primarily through consultants,
brokers, planners, agents, financial advisors, third party administrators
(“TPAs”) and other intermediaries. Insurance Solutions – Group
Protection distributes its products and services primarily through employee
benefit brokers, TPAs and other employee benefit firms. As of
December 31, 2009, LFD had approximately 600 internal and external wholesalers
(including sales managers). As of December 31, 2009, LFN offered LNC
and non-proprietary products and advisory services through a national network of
approximately 7,700 active producers who placed business with us within the last
twelve months.
Financial
information in the tables that follow is presented in conformity with accounting
principles generally accepted in the United States of America (“GAAP”), unless
otherwise indicated. We provide revenues, income (loss) from
operations and assets attributable to each of our business segments and Other
Operations, as well as revenues derived inside and outside the U.S. for the last
three fiscal years, in Note 23.
Revenues
by segment (in millions) were as follows:
|
|
For
the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Revenues
|
|
|
|
|
|
|
|
|
|
Operating
revenues:
|
|
|
|
|
|
|
|
|
|
Retirement
Solutions:
|
|
|
|
|
|
|
|
|
|
Annuities
|
|
$ |
2,301 |
|
|
$ |
2,438 |
|
|
$ |
2,535 |
|
Defined
Contribution
|
|
|
926 |
|
|
|
932 |
|
|
|
986 |
|
Total
Retirement Solutions
|
|
|
3,227 |
|
|
|
3,370 |
|
|
|
3,521 |
|
Insurance
Solutions:
|
|
|
|
|
|
|
|
|
|
|
|
|
Life
Insurance
|
|
|
4,293 |
|
|
|
4,259 |
|
|
|
4,189 |
|
Group
Protection
|
|
|
1,713 |
|
|
|
1,640 |
|
|
|
1,500 |
|
Total
Insurance Solutions
|
|
|
6,006 |
|
|
|
5,899 |
|
|
|
5,689 |
|
Other
Operations
|
|
|
467 |
|
|
|
534 |
|
|
|
578 |
|
Excluded
realized loss, pre-tax
|
|
|
(1,200 |
) |
|
|
(573 |
) |
|
|
(183 |
) |
Amortization
of deferred gain from reserve
|
|
|
|
|
|
|
|
|
|
|
|
|
changes
on business sold through
|
|
|
|
|
|
|
|
|
|
|
|
|
reinsurance,
pre-tax
|
|
|
3 |
|
|
|
3 |
|
|
|
9 |
|
Amortization
of deferred front-end loads
|
|
|
|
|
|
|
|
|
|
|
|
|
(“DFEL”)
associated with benefit
|
|
|
|
|
|
|
|
|
|
|
|
|
ratio
unlocking, pre-tax
|
|
|
(4 |
) |
|
|
(9 |
) |
|
|
- |
|
Total
revenues
|
|
$ |
8,499 |
|
|
$ |
9,224 |
|
|
$ |
9,614 |
|
Acquisitions
and Dispositions
On
January 4, 2010, LNC and its wholly owned subsidiary, Lincoln National
Investment Companies, completed the sale of the outstanding capital stock of
Delaware, our former subsidiary, to Macquarie Bank Limited, pursuant to a
Purchase and Sale Agreement dated as of August 18, 2009. Delaware
provided investment products and services to individuals and
institutions. We currently expect to receive cash consideration at
closing of approximately $405 million, after-tax. The closing
purchase price is subject to post-closing adjustments, including an adjustment
based on the final closing balance sheet as determined under the Purchase and
Sale Agreement.
In
addition, certain of our subsidiaries, including The Lincoln National Life
Insurance Company (“LNL”), our primary insurance subsidiary, have entered into
investment advisory agreements with Delaware dated January 4, 2010, pursuant to
which Delaware will continue to manage the majority of the general account
insurance assets of the subsidiaries. The investment advisory
agreements will have 10-year terms, and we may terminate them without cause,
subject to a purchase price adjustment of up to $84 million in the event that
all of the agreements with our subsidiaries are terminated. The
amount of the potential adjustment will decline on a pro rata basis over the
10-year term of the advisory agreements.
On
October 1, 2009, we completed the sale of the capital stock of Lincoln UK to SLF
of Canada UK Limited for proceeds of $307 million, after-tax, subject to
customary post-closing adjustments. We retained Lincoln UK’s pension
plan assets and liabilities. The former Lincoln UK segment primarily focused on
providing life and retirement income products in the United
Kingdom.
On
January 8, 2009, the Office of Thrift Supervision approved our application to
become a savings and loan holding company and our acquisition of Newton County
Loan & Savings, FSB (“NCLS”), a federally regulated savings bank located in
Indiana. We contributed $10 million to the capital of
NCLS. We closed on our purchase of NCLS on January 15,
2009.
On
November 12, 2007, Lincoln Financial Media Company (“LFMC”), our wholly-owned
subsidiary, entered into two stock purchase agreements with Raycom Holdings, LLC
(“Raycom”). Pursuant to one of the agreements, LFMC agreed to sell to
Raycom all of the outstanding capital stock of three of LFMC’s wholly-owned
subsidiaries: WBTV, Inc., the owner and operator of television
station WBTV, Charlotte, North Carolina; WCSC, Inc., the owner and operator of
television station WCSC, Charleston, South Carolina; and WWBT, Inc., the owner
and operator of television station WWBT, Richmond, Virginia. The
transaction closed on March 31, 2008, and LFMC received proceeds of $546
million. Pursuant to the other agreement, LFMC agreed to sell to
Raycom all of the outstanding capital stock of Lincoln Financial Sports, Inc., a
wholly-owned subsidiary of LFMC. This transaction closed on November
30, 2007, and LFMC received $42 million of proceeds.
On
November 12, 2007, LFMC also entered into a stock purchase agreement with
Greater Media, Inc., to sell all of the outstanding capital stock of LFMC of
North Carolina, the owner and operator of radio stations WBT(AM), Charlotte,
North Carolina; WBT-FM, Chester, South Carolina; and WLNK(FM), Charlotte, North
Carolina. This transaction closed on January 31, 2008, and LFMC
received proceeds of $100 million. More information on these LFMC
transactions can be found in our Form 8-K filed on November 14, 2007, and in
Note 3.
On April
3, 2006, we completed our merger with Jefferson-Pilot Corporation
(“Jefferson-Pilot”), pursuant to which Jefferson-Pilot merged into one of our
wholly-owned subsidiaries. Prior to the merger, Jefferson-Pilot,
through its subsidiaries, offered full lines of individual life, annuity and
investment products, and group life insurance products, disability income and
dental contracts, and it operated television and radio stations and a sports
broadcasting network.
For
further information about acquisitions and divestitures, see Note
3.
BUSINESS
SEGMENTS AND OTHER OPERATIONS
RETIREMENT
SOLUTIONS
Overview
The
Retirement Solutions business, with principal operations in Radnor,
Pennsylvania; Fort Wayne, Indiana; Hartford, Connecticut; and Greensboro, North
Carolina and additional operations in Concord, New Hampshire and Arlington
Heights, Illinois, provides its products through two
segments: Annuities and Defined Contribution. The
Annuities segment provides tax-deferred growth and lifetime income opportunities
for its clients by offering individual fixed annuities, including indexed
annuities, and variable annuities. The Defined Contribution segment
provides employer-sponsored fixed and variable annuities and mutual fund-based
programs in the 401(k), 403(b) and 457 plan marketplaces. Products
for both segments are distributed through a wide range of intermediaries
including both affiliated and unaffiliated channels including advisors,
consultants, brokers, banks and wirehouses.
Retirement
Solutions – Annuities
Overview
The
Retirement Solutions – Annuities segment provides tax-deferred growth and
lifetime income opportunities for its clients by offering fixed and variable
annuities. The Retirement Solutions – Annuities segment offers
non-qualified and qualified fixed and variable annuities to
individuals. The “fixed” and “variable” classification describes
whether we or the contract holders bear the investment risk of the assets
supporting the contract. This also determines the manner in which we
earn investment margin profits from these products, either as investment spreads
for fixed products or as asset-based fees charged to variable
products.
Annuities
have several features that are attractive to customers. First, they
provide tax-deferred growth in the underlying principal, thereby deferring the
tax consequences of the growth in value until withdrawals are made from the
accumulation values, often at lower tax rates occurring during
retirement. Second, annuities are unique in that contract holders can
select a variety of payout alternatives to help provide an income flow for
life. Many annuity contracts include guarantee features (living and
death benefits) that are not found in any other investment vehicle and, we
believe, make annuities attractive especially in times of economic
uncertainty. Over the last several years, the individual annuities
market has seen an increase in competition with respect to guarantee
features.
Products
In
general, an annuity is a contract between an insurance company and an individual
or group in which the insurance company, after receipt of one or more premium
payments, agrees to pay an amount of money either in one lump sum or on a
periodic basis (i.e., annually, semi-annually, quarterly or monthly), beginning
on a certain date and continuing for a period of time as specified in the
contract. Periodic payments can begin within twelve months after the
premium is received (referred to as an immediate annuity) or at a future date in
time (referred to as a deferred annuity). This retirement vehicle
helps protect an individual from outliving his or her money and can be either a
fixed annuity or a variable annuity.
The
Retirement Solutions – Annuities segment’s deposits (in millions) were as
follows:
|
|
For
the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Deposits
|
|
|
|
|
|
|
|
|
|
Variable
portion of variable annuity
|
|
$ |
4,007 |
|
|
$ |
6,690 |
|
|
$ |
9,135 |
|
Fixed
portion of variable annuity
|
|
|
3,194 |
|
|
|
3,433 |
|
|
|
2,795 |
|
Total
variable annuity
|
|
|
7,201 |
|
|
|
10,123 |
|
|
|
11,930 |
|
Fixed
indexed annuity
|
|
|
2,182 |
|
|
|
1,078 |
|
|
|
755 |
|
Other
fixed annuity
|
|
|
979 |
|
|
|
529 |
|
|
|
772 |
|
Total
annuity deposits
|
|
$ |
10,362 |
|
|
$ |
11,730 |
|
|
$ |
13,457 |
|
Variable
Annuities
A
variable annuity provides the contract holder the ability to direct the
investment of premium deposits into one or more sub-accounts offered through the
product (“variable portion”) or into a fixed account with a guaranteed return
(“fixed portion”). The value of the variable portion of the contract
holder’s account varies with the performance of the underlying sub-accounts
chosen by the contract holder. The underlying assets of the
sub-accounts are managed within a special insurance series of mutual
funds. The contract holder’s return is tied to the performance of the
segregated assets underlying the variable annuity (i.e. the contract holder
bears the investment risk associated with these investments). The
value of the fixed portion is guaranteed by us and recorded in our general
account liabilities. Variable annuity account values were $59.4
billion, $44.5 billion and $62.1 billion for the years ended December 31, 2009,
2008 and 2007, respectively, including the fixed portion of variable accounts of
$4.0 billion, $3.6 billion and $3.5 billion, for the years ended December 31,
2009, 2008 and 2007, respectively.
We charge
mortality and expense assessments and administrative fees on variable annuity
accounts to cover insurance and administrative expenses. These
assessments are built into accumulation unit values, which when multiplied by
the number of units owned for any sub-account equals the contract holder’s
account value for that sub-account. The fees that we earn from these
contracts are reported as insurance fees on our Consolidated Statements of
Income (Loss). In addition, for some contracts, we collect surrender
charges that range from 0% to 10% of withdrawals when contract holders surrender
their contracts during the surrender charge period, which is generally higher
during the early years of a contract. Our individual variable annuity
products have a maximum surrender charge period of ten years.
We offer
A-share, B-share, C-share, L-share and bonus variable annuities, although not
with every annuity product. The differences in these relate to the
sales charge and fee structure associated with the contract.
·
|
An
A-share has a front-end sales charge and no back-end contingent deferred
sales charge, also known as a surrender charge. The net premium
(premium less front-end charge) is invested in the contract, resulting in
full liquidity and lower mortality and expense assessments over the long
term than those in other share classes.
|
·
|
A
B-share has a seven-year surrender charge that is only paid if the account
is surrendered or withdrawals are in excess of contractual free
withdrawals within the contract’s specified surrender charge
period. The entire premium is invested in the contract, but it
offers limited liquidity during the surrender charge
period.
|
·
|
A
C-share has no front-end sales charge or back-end surrender
charge. Accordingly, it offers maximum liquidity but mortality
and expense assessments are higher than those for A-share or B-share
during the surrender charge period. A persistency credit is
applied beginning in year eight so that the total charge to the customer
is consistent with B-share
levels.
|
·
|
An
L-share has a four to five year surrender charge that is only paid if the
account is surrendered or withdrawals are in excess of contractual free
withdrawals within the contract’s specified surrender charge
period. The differences between the L-share and the B-share are
the length of the surrender charge period and the fee
structure. L-shares have a shorter surrender charge period, so
for the added liquidity, mortality and expense assessments are
higher. We offer L-share annuity products with persistency
credits that are applied in all years after surrender charges are no
longer applicable so that the total charge to the customer is consistent
with B-share levels.
|
·
|
A
bonus annuity is a variable annuity contract that offers a bonus credit to
a contract based on a specified percentage (typically ranging from 2% to
5%) of each deposit. The entire premium plus the bonus are
invested in the sub-accounts supporting the contract. It has a
seven to nine-year surrender charge. The expenses are slightly
more than those for a B-share. We offer bonus annuity products
with persistency credits that are applied in all years after surrender
charges are no longer applicable so that the total charge to the customer
is consistent with B-share levels.
|
We offer
guaranteed benefit riders with certain of our variable annuity products, such as
a guaranteed death benefit (“GDB”), a guaranteed withdrawal benefit (“GWB”), a
guaranteed income benefit (“GIB”) and a combination of such
benefits. Most of our variable annuity products also offer the choice
of a fixed option that provides for guaranteed interest credited to the account
value.
We design
and actively manage the features and structure of our guaranteed benefit riders
to maintain a competitive suite of products consistent with profitability and
risk management goals. In late 2008 and early 2009, in light of
changes in the variable annuity marketplace driven by financial market
conditions, we made changes to our riders to reduce our exposure to equity
market volatility and interest rate movements while compensating us for
increasing costs to provide the benefits. The changes include, but
are not limited to, implementing investment restrictions for all new rider sales
and for the majority of in-force policies with guaranteed riders, raising the
charge for guaranteed benefit riders, reducing roll-up periods and eliminating
certain features.
Approximately
92%, 91% and 91% of
variable annuity separate account values had a GDB rider as of December 31,
2009, 2008 and 2007, respectively. The GDB features currently offered
include those where we contractually guarantee to the contract holder that upon
death, we will return no less than: the total deposits made to the
contract, adjusted to reflect any partial withdrawals; the total deposits made
to the contract, adjusted to reflect any partial withdrawals, plus a minimum
return; or the highest contract value on a specified anniversary date adjusted
to reflect any partial withdrawals following the contract
anniversary.
Approximately
23%, 26% and 28% of variable annuity account values as of December 31, 2009,
2008 and 2007, respectively, had a Lincoln SmartSecurity®
Advantage rider. The Lincoln SmartSecurity®
Advantage one-year benefit is a GWB rider that offers the contract holder a
guarantee equal to the initial deposit (or contract value, if elected after
issue), adjusted for any subsequent purchase payments or
withdrawals. Lincoln SmartSecurity®
Advantage one-year allows an owner to step up the guarantee amount automatically
on the benefit anniversary to the current contract value if the contract value
is greater than the guarantee amount at the time of step up. To
receive the full amount of the guarantee, annual withdrawals are limited to 5%
of the guaranteed amount. Withdrawals will continue until the longer
of when the guarantee is equal to zero or for the rest of the owner’s life
(“single life version”) or the life of the owner or owner’s spouse (“joint life
version”) as long as withdrawals begin after attained age 65 and are limited to
5% of the guaranteed amount. Withdrawals in excess of the applicable
maximum in any contract year are assessed any applicable surrender charges, and
the guaranteed amount is recalculated.
We offer
other product riders including i4LIFE® Advantage and
4LATER® Advantage. The i4LIFE® rider, on which we
have received a U.S. patent, allows variable annuity contract holders access and
control during the income distribution phase of their contract. This
added flexibility allows the contract holder to access the account value for
transfers, additional withdrawals and other service features like portfolio
rebalancing. Approximately 11%, 11% and 9% of variable annuity
account values as of December 31, 2009, 2008 and 2007, respectively, have
elected an i4LIFE®
Advantage feature. In general, GIB is an optional feature available
with i4LIFE® Advantage
that guarantees regular income payments will not fall below 75% of the highest
income payment on a specified anniversary date (reduced for any subsequent
withdrawals). Approximately 94%, 92% and 88% of i4LIFE® Advantage account
values elected the GIB feature as of December 31, 2009, 2008 and 2007,
respectively. 4LATER® Advantage provides a
minimum income base used to determine the GIB floor when a client begins income
payments under i4LIFE®
Advantage. The income base is equal to the initial deposit (or contract
value, if elected after issue) and increases by 15% every three years (subject
to a 200% cap). The owner may step up the income base on or after the
third anniversary of rider election or of the most recent step-up (which also
resets the 200% cap).
The Lincoln Lifetime IncomeSM
Advantage and Lincoln Lifetime
IncomeSM
Advantage Plus are hybrid benefit riders combining aspects of GWB and GIB.
Both benefit riders allow the contract holder the ability to take income
at a maximum rate of 5% of the guaranteed amount when they are above the
lifetime income age or income through i4LIFE® Advantage with the
GIB. Lincoln Lifetime
IncomeSM
Advantage and Lincoln Lifetime
IncomeSM
Advantage Plus provide higher income if the contract holder delays withdrawals,
including both a 5% enhancement to the guaranteed amount each year a withdrawal
is not taken for a specified period of time and an annual step-up of the
guaranteed amount to the current contract value. The Lincoln Lifetime IncomeSM
Advantage Plus provides an additional benefit, which is a return of principal at
the end of the seventh year if the customer has not taken any
withdrawals. Contract holders under both the Lincoln Lifetime IncomeSM
Advantage and Lincoln Lifetime
IncomeSM
Advantage Plus are subject to restrictions on the allocation of their account
value within the various investment choices. Approximately 17% and 8%
of variable annuity account values as of December 31, 2009 and 2008,
respectively, had a Lincoln
Lifetime IncomeSM
Advantage or Lincoln Lifetime
IncomeSM
Advantage Plus rider.
To
mitigate the increased risks associated with guaranteed benefits, we developed a
dynamic hedging program. The customized dynamic hedging program uses
equity and interest rate futures positions, interest rate and variance swaps, as
well as equity-based options depending upon the risks underlying the
guarantees. Our program is designed to offset both positive and
negative changes in the carrying value of the guarantees. However,
while we actively manage these hedge positions, the hedge positions may not be
effective to exactly offset the changes in the carrying value of the guarantees
due to, among other things, the time lag between changes in their values and
corresponding changes in the hedge positions, high levels of volatility in the
equity markets, contract holder behavior, management decisions not to fully
hedge every risk and divergence between the performance of the underlying funds
and hedging indices, which is referred to as basis risk. For more
information on our hedging program, see “Critical Accounting Policies and
Estimates – Derivatives” and “Realized Loss” in the MD&A. For
information regarding risks related to guaranteed benefits, see “Item 1A. Risk
Factors – Changes in the equity markets, interest rates and/or volatility affect
the profitability of our products with guaranteed benefits; therefore, such
changes may have a material adverse effect on our business and
profitability.”
Fixed
Annuities
A fixed
annuity preserves the principal value of the contract while guaranteeing a
minimum interest rate to be credited to the accumulation value. We
offer single and flexible premium fixed deferred annuities to the individual
annuities market. Single premium fixed deferred annuities are
contracts that allow only a single premium to be paid. Flexible
premium fixed deferred annuities are contracts that allow multiple premium
payments on either a scheduled or non-scheduled basis. Our fixed
annuities include both traditional fixed-rate and fixed indexed
annuities. With fixed deferred annuities, the contract holder has the
right to surrender the contract and receive the current accumulation value less
any applicable surrender charge and, if applicable, a market value adjustment
(“MVA”). Depending on market conditions, MVAs can, for some products,
be less than zero, which means the MVA results in an increase to the amount
received by the contract holder.
Fixed
indexed annuities allow the contract holder to elect an interest rate linked to
the performance of the Standard & Poor’s (“S&P”) 500 Index® (“S&P
500”). The indexed interest rate is guaranteed never to be less than
zero. Our fixed indexed annuities provide contract holders a choice
of a traditional fixed-rate account and one or more different indexed
accounts. A contract holder may elect to change allocations at
renewal dates, either annually or biannually. At each renewal date,
we have the opportunity to re-price the indexed component (i.e. reset the caps,
spreads or participation rates), subject to guarantees.
Fixed
annuity contracts are general account obligations. We bear the
investment risk for fixed annuity contracts. To protect from
premature withdrawals, we impose surrender charges. Surrender charges
are typically applicable during the early years of the annuity contract, with a
declining level of surrender charges over time. We expect to earn a
spread between what we earn on the underlying general account investments
supporting the fixed annuity product line and what we credit to our fixed
annuity contract holders’ accounts. In addition, with respect to
fixed indexed annuities, we purchase options that are highly correlated to the
indexed account allocation decisions of our contract holders, such that we are
closely hedged with respect to indexed interest for the current reset
period. For more information on our hedging program for fixed indexed
annuities, see “Critical Accounting Policies and Estimates – Derivatives” and
“Realized Loss” in the MD&A.
Individual
fixed annuity account values were $15.9 billion, $14.0 billion and $14.4 billion
as of December 31, 2009, 2008 and 2007, respectively. Approximately
$11.8 billion of individual fixed annuity account values as of December 31,
2009, were still within the surrender charge period.
Our fixed
annuity product offerings as of December 31, 2009, consisted of traditional
fixed-rate and fixed indexed deferred annuities, as well as fixed-rate immediate
annuities with various payment options, including lifetime
incomes. In addition to traditional fixed-rate immediate annuities,
in 2007 we introduced Lincoln
SmartIncomeSM
Inflation Annuity. This product provides lifetime income with annual
adjustments to keep pace with inflation. It uses a patent-pending
design to preserve access to remaining principal, also adjusted annually for
inflation, for premature death or unexpected needs. The traditional
fixed-rate deferred annuity products include the Lincoln ClassicSM
(Single and Flexible Premium), Lincoln SelectSM and
Lincoln ChoicePlusSM
Fixed annuities. The fixed indexed deferred annuity products include
the Lincoln OptiPoint®,
Lincoln OptiChoiceSM,
Lincoln New Directions®
and Lincoln Future Point®
annuities. The fixed indexed annuities offer one or more of the
following indexed accounts:
·
|
The
Performance Triggered Indexed Account pays a specified rate, declared at
the beginning of the indexed term, if the S&P 500 value at the end of
the indexed term is the same or greater than the S&P 500 value at the
beginning of the indexed term;
|
·
|
The
Point to Point Indexed Account compares the value of the S&P 500 at
the end of the indexed term to the S&P 500 value at the beginning of
the term. If the S&P 500 at the end of the indexed term is
higher than the S&P 500 value at the beginning of the term, then the
percentage change, up to the declared indexed interest cap, is credited to
the indexed account;
|
·
|
The
Monthly Cap Indexed Account reflects the monthly changes in the S&P
500 value over the course of the indexed term. Each month, the
percentage change in the S&P 500 value is calculated, subject to a
monthly indexed cap that is declared at the beginning of the indexed
term. At the end of the indexed term, all of the monthly change
percentages are summed to determine the rate of indexed interest that will
be credited to the account; and
|
·
|
The
Monthly Average Indexed Account compares the average monthly value of the
S&P 500 to the S&P 500 value at the beginning of the
term. The average of the S&P 500 values at the end of each
of the twelve months in the indexed term is calculated. The
percentage change of the average S&P 500 value to the starting S&P
500 value is calculated. From that amount, the indexed interest
spread, which is declared at the beginning of the indexed term, is
subtracted. The resulting rate is used to calculate the indexed
interest that will be credited to the
account.
|
If the
S&P 500 values produce a negative indexed interest rate, no indexed interest
is credited to the indexed account.
During
2009, we added new traditional fixed annuity products, Lincoln MYGuaranteeSM Plus
and Lincoln
GrowSmartSM
Fixed Annuity, with multi-year guarantee periods that vary from 3-10 years to
allow consumers greater flexibility.
We
introduced the Lincoln Living
IncomeSM
Advantage in 2007. Available with certain of our fixed indexed
annuities, it provides the contract holder a guaranteed lifetime withdrawal
benefit. Withdrawals in excess of the free amount are assessed any
applicable surrender charges, and the guaranteed withdrawal amount is
recalculated.
Many of
our fixed annuities have an MVA. If a contract with an MVA is
surrendered during the surrender charge period, both a surrender charge and an
MVA may be applied. The MVA feature increases or decreases the
contract value of the annuity based on a decrease or increase in interest
rates. We updated our MVA formula, during 2009, which provides better
protection when changes in available asset yields are not in line with changes
in Treasury rates. Individual fixed annuities with an MVA feature
constituted 55%, 46% and 40% of total fixed annuity account values as of
December 31, 2009, 2008 and 2007, respectively.
Distribution
The
Retirement Solutions – Annuities segment distributes its individual fixed and
variable annuity products through LFD. LFD’s distribution channels
give the Retirement Solutions – Annuities segment access to its target
markets. LFD distributes the segment’s products to a large number of
financial intermediaries, including LFN. The financial intermediaries
include wire/regional firms, independent financial planners, financial
institutions and managing general agents.
Competition
The
annuities market is very competitive and consists of many companies, with no one
company dominating the market for all products. The Annuities segment
competes with numerous other financial services companies. The main
factors upon which entities in this market compete are distribution channel
access and the quality of wholesalers, investment performance, cost, product
features, speed to market, brand recognition, financial strength ratings,
crediting rates and client service.
Retirement
Solutions – Defined Contribution
Overview
The
Retirement Solutions – Defined Contribution segment provides employers the
ability to offer tax-deferred retirement savings plans to their employees,
primarily through 403(b) and 401(k) retirement savings plans. We
provide a variety of plan investment vehicles, including individual and group
variable annuities, group fixed annuities and mutual funds. We also
offer a broad array of plan services including plan recordkeeping, compliance
testing, participant education and other related services.
DC plans
are a popular employee benefit offered by many employers across a wide spectrum
of industries and by employers large and small. Some plans include
employer matching of contributions, which can increase participation by
employees. Growth in the number of DC plans has occurred as these
plans have been used as replacements for frozen or eliminated defined benefit
retirement plans. In general, DC plans offer tax-deferred
contributions and investment growth, thereby deferring the tax consequences of
both the contributions and investment growth until withdrawals are made from the
accumulated values, often at lower tax rates occurring during
retirement.
Lincoln’s
403(b) assets accounted for 58% of total assets under management in this segment
as of December 31, 2009. The 401(k) business accounted for 43% of our
deposits during 2009 for this segment.
Products
and Services
The
Retirement Solutions – Defined Contribution segment currently brings four
primary offerings to the employer-sponsored market: LINCOLN
DIRECTORSM
group variable annuity, LINCOLN ALLIANCE® program,
Lincoln SmartFuture®
program and Multi-Fund®
variable annuity.
The
Retirement Solutions – Defined Contribution segment’s deposits (in millions)
were as follows:
|
|
For
the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Deposits
|
|
|
|
|
|
|
|
|
|
Variable
portion of variable annuity
|
|
$ |
1,586 |
|
|
$ |
2,170 |
|
|
$ |
2,355 |
|
Fixed
portion of variable annuity
|
|
|
331 |
|
|
|
369 |
|
|
|
351 |
|
Total
variable annuity
|
|
|
1,917 |
|
|
|
2,539 |
|
|
|
2,706 |
|
Fixed
annuity
|
|
|
1,011 |
|
|
|
812 |
|
|
|
754 |
|
Mutual
fund
|
|
|
2,024 |
|
|
|
2,196 |
|
|
|
2,090 |
|
Total
annuity and mutual fund deposits
|
|
$ |
4,952 |
|
|
$ |
5,547 |
|
|
$ |
5,550 |
|
LINCOLN
DIRECTORSM and
Multi-Fund® products
are variable annuities. LINCOLN ALLIANCE® and Lincoln SmartFuture® programs
are mutual fund-based programs. This suite of products covers the
403(b), 401(k) and 457 marketplace. These 403(b), 401(k) and 457
plans are tax-deferred, DC plans offered to employees of an entity to enable
them to save for retirement. The 403(b) plans are available to
employees of educational institutions, not-for-profit healthcare organizations
and certain other not-for-profit entities; 401(k) plans are generally available
to employees of for-profit entities; and 457 plans are available to government
employees and certain employees of non-profit organizations. The
investment options for our annuities encompass the spectrum of asset classes
with varying levels of risk and include both equity and fixed
income. Healthcare clients accounted for 43%, 45% and 43% of account
values for these products as of December 31, 2009, 2008 and 2007,
respectively.
LINCOLN
DIRECTORSM group
variable annuity is a 401(k) DC retirement plan solution available to micro- to
small-sized businesses, typically those that have DC plans with less than $3
million in account values. The LINCOLN DIRECTORSM
product offers participants a broad array of investment options from several
fund families and a fixed account. In 2009, we updated our LINCOLN
DIRECTORSM
product, which now offers more than 90 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 offers our
patented distribution option, i4LIFE®
Advantage. In 2008, the investment options were significantly
enhanced with the addition of the funds that had been offered only through the
Lincoln American Legacy
Retirement® group
variable annuity. Lincoln
American Legacy Retirement® was
merged into LINCOLN DIRECTORSM
group variable annuity in 2008 and is no longer offered as a standalone
product for new sales. LINCOLN DIRECTORSM group
variable annuity has the option of being serviced through a TPA or fully
serviced by Lincoln. As of December 31, 2009, approximately 90% of
LINCOLN DIRECTORSM
clients were serviced through TPAs. The Retirement Solutions –
Defined Contribution segment earns revenue through asset charges, investment
management fees, surrender charges and recordkeeping fees from this
product. We also receive fees from the underlying mutual funds
companies for the services we provide and we also earn investment margins on
assets in the fixed account. Account values for LINCOLN DIRECTORSM group
variable annuity were $5.9 billion, $4.9 billion and $7.8 billion as of December
31, 2009, 2008 and 2007, respectively. Deposits for LINCOLN
DIRECTORSM group
variable annuity were $1.2 billion, $1.5 billion and $1.6 billion during 2009,
2008 and 2007, respectively.
The LINCOLN ALLIANCE® program is
a DC retirement plan solution aimed at mid to large employers, typically those
that have DC plans with $15 million or more in account value. The
target market is primarily for-profit corporations, educational institutions and
healthcare providers. The program bundles our traditional fixed
annuity products with the employer’s choice of retail mutual funds, along with
recordkeeping, plan compliance services and customized employee education
services. Included in the product offering is the LIFESPAN® learning program, which
provides participants with educational materials and one-on-one guidance for
retirement planning assistance. The program allows the use of any
retail mutual fund. We earn fees for our recordkeeping and
educational services and the services we provide to mutual fund
accounts. We also earn investment margins on fixed
annuities. The retail mutual funds associated with this program are
not included in the separate accounts reported on our Consolidated Balance
Sheets, as we do not have any ownership interest in them. LINCOLN ALLIANCE® program
account values were $13.4 billion, $9.4 billion and $9.5 billion as of December
31, 2009, 2008 and 2007, respectively.
The Lincoln SmartFuture® program
is a DC retirement plan solution aimed at small to mid to large employers,
typically those that have DC plans with between $3 million to $15 million or
more in account value. The target market is primarily for-profit
corporations, educational institutions and healthcare providers. The
Lincoln SmartFuture®
program was introduced in 2008 and is built on the LINCOLN ALLIANCE®
platform. Like
LINCOLN ALLIANCE®, the program bundles our traditional fixed annuity
products with retail mutual funds, recordkeeping, plan compliance services and
employee education services using the LIFESPAN® learning program, which
is described further above. However, the Lincoln SmartFuture® program
allows the employer to choose from a list of over 100 retail mutual funds chosen
by us, which consists of a broad range of low-cost funds. Services
for this program are typically not customized for each employer. We
earn fees for our recordkeeping and educational services and the services we
provide to mutual fund accounts. We also earn investment margins on
fixed annuities. The retail mutual funds associated with this program
are not included in the separate accounts reported on our Consolidated Balance
Sheets, as we do not have any ownership interest in them. Lincoln SmartFuture® program
account values were $223 million and $104 million as of December 31, 2009 and
2008, respectively.
Multi-Fund® Variable Annuity
is a DC retirement plan solution with full-bundled administrative services and
high quality investment choices marketed to small- to mid-sized healthcare,
education, governmental and not-for-profit plans. The product can be sold
either to the employer through the Multi-Fund® group variable
annuity contract or directly to the individual through the Multi-Fund® Select variable
annuity contract. Included in the product offering is the
LIFESPAN® learning
program, which is described further above. We earn mortality and expense
charges, investment income on the fixed account and surrender charges from this
product. We also receive fees for services that we provide to the
underlying mutual fund accounts. The Multi-Fund® variable annuity
is currently available in all states except New York. Account values for
the Multi-Fund®
variable annuity were $10.9 billion, $9.7 billion and $13.3 billion as of
December 31, 2009, 2008 and 2007, respectively. Multi-Fund® program deposits
represented 13%, 15% and 17% of the segment’s deposits in 2009, 2008 and 2007,
respectively.
Also
within this segment, we have created the Lincoln Unifier® service
offering to further assist employers meet the administrative challenges of
bringing retirement plans into compliance with the new 403(b)
regulations. Lincoln Unifier® includes
common remitter administration, compliance monitoring and proactive transaction
monitoring.
Distribution
DC
products are primarily distributed by LFD. The wholesalers distribute
these products through advisors, consultants, banks, wirehouses, TPAs and
individual planners. Although the Multi-Fund® program is sold
primarily by affiliated advisors, certain non-affiliated advisors can also
distribute the product. The LINCOLN ALLIANCE® program and
the Lincoln
SmartFuture® program are sold primarily through consultants and
affiliated advisors. LINCOLN DIRECTORSM group
variable annuity is sold primarily by TPAs and individual planners and is
in the early stages of introduction to wirehouses and banks.
Competition
The DC
marketplace is very competitive and is comprised of many providers, with no one
company dominating the market for all products. We compete with
numerous other financial services companies. The main factors upon
which entities in this market compete are distribution channel access and the
quality of wholesalers, investment performance, cost, product features, speed to
market, brand recognition, financial strength ratings, crediting rates and
client service.
INSURANCE
SOLUTIONS
The
Insurance Solutions business provides its products through two
segments: Life Insurance and Group Protection. The
Insurance Solutions – Life Insurance segment offers wealth protection and
transfer opportunities through term insurance, a linked-benefit product and both
single and survivorship versions of UL and VUL, including COLI and BOLI
products. The Insurance Solutions – Group Protection segment offers
group life, disability and dental insurance primarily in the small- to mid-sized
employer marketplace for their eligible employees.
Insurance
Solutions – Life Insurance
Overview
The
Insurance Solutions – Life Insurance segment, with principal operations in
Greensboro, North Carolina and Hartford, Connecticut and additional operations
in Concord, New Hampshire and Fort Wayne, Indiana, focuses on the creation and
protection of wealth for its clients through the manufacturing of life insurance
products. The Insurance Solutions – Life Insurance segment offers
wealth protection and transfer opportunities through term insurance, a
linked-benefit product (which is a UL policy linked with riders that provide for
long-term care costs) and both single and survivorship versions of UL and VUL,
including COLI and BOLI products.
The
Insurance Solutions – Life Insurance segment primarily targets the affluent to
high net worth markets, defined as households with at least $250,000 of
financial assets. For those individual policies we sold in 2009, the
average face amount (excluding term and MoneyGuard® products) was $1 million and
average first year premiums paid were approximately $50,000.
The
Insurance Solutions – Life Insurance segment also offers COLI and BOLI products
and services to small- to mid-sized banks and mid- to large-sized corporations,
mostly through executive benefit brokers.
Products
The
Insurance Solutions – Life Insurance segment sells primarily
interest/market-sensitive products (UL and VUL), including COLI and BOLI
products, and term products. The segment’s sales (in millions) were
as follows:
|
|
For
the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Sales
by Product
|
|
|
|
|
|
|
|
|
|
UL:
|
|
|
|
|
|
|
|
|
|
Excluding
MoneyGuard®
|
|
$ |
397 |
|
|
$ |
525 |
|
|
$ |
597 |
|
MoneyGuard®
|
|
|
67 |
|
|
|
50 |
|
|
|
40 |
|
Total
UL
|
|
|
464 |
|
|
|
575 |
|
|
|
637 |
|
VUL
|
|
|
36 |
|
|
|
54 |
|
|
|
77 |
|
COLI
and BOLI
|
|
|
51 |
|
|
|
84 |
|
|
|
91 |
|
Term/whole
life
|
|
|
59 |
|
|
|
28 |
|
|
|
32 |
|
Total
sales
|
|
$ |
610 |
|
|
$ |
741 |
|
|
$ |
837 |
|
UL and
VUL sales (including COLI and BOLI), represent first year commissionable
premiums plus 5% of excess premium received, including an adjustment for
internal replacements of approximately 50% of commissionable premiums; whole
life and term sales represent 100% of first year paid premiums; and
linked-benefit sales represent 15% of premium deposits.
The
segment generally has higher sales in the second half of the year than in the
first half of the year. Approximately 44% and 46% of total sales were
in the first half of 2009 and 2008, respectively; however, in 2007,
approximately 50% of total sales were in the first half of the
year. In 2007, this was due to the transition of our product
portfolio to the new unified product portfolio.
Life
policies’ in-force face amount (in millions) were as follows:
|
|
As
of December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
In-Force
Face Amount
|
|
|
|
|
|
|
|
|
|
UL
and other
|
|
$ |
291,879 |
|
|
$ |
310,198 |
|
|
$ |
299,598 |
|
Term
insurance
|
|
|
248,726 |
|
|
|
235,023 |
|
|
|
235,919 |
|
Total
in-force face amount
|
|
$ |
540,605 |
|
|
$ |
545,221 |
|
|
$ |
535,517 |
|
Mortality
margins, morbidity margins (for linked-benefit products), investment margins
(through spreads or fees), net expense charges (expense charges assessed to the
contract holder less expenses incurred to manage the business) and surrender
fees drive life insurance profits. Mortality margins represent the
difference between amounts charged to the customer to cover the mortality risk
and the actual cost of reinsurance and death benefits paid. Mortality
charges are either specifically deducted from the contract holder’s policy
account value (i.e., cost of insurance assessments or “COIs”) or are embedded in
the premiums charged to the customer. In either case, these amounts
are a function of the rates priced into the product and level of insurance in
force (less reserves previously set aside to fund
benefits). Insurance in force, in turn, is driven by sales,
persistency and mortality experience.
Similar
to the annuity product classifications described above, life products can be
classified as “fixed” or “variable” contracts. This classification
describes whether we or the contract holders bear the investment risk of the
assets supporting the policy. This also determines the manner in
which we earn investment margin profits from these products, either as
investment spreads for fixed products or as asset-based fees charged to variable
products.
We offer
four categories of life insurance products consisting of:
Interest-sensitive
Life Insurance (Primarily UL)
Interest-sensitive
life insurance products provide life insurance with account (cash) values that
earn rates of return based on company-declared interest
rates. Contract holder account values are invested in our general
account investment portfolio, so we bear the risk of investment
performance. Some of our UL contracts include secondary guarantees,
which are explained more fully below.
In a UL
contract, contract holders have flexibility in the timing and amount of premium
payments and the amount of death benefit, provided there is sufficient account
value to cover all policy charges for mortality and expenses for the coming
period. Under certain contract holder options and market conditions,
the death benefit amount may increase or decrease. Premiums received
on a UL product, net of expense loads and charges, are added to the contract
holder’s account value. The client has access to their account value
(or a portion thereof) through contractual liquidity features such as loans,
partial withdrawals and full surrenders. Loans and withdrawals reduce
the death benefit amount payable and are limited to certain contractual maximums
(some of which are required under state law), and interest is charged on all
loans. Our UL contracts assess surrender charges against the
policies’ account values for full or partial face amount surrenders that occur
during the contractual surrender charge period. Depending on the
product selected, surrender charge periods can range from 0 to 20
years.
We also
offer a fixed indexed UL product that functions similarly to a traditional UL
policy, with the added flexibility of allowing contract holders to have portions
of their account value earn interest credits linked to the performance of the
S&P 500. The indexed interest rate is guaranteed never to be less
than 1%. Our fixed indexed UL policy provides contract holders a
choice of a traditional fixed rate account and several different indexed
accounts. A contract holder may elect to change allocations annually
for amounts in the indexed accounts and quarterly for new premiums into the
policy. Prior to each new allocation, we have the opportunity to
re-price the indexed components, subject to minimum guarantees.
As
mentioned previously, we offer survivorship versions of our individual UL
products. These products insure two lives with a single policy and
pay death benefits upon the second death.
Sales
results are heavily influenced by the series of UL products with secondary
guarantees. A UL policy with a secondary guarantee can stay in force,
even if the base policy account value is zero, as long as secondary guarantee
requirements have been met. The secondary guarantee requirement is
based on the evaluation of a reference value within the policy, calculated in a
manner similar to the base policy account value, but using different assumptions
as to expense charges, COI charges and credited interest. The
assumptions for the secondary guarantee requirement are listed in the
contract. As long as the contract holder funds the policy to a level
that keeps this calculated reference value positive, the death benefit will be
guaranteed. The reference value has no actual monetary value to the
contract holder; it is only a calculated value used to determine whether or not
the policy will lapse should the base policy account value be less than zero.
Unlike
other GDB designs, our secondary guarantee benefits maintain the flexibility of
a traditional UL policy, which allows a contract holder to take loans or
withdrawals. Although loans and withdrawals are likely to shorten the
time period of the guaranteed death benefit, the guarantee is not automatically
or completely forfeited, as is sometimes the case with other death benefit
guarantee designs. The length of the guarantee may be increased at
any time through additional excess premium deposits. Secondary
guarantee UL face amount in force was $110.4 billion, $99.0 billion and $83.9
billion as of December 31, 2009, 2008 and 2007, respectively. For
information on the reserving requirements for this business, see “Regulatory”
below and “Review of Consolidated Financial Condition” in the
MD&A.
We manage
investment margins (i.e., the difference between the amount the portfolio earns
compared to the amount that is credited to the customer) by seeking to maximize
current yields, in line with asset/liability and risk management targets, while
crediting a competitive rate to the customer. Crediting rates are
typically subject to guaranteed minimums specified in the underlying life
insurance contract. Interest-sensitive life account values (including
MoneyGuard® and the
fixed portion of VUL) were $27.3 billion, $27.5 billion and $26.5 billion as of
December 31, 2009, 2008 and 2007, respectively.
Linked-benefit
Life Products
Linked-benefit
life products combine UL with long-term care insurance through the use of
riders. The first rider allows the contract holder to accelerate
death benefits on a tax-free basis in the event of a qualified long-term care
need. The second rider extends the long-term care insurance benefits
for an additional period of time if the death benefit is fully depleted for the
purposes of long-term care. If the long-term care benefits are never
used, the policy provides a tax-free death benefit to the contract holder’s
heirs. Linked-benefit life products generate earnings through
investment, mortality and morbidity margins. MoneyGuard® products are
linked-benefit life products.
VUL
VUL
products are UL products that provide a return on account values linked to an
underlying investment portfolio of sub-accounts offered through the
product. The value of the contract holder’s account varies with the
performance of the sub-accounts chosen by the contract holder. The
underlying assets of the sub-accounts are managed within a special insurance
series of mutual funds. Premiums, net of expense loads and charges
for mortality and expenses, received on VUL products are invested according to
the contract holder’s investment option selection. As the return on
the investment portfolio increases or decreases, the account value of the VUL
policy will increase or decrease. As with fixed UL products, contract
holders have access, within contractual maximums, to account values through
loans, withdrawals and surrenders. Surrender charges are assessed
during the surrender charge period, ranging from 0 to 20 years depending on the
product. The investment choices we offer in VUL products are the
same, in most cases, as the investment choices offered in our individual
variable annuity contracts.
In
addition, VUL products offer a fixed account option that is managed by
us. Investment risk is borne by the customer on all but the fixed
account option. We charge fees for mortality costs and administrative
expenses as well as asset-based investment management fees. VUL
account values (excluding the fixed portion of VUL) were $4.5 billion, $4.3
billion and $6.0 billion as of December 31, 2009, 2008 and 2007,
respectively.
We also
offer survivorship versions of our individual VUL products. These
products insure two lives with a single policy and pay death benefits upon the
second death.
We also
offer an enhanced single life version
of our secondary guarantee VUL products with a survivorship
option. These products combine the lapse protection elements of UL
with the upside potential of a traditional VUL product, giving clients the
flexibility to choose the appropriate balance between protection and market risk
that meets their individual needs. The combined single life and
survivorship face amount in force of these products was $5.3 billion, $4.9
billion and $4.0 billion as of December 31, 2009, 2008 and 2007,
respectively.
Term
Life Insurance
Term life
insurance provides a fixed death benefit for a scheduled period of
time. It usually does not offer cash values. Scheduled
policy premiums are required to be paid at least annually. Products
offering a return of premium benefit payable at the end of a specified period
are also available.
Distribution
The
Insurance Solutions – Life Insurance segment’s products are sold through
LFD. LFD provides the Insurance Solutions – Life Insurance segment
with access to financial intermediaries in the following primary distribution
channels: wire/regional firms; independent planner firms (including
LFN); financial institutions; and managing general agents/independent marketing
organizations. LFD primarily distributes COLI and BOLI products to 14
intermediaries who specialize in the executive benefits market and are serviced
through a network of internal and external sales professionals
Competition
The life
insurance industry is very competitive and consists of many companies with no
one company dominating the market for all products. As of the end of
2008, the latest year for which data is available, there were 976 life insurance
companies in the U.S., according to the American Council of Life
Insurers.
The
Insurance Solutions – Life Insurance segment competes on product design and
customer service. The Insurance Solutions –Life Insurance segment
designs products specifically for the high net worth and affluent
markets. In addition to the growth opportunity offered by its target
market, our product breadth, design innovation, competitiveness, speed to
market, customer service, underwriting and risk management and extensive
distribution network all contribute to the strength of the Insurance Solutions –
Life Insurance segment. On average, the development of products takes
approximately six months. The Insurance Solutions – Life Insurance
segment implemented several major product upgrades and/or new features,
including important UL, VUL, linked-benefit and term product enhancements in
2009. With respect to customer service, management tracks the speed,
accuracy and responsiveness of service to customers’ calls and transaction
requests. Further, the Insurance Solutions – Life Insurance segment
tracks the turnaround time and quality for various client services such as
processing of applications.
Underwriting
In the
context of life insurance, underwriting is the process of evaluating medical and
non-medical information about an individual and determining the effect these
factors statistically have on life expectancy or mortality. This
process of evaluation is often referred to as risk classification. Of
course, no one can accurately predict how long any individual will live, but
certain risk factors can affect life expectancy and are evaluated during the
underwriting process.
Claims
Administration
Claims
services are delivered to customers from the Greensboro, North Carolina and
Concord, New Hampshire home offices. Claims examiners are assigned to
each claim notification based on coverage amount, type of claim and the
experience of the examiner. Claims meeting certain criteria are
referred to senior claim examiners. A formal quality assurance
program is carried out to ensure the consistency and effectiveness of claims
examining activities. A network of in-house legal counsel, compliance
officers, medical personnel and an anti-fraud investigative unit also support
claim examiners. A special team of claims examiners, in conjunction
with claims management, focus on more complex claims matters such as long-term
care claims, claims incurred during the contestable period, beneficiary
disputes, litigated claims and the few invalid claims that are
encountered.
The
Insurance Solutions – Life Insurance segment maintains a centralized claim
service center in order to minimize the volume of clerical and repetitive
administrative demands on its claims examiners while providing convenient
service to policy owners and beneficiaries.
Insurance
Solutions – Group Protection
Overview
The
Insurance Solutions – Group Protection segment based in Omaha, Nebraska offers
group non-medical insurance products, principally term life, disability and
dental, to the employer marketplace through various forms of contributory and
noncontributory plans. Most of the segment’s group contracts are sold
to employers with fewer than 500 employees.
The
segment’s insurance premiums (in millions) by product line were as
follows:
|
|
For
the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Insurance
Premiums by Product Line
|
|
|
|
|
|
|
|
|
|
Life
|
|
$ |
584 |
|
|
$ |
541 |
|
|
$ |
494 |
|
Disability
|
|
|
692 |
|
|
|
672 |
|
|
|
601 |
|
Dental
|
|
|
149 |
|
|
|
150 |
|
|
|
136 |
|
Total
non-medical
|
|
|
1,425 |
|
|
|
1,363 |
|
|
|
1,231 |
|
Medical
|
|
|
154 |
|
|
|
154 |
|
|
|
149 |
|
Total
insurance premiums
|
|
$ |
1,579 |
|
|
$ |
1,517 |
|
|
$ |
1,380 |
|
Products
Group
Life Insurance
We offer
employer-sponsored group term life insurance products including basic, optional
and voluntary term life insurance to employees and their
dependents. Additional benefits may be provided in the event of a
covered individual’s accidental death or dismemberment.
Group
Disability Insurance
We offer
short- and long-term employer-sponsored group disability insurance, which
protects an employee against loss of wages due to illness or
injury. Short-term disability generally provides benefits for up to
26 weeks following a short waiting period, ranging from 1 to 30
days. Long-term disability provides benefits following a longer
waiting period, usually between 30 and 180 days and provides benefits for a
longer period, at least 2 years and typically extending to normal (Social
Security) retirement age.
Group
Dental
We offer
employer-sponsored group dental insurance, which covers a portion of the cost of
eligible dental procedures for employees and their
dependents. Products offered include indemnity coverage, which does
not distinguish benefits based on a dental provider’s participation in a network
arrangement, and a Preferred Provider Organization (“PPO”) product that does
reflect the dental provider’s participation in the PPO network arrangement,
including agreement with network fee schedules.
Distribution
The
segment’s products are marketed primarily through a national distribution
system, including approximately 140 managers and marketing
representatives. The managers and marketing representatives develop
business through employee benefit brokers, TPAs and other employee benefit
firms.
Competition
The group
protection marketplace is very competitive. Principal competitive
factors include particular product features, price, quality of customer service
and claims management, technological capabilities, financial strength and
claims-paying ratings. In the group insurance market, the Insurance
Solutions – Group Protection segment competes with a limited number of major
companies and selected other companies that focus on these
products.
Underwriting
The
Insurance Solutions – Group Protection segment’s underwriters evaluate the risk
characteristics of each employee group. Generally, the relevant
characteristics evaluated include employee census information (such as age,
gender, income and occupation), employer industry classification, geographic
location, benefit design elements and other factors. The segment
employs detailed underwriting policies, guidelines and procedures designed to
assist the underwriter to properly assess and quantify risks. The
segment uses technology to efficiently review, price and issue smaller cases,
utilizing its underwriting staff on larger, more complex
cases. Individual underwriting techniques (including evaluation of
individual medical history information) may be used on certain covered
individuals selecting larger benefit amounts. For voluntary and other
forms of employee paid coverages, minimum participation requirements are used to
obtain a better spread of risk and minimize the risk of
anti-selection.
Claims
Administration
Claims
for the Insurance Solutions – Group Protection segment are managed by a staff of
experienced claim specialists. Disability claims management is
especially important to segment results, as results depend on both the incidence
and the length of approved disability claims. The segment employs
nurses and rehabilitation specialists to help evaluate medical conditions and
develop return to work plans. Independent medical reviews are
routinely performed by external medical professionals to further evaluate
conditions as part of the claim management process.
OTHER
OPERATIONS
Other
Operations includes the results of operations that are not directly related
to the business segments, unallocated corporate items and the ongoing
amortization of deferred gain on the indemnity reinsurance portion of the sale
of our former reinsurance segment to Swiss Re in the fourth quarter of
2001. Unallocated corporate items include investment income on
investments related to the amount of statutory surplus in our insurance
subsidiaries that is not allocated to our business units and other corporate
investments, such as our remaining radio properties, interest expense on
short-term and long-term borrowings, our closed block of run-off pension
business in the form of group annuity and insured funding-type of contracts with
assets under management of approximately $1.9 billion as of December 31, 2009,
and certain expenses, including restructuring and merger-related expenses. Other
Operations also includes the results of certain disability income business due
to the rescission of the indemnity reinsurance agreement with Swiss Re and the
results of our remaining media businesses.
Revenues
(in millions) from Other Operations were as follows:
|
|
For
the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
Operating
Revenues
|
|
|
|
|
|
|
|
|
|
Insurance
premiums
|
|
$ |
4 |
|
|
$ |
4 |
|
|
$ |
3 |
|
Net
investment income
|
|
|
307 |
|
|
|
358 |
|
|
|
372 |
|
Amortization
of deferred gain on business
|
|
|
|
|
|
|
|
|
|
|
|
|
sold
through reinsurance
|
|
|
73 |
|
|
|
74 |
|
|
|
74 |
|
Media
revenues (net)
|
|
|
68 |
|
|
|
85 |
|
|
|
107 |
|
Other
revenues and fees
|
|
|
15 |
|
|
|
13 |
|
|
|
22 |
|
Total
operating revenues
|
|
$ |
467 |
|
|
$ |
534 |
|
|
$ |
578 |
|
REINSURANCE
We follow
the industry practice of reinsuring a portion of our life insurance and annuity
risks with unaffiliated reinsurers. In a reinsurance transaction, a
reinsurer agrees to indemnify another insurer for part or all of its liability
under a policy or policies it has issued for an agreed upon
premium. We use reinsurance to protect our insurance subsidiaries
against the severity of losses on individual claims and unusually serious
occurrences in which a number of claims produce an aggregate extraordinary
loss. We also use reinsurance to improve our results by leveraging
favorable reinsurance pricing. Although reinsurance does not
discharge the insurance subsidiaries from their primary liabilities to their
contract holders for losses insured under the insurance policies, it does make
the assuming reinsurer liable to the insurance subsidiaries for the reinsured
portion of the risk. Because we bear the risk of nonpayment by one or
more of our reinsurers, we primarily cede reinsurance to well-capitalized,
highly rated reinsurers.
We
reinsure approximately 45% to 50% of the mortality risk on newly issued non-term
life insurance contracts and approximately 30% to 35% of total mortality risk
including term insurance contracts. Our policy for this program is to
retain no more than $10 million on a single insured life issued on fixed and VUL
insurance contracts. Additionally, the retention per single insured
life for term life insurance and for COLI is $2 million for each type of
insurance.
Portions
of our deferred annuity business have been reinsured on a modified coinsurance
(“Modco”) basis with other companies to limit our exposure to interest rate
risks. In a Modco program, the reinsurer shares proportionally in all
financial terms of the reinsured policies (i.e. premiums, expenses, claims,
etc.) based on their respective quota share of the risk.
In
addition, we acquire other reinsurance to cover products other than as discussed
above with retentions and limits that management believes are appropriate for
the circumstances.
We obtain
reinsurance from a diverse group of reinsurers and we monitor concentration and
financial strength ratings of our principal reinsurers. Swiss Re
represents our largest exposure. As of December 31, 2009 and 2008,
the amounts recoverable from reinsurers were $6.4 billion and $8.4 billion,
respectively, of which $3.0 billion and $4.5 billion was recoverable from Swiss
Re for the same periods, respectively.
For more
information regarding reinsurance, see “Reinsurance” in the MD&A and Note
9. For risks involving reinsurance, see “Item 1A. Risk Factors – We
face a risk of non-collectibility of reinsurance, which could materially affect
our results of operations.”
RESERVES
The
applicable insurance laws under which insurance companies operate require that
they report, as liabilities, policy reserves to meet future obligations on their
outstanding policies. These reserves are the amounts that, with the
additional premiums to be received and interest thereon compounded annually at
certain assumed rates, are calculated to be sufficient to meet the various
policy and contract obligations as they mature. These laws specify
that the reserves shall not be less than reserves calculated using certain
specified mortality and morbidity tables, interest rates and methods of
valuation.
For more
information on reserves, see “Critical Accounting Policies and Estimates –
Derivatives” and “Critical Accounting Policies and Estimates – Future Contract
Benefits and Other Contract Holder Obligations” in the MD&A.
See
“Regulatory” below for information on permitted practices and proposed
regulations that may impact the amount of statutory reserves necessary to
support our current insurance liabilities.
For risks
related to reserves, see “Item 1A. Risk Factors – Changes in interest rates may
cause interest rate spreads to decrease and may result in increased contract
withdrawals.”
INVESTMENTS
An
important component of our financial results is the return on invested
assets. Our investment strategy is to balance the need for current
income with prudent risk management, with an emphasis on generating sufficient
current income to meet our obligations. This approach requires the
evaluation of risk and expected return of each asset class utilized, while still
meeting our income objectives. This approach also permits us to be
more effective in our asset-liability management because decisions can be made
based upon both the economic and current investment income considerations
affecting assets and liabilities. Investments by our insurance
subsidiaries must comply with the insurance laws and regulations of the states
of domicile.
We do not
use derivatives for speculative purposes. Derivatives are used for
hedging purposes and income generation. Hedging strategies are
employed for a number of reasons including, but not limited to, hedging certain
portions of our exposure to changes in our GDB, GWB and GIB liabilities,
interest rate fluctuations, the widening of bond yield spreads over comparable
maturity U.S. Government obligations and credit, foreign exchange and equity
risks. Income generation strategies include credit default swaps
through replication synthetic asset transactions. These derivatives
synthetically create exposure in the general account to corporate debt, similar
to investing in the credit markets.
As of
December 31, 2009 and 2008, our most significant investment in one issuer was
our investment securities issued by the Federal Home Loan Mortgage Corporation
with a fair value of $4.8 billion and $3.5 billion, or 6% and 5% of our invested
assets portfolio totaling $75.9 billion and $66.5 billion,
respectively. As of December 31, 2009 and 2008, our most significant
investment in one industry was our investment securities in
the collateralized mortgage obligation industry with a fair value of $6.9
billion and $6.8 billion, or 9% and 10% of the invested assets portfolio,
respectively.
For
additional information on our investments, including carrying values by
category, quality ratings and net investment income, see “Consolidated
Investments” in the MD&A, as well as Notes 1 and 5.
RATINGS
The
Nationally Recognized Statistical Ratings Organizations rate the financial
strength of our principal insurance subsidiaries and the debt of
LNC. Ratings are not recommendations to buy our
securities.
Rating
agencies rate insurance companies based on financial strength and the ability to
pay claims, factors more relevant to contract holders than
investors. We believe that the ratings assigned by nationally
recognized, independent rating agencies are material to our
operations. There may be other rating agencies that also rate our
securities, which we do not disclose in our reports.
Insurer
Financial Strength Ratings
The
insurer financial strength rating scales of A.M. Best, Fitch Ratings (“Fitch”),
Moody’s Investors Service (“Moody’s”) and S&P are characterized as
follows:
As of
February 19, 2010, the financial strength ratings of our principal insurance
subsidiaries, as published by the principal rating agencies that rate our
securities, or us, were as follows:
|
|
|
|
|
A.M.
Best
|
|
Fitch
|
|
Moody's
|
|
S&P
|
Insurer
Financial Strength Ratings
|
|
|
|
|
|
|
|
|
|
LNL
|
|
|
|
|
A+
|
|
A+
|
|
A2
|
|
AA-
|
|
|
|
|
|
(2nd
of 16)
|
|
(5th
of 21)
|
|
(6th
of 21)
|
|
(4th
of 21)
|
|
|
|
|
|
|
|
|
|
|
|
|
Lincoln
Life & Annuity Co. of New York ("LLANY")
|
|
A+
|
|
A+
|
|
A2
|
|
AA-
|
|
|
|
|
|
(2nd
of 16)
|
|
(5th
of 21)
|
|
(6th
of 21)
|
|
(4th
of 21)
|
|
|
|
|
|
|
|
|
|
|
|
|
First
Penn-Pacific Life Insurance Co. ("FPP")
|
|
A+
|
|
A+
|
|
A2
|
|
A+
|
|
|
|
|
|
(2nd
of 16)
|
|
(5th
of 21)
|
|
(6th
of 21)
|
|
(5th
of 21)
|
A
downgrade of the financial strength rating of one of our principal insurance
subsidiaries could affect our competitive position in the insurance industry and
make it more difficult for us to market our products, as potential customers may
select companies with higher financial strength ratings.
Debt
Ratings
The
long-term credit rating scales of A.M. Best, Fitch, Moody’s and S&P are
characterized as follows:
As of
February 19, 2010, our long-term credit ratings, as published by the principal
rating agencies that rate our long-term credit, were as follows:
A.M.
Best
|
|
Fitch
|
|
Moody's
|
|
S&P
|
a-
|
|
BBB
|
|
Baa2
|
|
A-
|
(7th
of 23)
|
|
(9th
of 21)
|
|
(9th
of 21)
|
|
(7th
of 22)
|
The
short-term credit rating scales of A.M. Best, Fitch, Moody’s and S&P are
characterized as follows:
·
|
A.M.
Best – AMB-1+ to d
|
As of
February 19, 2010, our short-term credit ratings, as published by the principal
rating agencies that rate our short-term credit, were as follows:
A.M.
Best
|
|
Fitch
|
|
Moody's
|
|
S&P
|
AMB-1
|
|
F2
|
|
P-2
|
|
A-2
|
(2nd
of 6)
|
|
(3rd
of 7)
|
|
(2nd
of 4)
|
|
(3rd
of 10)
|
A
downgrade of our debt ratings could affect our ability to raise additional debt
with terms and conditions similar to our current debt, and accordingly, likely
increase our cost of capital. In addition, a downgrade of these
ratings could make it more difficult to raise capital to refinance any maturing
debt obligations, to support business growth at our insurance subsidiaries and
to maintain or improve the current financial strength ratings of our principal
insurance subsidiaries described above.
All
ratings are on outlook negative, with the exception of S&P, which is
stable. All of our ratings are subject to revision or withdrawal at
any time by the rating agencies, and therefore, no assurance can be given that
our principal insurance subsidiaries or LNC can maintain these
ratings. Each rating should be evaluated independently of any other
rating.
REGULATORY
Insurance
Regulation
Our
insurance subsidiaries, like other insurance companies, are subject to
regulation and supervision by the states, territories and countries in which
they are licensed to do business. The extent of such regulation
varies, but generally has its source in statutes that delegate regulatory,
supervisory and administrative authority to supervisory agencies. In
the U.S., this power is vested in state insurance departments.
In
supervising and regulating insurance companies, state insurance departments,
charged primarily with protecting contract holders and the public rather than
investors, enjoy broad authority and discretion in applying applicable insurance
laws and regulation for that purpose. Our principal insurance
subsidiaries, LNL, LLANY and FPP, are domiciled in the states of Indiana, New
York and Indiana, respectively.
The
insurance departments of the domiciliary states exercise principal regulatory
jurisdiction over our insurance subsidiaries. The extent of
regulation by the states varies, but in general, most jurisdictions have laws
and regulations governing standards of solvency, adequacy of reserves,
reinsurance, capital adequacy, licensing of companies and agents to transact
business, prescribing and approving policy forms, regulating premium rates for
some lines of business, prescribing the form and content of financial statements
and reports, regulating the type and amount of investments permitted and
standards of business conduct. Insurance company regulation is
discussed further under “Insurance Holding Company Regulation” and “Restrictions
on Subsidiaries’ Dividends and Other Payments.”
As part
of their regulatory oversight process, state insurance departments conduct
periodic, generally once every three to five years, examinations of the books,
records, accounts, and business practices of insurers domiciled in their
states. During the three-year period ended December 31, 2009, we
have not received any material adverse findings resulting from state insurance
department examinations of our insurance subsidiaries conducted during this
three-year period.
State
insurance laws and regulations require our U.S. insurance companies to file
financial statements with state insurance departments everywhere they do
business, and the operations of our U.S. insurance companies and accounts are
subject to examination by those departments at any time. Our U.S.
insurance companies prepare statutory financial statements in accordance with
accounting practices and procedures prescribed or permitted by these
departments. The National Association of Insurance Commissioners
(“NAIC”) has approved a series of statutory accounting principles that have been
adopted, in some cases with minor modifications, by virtually all state
insurance departments.
The NAIC
allows our U.S. insurance subsidiaries to include certain deferred tax assets in
our statutory capital and surplus, but we are not able to consider the benefit
from this when calculating available dividends.
A new
statutory reserving standard, Actuarial Guideline 43, Commissioners Annuity
Reserve Valuation Method for Variable Annuities (“VACARVM”), replaced previous
statutory reserving practices for variable annuities with guaranteed benefits,
such as GWBs. VACARVM was adopted by the NAIC in September 2008 and was
effective as of December 31, 2009. The effect of the adoption was dependent
upon several factors, including account values, market conditions,
the carrying value of derivative and other assets as compared to the
carrying value of the reserves (whose change in value may be
uncorrelated with the new reserving requirements) they supported and the
use of captive or third-party reinsurance that existed as of December 31,
2009. For more information on VACARVM and our use of captive
reinsurance structures, see “Review of Consolidated Financial Condition –
Liquidity and Capital Resources” in the MD&A.
Insurance
Holding Company Regulation
LNC and
its primary insurance subsidiaries are subject to regulation pursuant to the
insurance holding company laws of the states of Indiana and New
York. These insurance holding company laws generally require an
insurance holding company and insurers that are members of such insurance
holding company’s system to register with the insurance department authorities,
to file with it certain reports disclosing information, including their capital
structure, ownership, management, financial condition, and certain inter-company
transactions, including material transfers of assets and inter-company business
agreements and to report material changes in that information. These
laws also require that inter-company transactions be fair and reasonable and,
under certain circumstances, prior approval of the insurance departments must be
received before entering into an inter-company transaction. Further,
these laws require that an insurer’s contract holders’ surplus following any
dividends or distributions to shareholder affiliates is reasonable in relation
to the insurer’s outstanding liabilities and adequate for its financial
needs.
In
general, under state holding company regulations, no person may acquire,
directly or indirectly, a controlling interest in our capital stock unless such
person, corporation or other entity has obtained prior approval from the
applicable insurance commissioner for such acquisition of
control. Pursuant to such laws, in general, any person acquiring,
controlling or holding the power to vote, directly or indirectly, 10% or more of
the voting securities of an insurance company, is presumed to have “control” of
such company. This presumption may be rebutted by a showing that
control does not exist in fact. The insurance commissioner, however,
may find that “control” exists in circumstances in which a person owns or
controls a smaller amount of voting securities. To obtain approval
from the insurance commissioner of any acquisition of control of an insurance
company, the proposed acquirer must file with the applicable commissioner an
application containing information regarding: the identity and
background of the acquirer and its affiliates; the nature, source and amount of
funds to be used to carry out the acquisition; the financial statements of the
acquirer and its affiliates; any potential plans for disposition of the
securities or business of the insurer; the number and type of securities to be
acquired; any contracts with respect to the securities to be acquired; any
agreements with broker-dealers; and other matters.
Other
jurisdictions in which our insurance subsidiaries are licensed to transact
business may have similar or additional requirements for prior approval of any
acquisition of control of an insurance or reinsurance company licensed or
authorized to transact business in those jurisdictions. Additional
requirements in those jurisdictions may include re-licensing or subsequent
approval for renewal of existing licenses upon an acquisition of
control. As further described below, laws that govern the holding
company structure also govern payment of dividends to us by our insurance
subsidiaries.
Restrictions
on Subsidiaries’ Dividends and Other Payments
We are a
holding company that transacts substantially all of our business directly and
indirectly through subsidiaries. Our primary assets are the stock of
our operating subsidiaries. Our ability to meet our obligations on
our outstanding debt and to pay dividends and our general and administrative
expenses depends on the surplus and earnings of our subsidiaries and the ability
of our subsidiaries to pay dividends or to advance or repay funds to
us.
Our
insurance subsidiaries are subject to certain insurance department regulatory
restrictions as to the transfer of funds and payment of dividends to the holding
company. Under Indiana laws and regulations, our Indiana insurance
subsidiaries, including our primary insurance subsidiary, LNL, may pay dividends
to LNC without prior approval of the Indiana Insurance Commissioner (the
“Commissioner”), only from unassigned surplus or must receive prior approval of
the Commissioner to pay a dividend if such dividend, along with all other
dividends paid within the preceding 12 consecutive months, would exceed the
statutory limitation. The current statutory limitation is the greater of 10% of the
insurer’s contract holders’ surplus, as shown on its last annual statement on
file with the Commissioner or the insurer’s statutory net gain from operations
for the previous 12 months, but in no event to exceed statutory unassigned
surplus. As discussed above, we may not consider the benefit from the
statutory accounting principles relating to our insurance subsidiaries’ deferred
tax assets in calculating available dividends. Indiana law gives the
Commissioner broad discretion to disapprove requests for dividends in excess of
these limits. New York, the state of domicile of our other major
insurance subsidiary, LLANY, has similar restrictions, except that in New York
it is the lesser of 10% of
surplus to contract holders as of the immediately preceding calendar year or net
gain from operations for the immediately preceding calendar year, not including
realized capital gains.
Indiana
law also provides that following the payment of any dividend, the insurer’s
contract holders’ surplus must be reasonable in relation to its outstanding
liabilities and adequate for its financial needs, and permits the Commissioner
to bring an action to rescind a dividend which violates these
standards. In the event that the Commissioner determines that the
contract holders’ surplus of one subsidiary is inadequate, the Commissioner
could use his or her broad discretionary authority to seek to require us to
apply payments received from another subsidiary for the benefit of that
insurance subsidiary. For information regarding dividends paid to us
during 2009 from our insurance subsidiaries, see “Review of Consolidated
Financial Condition – Liquidity and Capital Resources – Sources of Liquidity and
Cash Flow” in the MD&A.
Risk-Based
Capital (“RBC”)
The NAIC
has adopted RBC requirements for life insurance companies to evaluate the
adequacy of statutory capital and surplus in relation to investment and
insurance risks. The requirements provide a means of measuring the
minimum amount of statutory surplus appropriate for an insurance company to
support its overall business operations based on its size and risk
profile. There are five major risks involved in determining the
requirements:
|
|
Name
|
|
Description
|
Asset
risk - affiliates
|
|
|
C-0 |
|
Risk
of assets' default for certain affiliated investments
|
Asset
risk - other
|
|
|
C-1 |
|
Risk
of assets' default of principal and interest or
|
|
|
|
|
|
fluctuation
in fair value
|
Insurance
risk
|
|
|
C-2 |
|
Risk
of underestimating liabilities from business already
|
|
|
|
|
|
written
or inadequately pricing business to be written in
|
|
|
|
|
|
the
future
|
Interest
rate risk, health credit
|
|
|
C-3 |
|
Risk
of losses due to changes in interest rate levels, risk
|
risk
and market risk
|
|
|
|
|
that
health benefits prepaid to providers become the
|
|
|
|
|
|
obligation
of the health insurer once again and risk of
|
|
|
|
|
|
loss
due to changes in market levels associated with
|
|
|
|
|
|
variable
products with guarantees
|
Business
risk
|
|
|
C-4 |
|
Risk
of general business
|
A
company’s risk-based statutory surplus is calculated by applying factors and
performing calculations relating to various asset, premium, claim, expense and
reserve items. Regulators can then measure adequacy of a company’s
statutory surplus by comparing it to the RBC determined by the
formula. Under RBC requirements, regulatory compliance is determined
by the ratio of a company’s total adjusted capital, as defined by the NAIC, to
its company action level of RBC (known as the RBC ratio), also as defined by the
NAIC. Accordingly, factors that have an impact on the total adjusted
capital of our insurance subsidiaries, such as the permitted practices discussed
above, will also affect their RBC levels.
Four
levels of regulatory attention may be triggered if the RBC ratio is
insufficient:
·
|
“Company
action level” – If the RBC ratio is between 75% and 100%, then the insurer
must submit a plan to the regulator detailing corrective action it
proposes to undertake;
|
·
|
“Regulatory
action level” – If the RBC ratio is between 50% and 75%, then the insurer
must submit a plan, but a regulator may also issue a corrective order
requiring the insurer to comply within a specified
period;
|
·
|
“Authorized
control level” – If the RBC ratio is between 35% and 50%, then the
regulatory response is the same as at the “Regulatory action level,” but
in addition, the regulator may take action to rehabilitate or liquidate
the insurer; and
|
·
|
“Mandatory
control level” – If the RBC ratio is less than 35%, then the regulator
must rehabilitate or liquidate the
insurer.
|
As of
December 31, 2009, the RBC ratios of LNL, LLANY and FPP reported to their
respective states of domicile and the NAIC all exceeded the “company action
level.” We believe that we will be able to maintain the RBC ratios of
our insurance subsidiaries in excess of “company action level” through prudent
underwriting, claims handling, investing and capital
management. However, no assurances can be given that developments
affecting the insurance subsidiaries, many of which could be outside of our
control, will not cause the RBC ratios to fall below our targeted
levels. These developments may include, but may not be limited
to: changes to the manner in which the RBC ratio is calculated; new
regulatory requirements for calculating reserves, such as principles based
reserving; economic conditions leading to higher levels of impairments of
securities in our insurance subsidiaries’ general accounts; and an inability to
finance life reserves including the issuing of letters of credit
supporting captive reinsurance structures.
See “Item
1A. Risk Factors – A decrease in the capital and surplus of our insurance
subsidiaries may result in a downgrade to our credit and insurer financial
strength ratings.”
Privacy
Regulations
In the
course of our business, we collect and maintain personal data from our customers
including personally identifiable non-public financial and health information,
which subjects us to regulation under federal and state privacy laws.
These laws require that we institute certain policies and procedures in our
business to safeguard this information from improper use or disclosure. If
the federal or state regulators establish further regulations for addressing
customer privacy, we may need to amend our policies and adapt our internal
procedures.
Federal
Initiatives
The U.S.
federal government does not directly regulate the insurance industry; however,
federal initiatives from time to time can impact the insurance
industry.
Health
Care Reform Legislation
In 2009,
the House and the Senate passed health care reform legislation. Many
details will need to be worked out before a final bill emerges, but both the
House and Senate bills as passed include a number of provisions that provide for
new or increased taxes to help finance the cost of these reforms, substantive
changes to existing health care laws and the addition of new health care and
related laws, each of which could potentially impact some of our lines of
businesses.
Financial
Reform Legislation
In 2009,
the House and the Senate both considered legislation related to financial
regulatory reform. In December 2009, the House passed H.R. 4173, “The
Wall Street Reform and Consumer Protection Act of 2009,” a wide-ranging bill
that includes a number of reforms. The bill includes, among other
things, a new harmonized fiduciary standard for broker-dealers and investment
advisers, the creation of the Consumer Financial Protection Agency, the creation
of a pre-funded resolution trust to cover the costs of winding down certain
failing institutions, the creation of the Federal Insurance Office within the
Treasury Department and provisions relating to executive
compensation. The current version of the bill would require insurance
companies to contribute funds to the resolution trust, but the amount the
Company would have to contribute is currently unknown. Similar
legislation is currently under consideration, in draft form, in the Senate
Banking Committee. The House bill will have to be reconciled before a
single bill could be sent to the President and signed into law.
Stimulus
Legislation
In
reaction to the recession, credit market illiquidity and global financial crisis
experienced during the latter part of 2008 and into 2009, Congress enacted the
Emergency Economic Stabilization Act of 2008 (“EESA”) on October 3, 2008, and
the American Recovery and Reinvestment Act of 2009 (“ARRA”) which was signed
into law on February 17, 2009, in an effort to restore liquidity to the U.S.
credit markets and to stimulate the U.S. economy. The ARRA and the
Troubled Asset Relief Program (“TARP”) authorized the purchase of “troubled
assets” from financial institutions, including insurance
companies. Pursuant to the authority granted under the TARP, the U.S.
Treasury also adopted the Capital Purchase Program (“CPP”), the Generally
Available Capital Access Program and the Exceptional Financial Recovery
Assistance Program.
TARP
CPP
On
November 13, 2008, we filed an application to participate in the CPP that was
established under the EESA. On January 8, 2009, the Office of Thrift
Supervision approved our application to become a savings and loan holding
company and our acquisition of NCLS, a federally regulated savings bank located
in Indiana. We contributed $10 million to the capital of NCLS and
closed on our purchase on January 15, 2009. On May 8, 2009, the U.S.
Treasury granted us preliminary approval to participate in the
CPP. On July 10, 2009, we issued, in a private placement, $950
million of Series B preferred stock and a warrant for 13,049,451 shares of our
common stock with an exercise price of $10.92 per share to the U.S. Treasury
under the CPP. See “Review of Consolidated Financial Condition –
Liquidity and Capital Resources – Sources of Liquidity and Cash Flow – Financing
Activities” for more information about our preferred stock
issuance.
Participation
in the CPP subjects us to increased oversight by the U.S.
Treasury. The U.S. Treasury has the power to unilaterally amend the
terms of the purchase agreement to the extent required to comply with changes in
applicable statutes and to inspect our corporate books and records through our
federal banking regulators. In addition, the U.S. Treasury has the
right to appoint two directors to our Board if we miss dividend payments on the
preferred stock as discussed below. Participation in the CPP may also
subject us to increased Congressional scrutiny.
In
connection with participating in the CPP, because we registered as a savings and
loan holding company, we are subjected to new legal and regulatory requirements,
including minimum capital requirements, regulation and examination by the Office
of Thrift Supervision.
We are
also subject to certain restrictions, including limits on incentive compensation
for certain executives and employees for the duration of the U.S. Treasury’s
investment. We are subject to limits on increasing the dividend on
our common stock and redeeming capital stock (unless the U.S. Treasury
consents), both of which apply until the third anniversary of the U.S.
Treasury’s investment unless we redeem the Series B preferred shares in whole or
the U.S. Treasury transfers all of the Series B preferred stock to third
parties.
Financial
Crisis Responsibility Fee
In
January 2010, the President proposed as a part of its budget proposal a new
“financial crisis responsibility fee” on certain financial institutions as a
means to recoup any shortfall in revenues resulting from the TARP program, so
that the program does not add to the federal budget deficit. As
proposed, the fee would apply to financial institutions, including bank holding
companies, thrift holding companies, insured depositories, and insurance
companies that own one of these entities, with over $50 billion in assets,
regardless of whether the firm participated in the TARP program. The
fee as proposed is expected to be an assessment of 15 basis points against a
calculated “covered liabilities” amount and would be in place for a minimum of
10 years. Details as to the precise calculation of “covered
liabilities” are still unclear. Legislation implementing this fee
will need to be introduced and passed by Congress before this tax would take
effect.
Federal
Tax Legislation
In June
2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”)
was enacted. EGTRRA contains provisions that will continue in effect,
near term, the significantly lower individual tax rates. These may
have the effect of reducing the benefits of tax deferral on the inside build-up
of annuities and life insurance products. EGTRRA also includes
provisions that eliminate the estate tax for a single year in 2010, while also
replacing the step-up in basis rule applicable to property held in a decedent’s
estate with a modified carryover basis rule. EGTRRA also reduces the
gift tax rate in 2010 to the highest marginal rate (35% in
2010). Some of these changes might hinder our sales and result in the
increased surrender of insurance and annuity products. These
provisions all expire after 2010, unless extended. Should these provisions not
be extended, the higher marginal tax rates on individuals could have a positive
impact upon the sale of our insurance and annuity products.
In May
2003, the Jobs and Growth Tax Relief Reconciliation Act of 2003 (“JGTRRA”) was
enacted. Individual taxpayers are the principal beneficiaries of
JGTRRA, which accelerated certain of the income tax rate reductions enacted
originally under the EGTRRA, as well as reduced the long-term capital gains and
dividend tax rates to 15%. On May 17, 2006, the Tax Increase
Prevention and Reconciliation Act of 2006 (“TIPRA”) was signed into
law. TIPRA extended the lower capital gains and dividends rates
through the end of 2010. Unless further extended, these rate
reductions expire after 2010. Should the lower capital gains and
dividend rates not be extended beyond 2010, the higher rates on investment
income could have a positive impact on the sale of our insurance and annuity
products.
On August
17, 2006, the Pension Protection Act of 2006 (“PPA”) was signed into
law. The PPA makes numerous changes to pension and other tax laws
including: permanence for the EGTRRA enacted pension provisions
including higher annual contribution limits for DC plans and IRAs as well as
catch-up contributions for persons over age 50; clarification of the safest
available annuity standard for the selection of an annuity as a distribution
option for DC plans; expansion of investment advice options for DC plan
participants and IRA owners; more stringent funding requirements for defined
benefit pension plans and clarification of the legal status of hybrid (cash
balance) pension plans; non-pension related tax changes, such as the
codification of COLI best practices, bringing more certainty to this market
segment; permanence for EGTRRA enacted tax benefits for Section 529 college
savings plans; and favorable tax treatment for long-term care insurance included
as a rider to or on annuity products. We expect many of these changes
to have a beneficial effect upon various segments of our business
lines.
On
February 1, 2010, the Obama Administration submitted to Congress its fiscal year
2011 budget proposal. Included therein are policy and tax recommendations
that could have an effect upon our company and our products and many were
originally proposed in last year’s budget submission to Congress. Included
among the various proposed policy recommendations are modifications to the
dividend received deduction for life insurance company separate accounts, a
permanent extension of the unemployment insurance surtax at the 8% rate,
codification of the economic substance doctrine, a doctrine that generally
denies tax benefits from a transaction that does not meaningfully change a
taxpayer’s economic position other than tax consequences and the imposition of a
Financial Crisis Responsibility Fee upon financial services firms with assets in
excess of $50 billion. If these proposed changes were enacted into law or,
if applicable, changed through the rulemaking process, they could have an
adverse effect upon the company’s profitability. The budget also proposes
changes to the tax laws that would affect individuals that purchase
products offered and sold through our various business
lines, including such items as expanding the pro-rata disallowance for
COLI, changes to the estate tax, the expiration of lower marginal rates and
lower capital gains and dividends rates for certain upper-income taxpayers,
allowing partial annuitization of non-qualified annuity contracts, the creation
of an auto-enrollment IRA program for small employers and encouraging
increased use of qualified plans through tax credits to defray start up
costs. Some of these proposed changes, should they become law, would
have the potential to improve the attractiveness of our products to consumers
and enhance our sales. Other provisions could have the opposite
effect. The submission of the Administration’s budget to
Congress begins the Budget Resolution process that, if successfully
passed, could potentially include some combination of the provisions
described above. However, most of the proposed changes contained in either
the Administration’s budget submission to Congress or included in a
Congressional Budget Resolution should one be passed, would still require
separate legislation that would have to move through both houses of Congress
before being signed into law by the President.
Patriot
Act
The USA
PATRIOT Act of 2001 (“Patriot Act”) contains anti-money laundering and financial
transparency laws and mandates the implementation of various new regulations
applicable to broker-dealers and other financial services companies, including
insurance companies. The Patriot Act seeks to promote cooperation
among financial institutions, regulators and law enforcement entities in
identifying parties that may be involved in terrorism or money
laundering. Anti-money laundering laws outside of the U.S. contain
provisions that may be different, conflicting or more rigorous. The
increased obligations of financial institutions to identify their customers,
watch for and report suspicious transactions, respond to requests for
information by regulatory authorities and law enforcement agencies, and share
information with other financial institutions require the implementation and
maintenance of internal practices, procedures and controls.
Employee
Retirement Income Security Act (“ERISA”) Considerations
ERISA is
a comprehensive federal statute that applies to U.S. employee benefit plans
sponsored by private employers and labor unions. Plans subject to
ERISA include pension and profit sharing plans and welfare plans, including
health, life and disability plans. ERISA provisions include reporting
and disclosure rules, standards of conduct that apply to plan fiduciaries and
prohibitions on transactions known as “prohibited transactions,” such as
conflict-of-interest transactions and certain transactions between a benefit
plan and a party in interest. ERISA also provides for a scheme of
civil and criminal penalties and enforcement. Our insurance, asset
management, plan administrative services and other businesses provide services
to employee benefit plans subject to ERISA, including services where we may act
as an ERISA fiduciary. In addition to ERISA regulation of businesses
providing products and services to ERISA plans, we become subject to ERISA’s
prohibited transaction rules for transactions with those plans, which may affect
our ability to enter transactions, or the terms on which transactions may be
entered, with those plans, even in businesses unrelated to those giving rise to
party in interest status.
Broker-Dealer,
Securities and Savings and Loan Regulation
In
addition to being registered under the Securities Act of 1933, some of our
separate accounts as well as mutual funds that we sponsor are registered as
investment companies under the Investment Company Act of 1940, and the shares of
certain of these entities are qualified for sale in some or all states and the
District of Columbia. We also have several subsidiaries that are
registered as broker-dealers under the Securities Exchange Act of 1934
(“Exchange Act”) and are subject to federal and state regulation, including but
not limited to the Financial Industry Regulation Authority’s (“FINRA”) net
capital rules. In addition, we have several subsidiaries that are
investment advisors registered under the Investment Advisers Act of
1940. Agents and employees registered or associated with any of our
broker-dealer subsidiaries are subject to the Exchange Act and to examination
requirements and regulation by the U.S. Securities and Exchange Commission
(“SEC”), FINRA and state securities commissioners. Regulation also
extends to various LNC entities that employ or control those
individuals. The SEC and other governmental agencies and
self-regulatory organizations, as well as state securities commissions in the
U.S., have the power to conduct administrative proceedings that can result in
censure, fines, the issuance of cease-and-desist orders or suspension and
termination or limitation of the activities of the regulated entity or its
employees.
Our U.S.
banking operations are subject to federal and state regulation. As a
result of its ownership of NCLS, which was approved on January 8, 2009, LNC is
considered to be a savings and loan holding company and, along with NCLS, is
subject to annual examination by the Office of Thrift Supervision of the U.S.
Department of Treasury. Federal and state banking laws generally
provide that no person may acquire control of LNC, and gain indirect control of
NCLS, without prior regulatory approval. Generally, beneficial
ownership of 10% or more of the voting securities of LNC would be presumed to
constitute control.
Environmental
Considerations
Federal,
state and local environmental laws and regulations apply to our ownership and
operation of real property. Inherent in owning and operating real
property are the risk of hidden environmental liabilities and the costs of any
required clean-up. Under the laws of certain states, contamination of
a property may give rise to a lien on the property to secure recovery of the
costs of clean-up, which could adversely affect our commercial mortgage
lending. In several states, this lien has priority over the lien of
an existing mortgage against such property. In addition, in some
states and under the federal Comprehensive Environmental Response, Compensation,
and Liability Act of 1980 (“CERCLA”), we may be liable, as an “owner” or
“operator,” for costs of cleaning-up releases or threatened releases of
hazardous substances at a property mortgaged to us. We also risk
environmental liability when we foreclose on a property mortgaged to
us. Federal legislation provides for a safe harbor from CERCLA
liability for secured lenders that foreclose and sell the mortgaged real estate,
provided that certain requirements are met. However, there are
circumstances in which actions taken could still expose us to CERCLA
liability. Application of various other federal and state
environmental laws could also result in the imposition of liability on us for
costs associated with environmental hazards.
We
routinely conduct environmental assessments for real estate we acquire for
investment and before taking title through foreclosure to real property
collateralizing mortgages that we hold. Although unexpected
environmental liabilities can always arise, based on these environmental
assessments and compliance with our internal procedures, we believe that any
costs associated with compliance with environmental laws and regulations or any
clean-up of properties would not have a material adverse effect on our results
of operations.
We rely
on a combination of copyright, trademark, patent and trade secret laws to
establish and protect our intellectual property. We have implemented
a patent strategy designed to protect innovative aspects of our products and
processes which we believe distinguish us from competitors. We
currently own four issued U.S. patents and have additional patent
applications pending in the U.S. Patent and Trademark
Office. Our currently issued U.S. patents will expire between
2015 and 2021. We intend to continue to file patent applications as
we develop new products, technologies and patentable enhancements.
We regard
our patents as valuable assets and intend to vigorously protect them against
infringement. However, complex legal and factual determinations and
evolving laws make patent protection uncertain, and while we believe our patents
provide us with a competitive advantage, we cannot be certain that patents will
be issued from any of our pending patent applications or that any issued patents
will have sufficient breadth to offer meaningful protection. In
addition, our issued patents may be successfully challenged, invalidated,
circumvented or found unenforceable so that our patent rights would not create
an effective competitive barrier. We have in the past instituted
litigation against competitors to enforce our intellectual property rights with
success. For example, during 2009 we won a $13 million judgment that
upheld the validity of one of our patents and found infringement by the
defendants. We are currently reviewing the judgment and its
applicability in relation to other potentially infringing parties.
Finally,
we have an extensive portfolio of trademarks and service marks that we consider
important in the marketing of our products and services, including, among
others, the trademarks of the Lincoln National and Lincoln Financial names, the
Lincoln silhouette logo and the combination of these marks. Trademark
registrations may be renewed indefinitely subject to continued use and
registration requirements. We regard our trademarks as valuable
assets in marketing our products and services and protect them against
infringement.
EMPLOYEES
As of
December 31, 2009, we had a total of 8,208 employees. In addition, we
had a total of 1,331 planners and agents who had active sales contracts with one
of our insurance subsidiaries. None of our employees are represented
by a labor union, and we are not a party to any collective bargaining
agreements. We consider our employee relations to be
good.
AVAILABLE
INFORMATION
We file
annual, quarterly and current reports, proxy statements and other documents with
the SEC under the Exchange Act. The public may read and copy any
materials that we file with the SEC at the SEC’s Public Reference Room at 100 F
Street, NE, Washington, DC 20549. The public may obtain information
on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. Also, the SEC maintains an Internet website that
contains reports, proxy and information statements and other information
regarding issuers, including LNC, that file electronically with the
SEC. The public can obtain any documents that we file with the SEC at
http://www.sec.gov.
We also
make available, free of charge, on or through our Internet website
http://www.lincolnfinancial.com, our Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those
reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange
Act as soon as reasonably practicable after we electronically file such material
with, or furnish it to, the SEC.
The
information on the website listed above is not, and should not, be considered
part of this annual report on Form 10-K and is not incorporated by reference in
this document. This website is, and is only intended to be, an
inactive textual reference.
Item 1A. Risk
Factors
You
should carefully consider the risks described below before investing in our
securities. The risks and uncertainties described below are not the
only ones facing our company. Additional risks and uncertainties not
presently known to us or that we currently deem immaterial may also impair our
business operations. If any of these risks actually occur, our
business, financial condition and results of operations could be materially
affected. In that case, the value of our securities could decline
substantially.
Adverse
capital and credit market conditions may affect our ability to meet liquidity
needs, access to capital and cost of capital.
The
capital and credit markets have experienced extreme volatility and disruption
for more than twelve months. During this period, the markets 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, to maintain our securities lending activities and to replace
certain maturing liabilities. Without sufficient liquidity, we will
be forced to curtail our operations, and our business will suffer. As
a holding company with no direct operations, our principal asset is the capital
stock of our insurance subsidiaries. Our ability to meet our
obligations for payment of interest and principal on outstanding debt
obligations and to pay dividends to shareholders and corporate expenses depends
significantly upon the surplus and earnings of our subsidiaries and the ability
of our subsidiaries to pay dividends or to advance or repay funds to
us. Payments of dividends and advances or repayment of funds to us by
our insurance subsidiaries are restricted by the applicable laws and regulations
of their respective jurisdictions, including laws establishing minimum solvency
and liquidity thresholds. Changes in these laws could constrain the
ability of our subsidiaries to pay dividends or to advance or repay funds to us
in sufficient amounts and at times necessary to meet our debt obligations and
corporate expenses. For our insurance and other subsidiaries, the
principal sources of our liquidity are insurance premiums and fees, annuity
considerations and cash flow from our investment portfolio and assets,
consisting mainly of cash or assets that are readily convertible into
cash. At the holding company level, sources of liquidity in normal
markets also include a variety of short-term liquid investments and short- and
long-term instruments, including credit facilities, commercial paper and medium-
and long-term debt.
In the
event that current resources do not satisfy our needs, we may have to seek
additional financing. The availability of additional financing will
depend on a variety of factors such as market conditions, the general
availability of credit, the volume of trading activities, the overall
availability of credit to the financial services industry, our credit ratings
and credit capacity, as well as the possibility that customers or lenders could
develop a negative perception of our long- or short-term financial prospects if
we incur large investment losses or if the level of our business activity
decreases due to a market downturn. Similarly, our access to funds
may be impaired if regulatory authorities or rating agencies take negative
actions against us. See “Item 1. Business – Ratings” for a complete
description of our ratings. Our internal sources of liquidity may
prove to be insufficient, and in such case, we may not be able to successfully
obtain additional financing on favorable terms, or at all.
Disruptions,
uncertainty or volatility in the capital and credit markets may also limit our
access to capital required to operate our business, most significantly our
insurance operations. Such market conditions may limit our ability to
replace, in a timely manner, maturing liabilities; satisfy statutory capital
requirements; generate fee income and market-related revenue to meet liquidity
needs; and access the capital necessary to grow our business. As
such, we may be forced to delay raising capital, issue shorter term securities
than we prefer or bear an unattractive cost of capital which could decrease our
profitability and significantly reduce our financial
flexibility. Recently, our credit spreads have shown considerable
volatility. A widening of our credit spreads could increase 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 expect
any recovery to be slow.
Our
results of operations are materially affected by conditions in the global
capital markets and the economy generally, both in the U.S. and elsewhere around
the world. The stress experienced by global capital markets that
began in the second half of 2007, substantially increased during the second half
of 2008 and continued through the first part of 2009. Concerns over
unemployment, the availability and cost of credit, the U.S. mortgage market and
a declining real estate market in the U.S. contributed to increased volatility
and diminished expectations for the economy and the markets going
forward. These events and the reemergence of 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. For example, for the year ended December 31, 2009, our
earnings were unfavorable affected by realized investment losses and impairments
of intangible assets of $1.1 billion. Even in the absence of a market
downturn, we are exposed to substantial risk of loss due to market
volatility.
Factors
such as consumer spending, business investment, government spending, the
volatility and strength of the capital markets and inflation all affect the
business and economic environment and, ultimately, the amount and profitability
of our business. In an economic downturn characterized by higher
unemployment, lower family income, lower corporate earnings, lower business
investment and lower consumer spending, the demand for our financial and
insurance products could be adversely affected. In addition, we may
experience an elevated incidence of claims and lapses or surrenders of
policies. Our contract holders 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.
Our
participation in the TARP CPP subjects us to additional restrictions, oversight
and costs, and has other potential consequences, which could materially affect
our business, results and prospects.
On July
10, 2009, in connection with the TARP CPP, we issued and sold to the U.S.
Treasury 950,000 shares of Series B preferred stock together with a related
warrant to purchase up to 13,049,451 shares of our common stock at an exercise
price of $10.92 per share, in accordance with the terms of the TARP CPP, for an
aggregate purchase price of $950 million. Access to TARP CPP was an
important component of our strategy to enhance our capital position and
financial flexibility. We believe that the amount of our
participation in the TARP CPP offers us the ability to exit the program, if
necessary, to manage the potential material consequences to our businesses from
the potential restrictions, oversight and costs of participation, which include
the following:
·
|
Our
acceptance of the TARP CPP funds could cause us to be perceived as having
greater capital needs and weaker overall financial prospects than those of
our competitors that have stated that they are not participating in the
TARP CPP, which could adversely affect our competitive position and
results;
|
·
|
Receipt
of the TARP CPP funds subjects us to restrictions, oversight and costs
that may have an adverse impact on our financial condition, results of
operations and the price of our common stock. For example, the
ARRA and recently promulgated regulations thereunder contain significant
limitations on the amount and form of bonus, retention and other incentive
compensation that participants in the TARP CPP may pay to executive
officers and senior management. These provisions may adversely
affect our ability to attract and retain executive officers and other key
personnel. Other regulatory initiatives applicable to
participants in federal funding programs may also be forthcoming as the
U.S. Government continues to address dislocations in the financial
markets. Compliance with such current and potential regulation
and scrutiny may significantly increase our costs, impede the efficiency
of our internal business processes, require us to increase our regulatory
capital and limit our ability to pursue business opportunities in an
efficient manner;
|
·
|
Future
federal statutes may adversely affect the terms of the TARP CPP that are
applicable to us and the Treasury Department may amend the terms of our
agreement with them unilaterally if required by future statutes, including
in a manner materially adverse to
us;
|
·
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Our
participation in the TARP CPP imposes additional restrictions on our
ability to increase our common stock dividend. In particular,
we would need to obtain the U.S. Treasury’s consent for any increase in
our current quarterly dividend of $0.01 per share of our common stock, as
well as any stock repurchase, until the third anniversary of such
investment unless, prior to such third anniversary, we redeem all of the
shares of Series B preferred stock issued to the U.S. Treasury or the U.S.
Treasury transfers such preferred stock to third parties. We
are also unable to repurchase or redeem shares of our common stock or any
series of preferred stock outstanding unless all accrued and unpaid
dividends for all past dividend periods on the Series B preferred stock
issued to the U.S. Treasury are fully paid;
and
|
·
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If
we do not repurchase the warrant from the U.S. Treasury when we repay the
investment, the U.S. Treasury will liquidate the warrant, which will
dilute the ownership interest of our existing holders of common
stock.
|
If
our businesses do not perform well and/or their estimated fair values decline or
the price of our common stock does not increase, we may be required to recognize
an impairment of our goodwill or to establish a valuation allowance against the
deferred income tax asset, which could have a material adverse effect on our
results of operations and financial condition.
Goodwill
represents the excess of the acquisition price incurred to acquire subsidiaries
and other businesses over the fair value of their net assets as of the date of
acquisition. As of December 31, 2009, we had a total of $3.0 billion
of goodwill on our Consolidated Balance Sheets, of which $2.2 billion related to
our Insurance Solutions – Life Insurance segment and $440 million related to our
Retirement Solutions – Annuities segment. We test goodwill at least
annually for indications of value impairment with consideration given to
financial performance and other relevant factors. In addition,
certain events, including a significant and adverse change in legal factors or
the business climate, an adverse action or assessment by a regulator or
unanticipated competition, would cause us to review the carrying amounts of
goodwill for impairment. Impairment testing is performed based upon
estimates of the fair value of the “reporting unit” to which the goodwill
relates. The reporting unit is the operating segment or a business
one level below that operating segment if discrete financial information is
prepared and regularly reviewed by management at that level. If the
implied fair value of the reporting unit’s goodwill is lower than its carrying
amount, goodwill is impaired and written down to its fair value, and a charge is
reported in impairment of intangibles on our Consolidated Statements of Income
(Loss). For the year ended December 31, 2009, we took total pre-tax
impairment charges of $680 million, primarily related to our annuities
business.
Subsequent
reviews of goodwill could result in additional impairment of goodwill during
2010, and such write downs could have a material adverse effect on our results
of operations and financial position, but will not affect the statutory capital
of our insurance subsidiaries. For more information on goodwill, see
Note 10 and “Critical Accounting Policies and Estimates – Goodwill and Other
Intangible Assets” in the MD&A.
Deferred
income tax represents the tax effect of the differences between the book and tax
basis of assets and liabilities. Deferred tax assets are assessed
periodically by management to determine if they are
realizable. Factors in management’s determination include the
performance of the business, including the ability to generate capital gains
from a variety of sources and tax planning strategies. If, based on
available information, it is more likely than not that the deferred income tax
asset will not be realized, then a valuation allowance must be established with
a corresponding charge to net income. Such valuation allowance could
have a material adverse effect on our results of operations and financial
position, but will not affect the statutory capital of our insurance
subsidiaries.
Because
we are 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.
We are a
holding company and we have no direct operations. Our principal asset
is the capital stock of our insurance subsidiaries.
At the
holding company level, sources of liquidity in normal markets include a variety
of short- and long-term instruments, including credit facilities, commercial
paper and medium- 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 primarily on the ability of our subsidiaries to
pay dividends or to advance or repay funds to us. Under Indiana laws
and regulations, our Indiana insurance subsidiaries, including LNL, our primary
insurance subsidiary, may pay dividends to us without prior approval of 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 12 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.
In
addition, payments of dividends and advances or repayment of funds to us by our
insurance subsidiaries are restricted by the applicable laws of their respective
jurisdictions requiring that our insurance subsidiaries hold a specified amount
of minimum reserves 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, after giving
consideration to future required premiums to be received, and are based on
certain specified mortality and 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.
Changes
in these laws can constrain the ability of our subsidiaries to pay dividends or
to advance or repay funds to us in sufficient amounts and at times necessary to
meet our debt obligations and corporate expenses. For example, in
September of 2008, the NAIC adopted a new statutory reserving standard for
variable annuities known as VACARVM, which was effective as of December 31,
2009. This reserving requirement replaced the previous
statutory reserving practices for variable annuities with guaranteed benefits,
and any change in reserving practices has the potential to increase or
decrease statutory reserves from previous levels. Requiring
our insurance subsidiaries to hold additional reserves has the potential to
constrain their ability to pay dividends to the holding company.
Investments
of our insurance subsidiaries support their statutory reserve
liabilities. As of December 31, 2009, 67% of these investments were
available-for-sale (“AFS”) fixed maturity securities of various holdings, types
and maturities. These investments are subject to general credit,
liquidity, market and interest rate risks. Beginning in 2008 and
continuing into 2009, the capital and credit markets experienced an unusually
high degree of volatility. As a result, the market for fixed income
securities has experienced illiquidity, increased price volatility, credit
downgrade events and increased expected probability of
default. Securities that are less liquid are more difficult to value
and may be hard to sell, if desired. These market disruptions have
led to increased impairments of securities in the general accounts of our
insurance subsidiaries, thereby reducing contract holders’ surplus.
The
earnings of our insurance subsidiaries also impact contract holders’
surplus. Principal sources of earnings are insurance premiums and
fees, annuity considerations and income from our investment portfolio and
assets, consisting mainly of cash or assets that are readily convertible into
cash. Recent economic conditions have resulted in lower earnings in
our insurance subsidiaries. Lower earnings constrain the growth in
our insurance subsidiaries’ capital, and therefore, can constrain the payment of
dividends and advances or repayment of funds to us.
In
addition, the amount of surplus that our insurance subsidiaries could pay as
dividends is constrained by the amount of surplus they hold to maintain their
financial strength ratings, to provide an additional layer of margin for risk
protection and for future investment in our
businesses. Notwithstanding the foregoing, we believe that our
insurance subsidiaries have sufficient liquidity to meet their contract holder
obligations and maintain their operations.
The
result of the difficult economic and market conditions in reducing the contract
holders’ surplus of our insurance subsidiaries has affected our ability to pay
shareholder dividends and to engage in share repurchases. We have
taken actions to reduce the holding company’s liquidity needs, including
reducing our quarterly common dividend to $0.01 per share, as well as to
increase the capital of our insurance subsidiaries through our $690 million
common stock offering in June 2009 and participation in the TARP
CPP. In the event that current resources do not satisfy our current
needs, we may have to seek additional financing, which may not be available or
only available with unfavorable terms and conditions. For a further
discussion of liquidity, see “Review of Consolidated Financial Condition –
Liquidity and Capital Resources” in the MD&A.
The
difficulties faced by other financial institutions could adversely affect
us.
We have
exposure to many different industries and counterparties, and routinely execute
transactions with counterparties in the financial services industry, including
brokers and dealers, commercial banks, investment banks and other
institutions. Many of these transactions expose us to credit risk in
the event of default of our counterparty. In addition, with respect
to secured transactions, our credit risk may be exacerbated when the collateral
held by us cannot be realized upon or is liquidated at prices not sufficient to
recover the full amount of the loan or derivative exposure due to
it. We also may have exposure to these financial institutions in the
form of unsecured debt instruments, derivative transactions and/or equity
investments. There can be no assurance that any such losses or
impairments to the carrying value of these assets would not materially and
adversely affect our business and results of operations.
Furthermore,
we distribute a significant amount of our insurance, annuity and mutual fund
products through large financial institutions. We believe that the
mergers of several of these entities, as well as the negative impact of the
markets on these entities, has disrupted and may lead to further disruption of
their businesses, which may have a negative effect on our production
levels.
Our
participation in a securities lending program and a reverse repurchase program
subjects us to potential liquidity and other risks.
We
participate in a securities lending program for our general account whereby
fixed income securities are loaned by our agent bank to third parties, primarily
major brokerage firms and commercial banks. The borrowers of our
securities provide us with collateral, typically in cash, which we separately
maintain. We invest such cash collateral in other securities,
primarily in commercial paper and money market or other short term
funds. Securities with a fair value of $479 million were on loan
under the program as of December 31, 2009. Securities loaned under
such transactions may be sold or repledged by the transferee. We were
liable for cash collateral under our control of $501 million as of December 31,
2009.
We
participate in a reverse repurchase program for our general account whereby we
sell fixed income securities to third parties, primarily major brokerage firms,
with a concurrent agreement to repurchase those same securities at a determined
future date. The borrowers of our securities provide us with cash
collateral which is typically invested in fixed maturity
securities. The fair value of securities pledged under reverse
repurchase agreements was $359 million as of December 31, 2009.
As of
December 31, 2009, substantially all of the securities on loan under the program
could be returned to us by the borrowers at any time. Collateral
received under the reverse repurchase program cannot be returned prior to
maturity; however, market conditions on the repurchase date may limit our
ability to enter into new agreements. The return of loaned securities
or our inability to enter into new reverse repurchase agreements would require
us to return the cash collateral associated with such securities. In
addition, in some cases, the maturity of the securities held as invested
collateral (i.e., securities that we have purchased with cash received from the
third parties) may exceed the term of the related securities and the market
value may fall below the amount of cash received as collateral and
invested. If we are required to return significant amounts of cash
collateral on short notice and we are forced to sell securities to meet the
return obligation, we may have difficulty selling such collateral that is
invested in securities in a timely manner, and we may 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 in the last twelve months, 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.
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 insurance
products, we calculate these reserves based on many assumptions and estimates,
including, but not limited to, 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.
As part
of our transition plan related to the rescission of a reinsurance treaty
covering disability income business, we conducted a reserve study to determine
the adequacy of the reserves to cover contract holder obligations during the
fourth quarter of 2009. During the fourth quarter of 2009, we
increased reserves as a result of our review of the adequacy of reserves
supporting this business and wrote off certain receivables related to the
rescission that were deemed to be uncollectible, which resulted in a $33 million
unfavorable effect to net income.
The
sensitivity of our statutory reserves and surplus established for our variable
annuity base contracts and riders to changes in the equity markets will vary
depending on the magnitude of the decline. The sensitivity will be
affected by the level of account values relative to the level of guaranteed
amounts, product design and reinsurance. Statutory reserves for
variable annuities depend upon the cumulative equity market impacts on the
business in force, and therefore, result in non-linear relationships with
respect to the level of equity market performance within any reporting
period.
The
assumptions and estimates we use in connection with establishing and carrying
our reserves are inherently uncertain. Accordingly, we cannot
determine with precision the ultimate amount or the timing of the payment of
actual benefits and claims or whether the assets supporting the policy
liabilities will grow to the level we assume prior to payment of benefits or
claims. If our actual experience is different from our assumptions or
estimates, our reserves may prove to be inadequate in relation to our estimated
future benefits and claims.
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 and VUL insurance
policies is based upon account values. Because strong equity markets
result in higher account values, strong equity markets positively affect our net
income through increased fee revenue. Conversely, a weakening of the
equity markets results in lower fee income and may have a material adverse
effect on our results of operations and capital resources.
The
increased fee revenue resulting from strong equity markets increases the
expected gross profits (“EGPs) from variable insurance products as do better
than expected lapses, mortality rates and expenses. As a result,
higher EGPs may result in lower net amortized costs related to deferred
acquisition costs (“DAC”), deferred sales inducements (“DSI”), value of business
acquired (“VOBA”), DFEL and changes in future contract
benefits. However, a decrease in the equity markets, as well as worse
than expected increases in lapses, mortality rates and expenses, depending upon
their significance, may result in higher net amortized costs associated with
DAC, DSI, VOBA, DFEL and changes in future contract benefits and may have a
material adverse effect on our results of operations and capital
resources. For example, in the fourth quarter of 2008, we reset our
baseline of account values from which EGPs are projected, which we refer to as
our “reversion to the mean” (“RTM”) process. As a result of this and
the impact of the volatile capital market conditions on our annuity reserves, we
had a cumulative unfavorable prospective unlocking of $223 million,
after-tax. If unfavorable economic conditions return, additional
unlocking of our RTM assumptions could be possible in future periods.
However, if we were to have unlocked our RTM assumption in the corridor as of
December 31, 2009, we would have recorded a favorable prospective unlocking of
approximately $300 million, pre-tax, as a result of improved market conditions
in 2009. For further information about our RTM process, see “Critical
Accounting Policies and Estimates – DAC, VOBA, DSI and DFEL” in the
MD&A.
Changes
in the equity markets, interest rates and/or volatility affect the profitability
of our products with guaranteed benefits; therefore, such changes may have a
material adverse effect on our business and profitability.
Certain
of our variable annuity products include guaranteed benefit
riders. These include GDB, GWB and GIB riders. Our GWB,
GIB and 4LATER® (a form of GIB rider) features have elements of both insurance
benefits accounted for under the Financial Services – Insurance – Claim Costs
and Liabilities for Future Policy Benefits Subtopic of the Financial Accounting
Standards Board (“FASB”) Accounting Standards
CodificationTM
(“ASC”) (“benefit reserves”) and embedded derivatives accounted for under the
Derivatives and Hedging and the Fair Value Measurements and Disclosures Topics
of the FASB ASC (“embedded derivative reserves”). The benefit reserves resulting
from a benefit ratio unlocking component are calculated in a manner consistent
with our GDB, as described below. We calculate the value of the
embedded derivative reserve and the benefit reserves based on the specific
characteristics of each guaranteed living benefit feature. The amount
of reserves related to GDB for variable annuities is tied to the difference
between the value of the underlying accounts and the GDB, calculated using a
benefit ratio approach. The GDB reserves take into account the
present value of total expected GDB payments, the present value of total
expected GDB assessments over the life of the contract, claims paid to date and
assessments to date. Reserves for our GIB and certain GWB with
lifetime benefits are based on a combination of fair value of the underlying
benefit and a benefit ratio approach that is based on the projected future
payments in excess of projected future account values. The benefit
ratio approach takes into account the present value of total expected GIB
payments, the present value of total expected GIB assessments over the life of
the contract, claims paid to date and assessments to date. The amount
of reserves related to those GWB that do not have lifetime benefits is based on
the fair value of the underlying benefit.
Both the
level of expected payments and expected total assessments used in calculating
the benefit ratio are affected by the equity markets. The liabilities
related to fair value are impacted by changes in equity markets, interest rates
and volatility. Accordingly, strong equity markets will decrease the
amount of reserves that we must carry, and strong equity markets, increases in
interest rates and decreases in volatility will generally decrease the reserves
calculated using fair value. Conversely, a decrease in the equity
markets will increase the expected future payments used in the benefit ratio
approach, which has the effect of increasing the amount of
reserves. Also, a decrease in the equity market along with a decrease
in interest rates and an increase in volatility will generally result in an
increase in the reserves calculated using fair value, which are the conditions
we have experienced recently.
Increases
in reserves would result in a charge to our earnings in the quarter in which the
increase occurs. Therefore, we maintain a customized dynamic hedge
program that is designed to mitigate the risks associated with income volatility
around the change in reserves on guaranteed benefits. However, the
hedge positions may not be effective to exactly offset the changes in the
carrying value of the guarantees due to, among other things, the time lag
between changes in their values and corresponding changes in the hedge
positions, high levels of volatility in the equity markets and derivatives
markets, extreme swings in interest rates, contract holder behavior different
than expected, a strategic decision to under- or over-hedge in reaction to
extreme market conditions or inconsistencies between economic and statutory
reserving guidelines and divergence between the performance of the underlying
funds and hedging indices. For example, for the years ended December
31, 2009, 2008 and 2007, we experienced a breakage on our guaranteed living
benefits net derivatives results of $(137) million, $176 million and $(136)
million, respectively, pre-tax and before the associated amortization of DAC,
VOBA, DSI and DFEL and changes in other contract holder funds and funds withheld
reinsurance liabilities. Breakage is defined as the difference
between the change in the value of the liabilities, excluding the amount related
to the non-performance risk component, and the change in the fair value of the
derivatives. Breakage can be positive or negative. The
non-performance risk factor is required under the Fair Value Measurements and
Disclosures Topic of the FASB ASC, which requires us to consider our own credit
standing, which is not hedged, in the valuation of certain of these
liabilities. A decrease in our own credit spread could cause the
value of these liabilities to increase, resulting in a reduction to net
income. Conversely, an increase in our own credit spread could cause
the value of these liabilities to decrease, resulting in an increase to net
income.
In
addition, we remain liable for the guaranteed benefits in the event that
derivative counterparties are unable or unwilling to pay, and we are also
subject to the risk that the cost of hedging these guaranteed benefits
increases, resulting in a reduction to net income. These,
individually or collectively, may have a material adverse effect on net income,
financial condition or liquidity.
Changes
in interest rates may cause interest rate spreads to decrease and may result in
increased contract withdrawals.
Because
the profitability of our fixed annuity and interest-sensitive whole life, UL and
fixed portion of defined contribution and VUL insurance business depends in part
on interest rate spreads, interest rate fluctuations could negatively affect our
profitability. Changes in interest rates may reduce both our
profitability from spread businesses and our return on invested
capital. Some of our products, principally fixed annuities,
interest-sensitive whole life, UL and the fixed portion of VUL insurance, have
interest rate guarantees that expose us to the risk that changes in interest
rates will reduce our spread, or the difference between the amounts that we are
required to pay under the contracts and the amounts we are able to earn on our
general account investments intended to support our obligations under the
contracts. Declines in our spread or instances where the returns on
our general account investments are not enough to support the interest rate
guarantees on these products could have a material adverse effect on our
businesses or results of operations.
In
periods of increasing interest rates, we may not be able to replace the assets
in our general account with higher yielding assets needed to fund the higher
crediting rates necessary to keep our interest-sensitive products
competitive. We therefore may have to accept a lower spread and thus
lower profitability or face a decline in sales and greater loss of existing
contracts and related assets. In periods of declining interest rates,
we have to reinvest the cash we receive as interest or return of principal on
our investments in lower yielding instruments then
available. Moreover, borrowers may prepay fixed-income securities,
commercial mortgages and mortgage-backed securities in our general account in
order to borrow at lower market rates, which exacerbates this
risk. Because we are entitled to reset the interest rates on our
fixed rate annuities only at limited, pre-established intervals, and since many
of our contracts have guaranteed minimum interest or crediting rates, our
spreads could decrease and potentially become negative. Increases in
interest rates may cause increased surrenders and withdrawals of insurance
products. In periods of increasing interest rates, policy loans and
surrenders and withdrawals of life insurance policies and annuity contracts may
increase as contract holders seek to buy products with perceived higher
returns. This process may lead to a flow of cash out of our
businesses. These outflows may require investment assets to be sold
at a time when the prices of those assets are lower because of the increase in
market interest rates, which may result in realized investment
losses. A sudden demand among consumers to change product types or
withdraw funds could lead us to sell assets at a loss to meet the demand for
funds.
Our
requirements to post collateral or make payments related to declines in market
value of specified assets may adversely affect our liquidity and expose us to
counterparty credit risk.
Many of
our transactions with financial and other institutions, including settling
futures positions, specify the circumstances under which the parties are
required to post collateral. The amount of collateral we may be
required to post under these agreements may increase under certain
circumstances, which could adversely affect our liquidity. In
addition, under the terms of some of our transactions, we may be required to
make payments to our counterparties related to any decline in the market value
of the specified assets.
Losses
due to defaults by others could reduce our profitability or negatively affect
the value of our investments.
Third
parties that owe us money, securities or other assets may not pay or perform
their obligations. These parties include the issuers whose securities
we hold, borrowers under the mortgage loans we make, customers, trading
counterparties, counterparties under swaps and other derivative contracts,
reinsurers and other financial intermediaries. These parties may
default on their obligations to us due to bankruptcy, lack of liquidity,
downturns in the economy or real estate values, operational failure, corporate
governance issues or other reasons. A further downturn in the U.S.
and other economies could result in increased impairments.
Defaults
on our mortgage loans and write downs of mortgage equity may adversely affect
our profitability.
Our
mortgage loans face default risk and are principally collateralized by
commercial properties. Mortgage loans are stated on our balance sheet
at unpaid principal balance, adjusted for any unamortized premium or discount,
deferred fees or expenses, and are net of valuation allowances. We
establish valuation allowances for estimated impairments as of the balance sheet
date based on information, such as the market value of the underlying real
estate securing the loan, any third party guarantees on the loan balance or any
cross collateral agreements and their impact on expected recovery
rates. As of December 31, 2009, there were nine impaired mortgage
loans, or less than 1% of total mortgage loans, and eight commercial mortgage
loans that were two or more payments delinquent. 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.
For
information about our risk of write downs of mortgage equity, see “Consolidated
Investments – Standby Real Estate Equity Commitments” and “Review of
Consolidated Financial Condition – Liquidity and Capital Resources – Uses of
Capital” in the MD&A.
Our
investments are reflected within our consolidated financial statements utilizing
different accounting bases, and, accordingly, there may be significant
differences between cost and fair value that are not recorded in our
consolidated financial statements.
Our
principal investments are in fixed maturity and equity securities, mortgage
loans on real estate, policy loans, short-term investments, derivative
instruments, limited partnerships and other invested assets. The
carrying value of such investments is as follows:
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Fixed
maturity and equity securities are classified as AFS, 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) is recorded as a separate component of other comprehensive income
(loss) (“OCI”), net of adjustments to DAC, contract holder related amounts
and deferred income taxes;
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·
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Fixed
maturity and equity securities designated as trading securities, which in
certain cases support reinsurance arrangements, are recorded at fair value
with subsequent changes in fair value recognized in realized
loss. However, offsetting the changes to fair value of the
trading securities are corresponding changes in the fair value of the
embedded derivative liability associated with the underlying reinsurance
arrangement. In other words, the investment results for the
trading securities, including gains and losses from sales, are passed
directly to the reinsurers through the contractual terms of the
reinsurance arrangements. However, there are trading securities
associated with the disability income business for which the reinsurance
agreement with Swiss Re was rescinded, and therefore, we now retain the
gains and losses on those
securities;
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·
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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;
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·
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Mortgage
loans on real estate are carried at unpaid principal balances, adjusted
for any unamortized premiums or discounts and deferred fees or expenses,
net of valuation allowances;
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·
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Policy
loans are carried at unpaid principal
balances;
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Real
estate joint ventures and other limited partnership interests are carried
using the equity method of accounting;
and
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·
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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.
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Investments
not carried at fair value on 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 on 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 and trading securities and short-term investments, which are
reported at fair value on our Consolidated Balance Sheets, represented the
majority of our total cash and invested assets. Pursuant to the Fair
Value Measurements and Disclosures Topics of the FASB ASC, we have categorized
these securities into a three-level hierarchy, based on the priority of the
inputs to the respective valuation technique. The fair value
hierarchy gives the highest priority to quoted prices in active markets for
identical assets or liabilities (Level 1) and the lowest priority to
unobservable inputs (Level 3).
The
determination of fair values in the absence of quoted market prices is based on
valuation methodologies, securities we deem to be comparable and assumptions
deemed appropriate given the circumstances. The fair value estimates
are made at a specific point in time, based on available market information and
judgments about financial instruments, including estimates of the timing and
amounts of expected future cash flows and the credit standing of the issuer or
counterparty. Factors considered in estimating fair value include
coupon rate, maturity, estimated duration, call provisions, sinking fund
requirements, credit rating, industry sector of the issuer and quoted market
prices of comparable securities. The use of different methodologies
and assumptions may have a material effect on the estimated fair value
amounts.
During
periods of market disruption, including periods of significantly
increasing/decreasing or high/low interest rates, rapidly widening credit
spreads or illiquidity, it may be difficult to value certain of our securities
if trading becomes less frequent and/or market data becomes less
observable. There may be certain asset classes that were in active
markets with significant observable data that become illiquid due to the current
financial environment. In such cases, more securities may fall to
Level 3 and thus require more subjectivity and management
judgment. As such, valuations may include inputs and assumptions that
are less observable or require greater estimation, as well as valuation methods
which are more sophisticated or require greater estimation, thereby resulting in
values which may be less than the value at which the investments may be
ultimately sold. Further, rapidly changing and unprecedented credit
and equity market conditions could materially impact the valuation of securities
as reported within our consolidated financial statements and the
period-to-period changes in value could vary significantly. Decreases
in value may have a material adverse effect on our results of operations or
financial condition.
Some
of our investments are relatively illiquid and are in asset classes that have
been experiencing significant market valuation fluctuations.
We hold
certain investments that may lack liquidity, such as privately placed fixed
maturity securities, mortgage loans, policy loans and other limited partnership
interests. These asset classes represented 24% of the carrying value
of our total cash and invested assets as of December 31, 2009. Even
some of our very high quality assets have been more illiquid as a result of the
recent challenging market conditions.
If we
require significant amounts of cash on short notice in excess of normal cash
requirements or are required to post or return collateral in connection with our
investment portfolio, derivatives transactions or securities lending activities,
we may have difficulty selling these investments in a timely manner, be forced
to sell them for less than we otherwise would have been able to realize, or
both.
The
reported value of our relatively illiquid types of investments, our investments
in the asset classes described in the paragraph above and, at times, our high
quality, generally liquid asset classes, do not necessarily reflect the lowest
current market price for the asset. If we were forced to sell certain
of our assets in the current market, there can be no assurance that we would be
able to sell them for the prices at which we have recorded them and we might be
forced to sell them at significantly lower prices.
We invest
a portion of our invested assets in investment funds, many of which make private
equity investments. The amount and timing of income from such
investment funds tends to be uneven as a result of the performance of the
underlying investments, including private equity investments. The
timing of distributions from the funds, which depends on particular events
relating to the underlying investments, as well as the funds’ schedules for
making distributions and their needs for cash, can be difficult to
predict. As a result, the amount of income that we record from these
investments can vary substantially from quarter to quarter. Recent
equity and credit market volatility may reduce investment income for these types
of investments.
In
addition, other external factors may cause a drop in value of investments, such
as ratings downgrades on asset classes. For example, Congress has
proposed legislation to amend the U.S. Bankruptcy Code to permit bankruptcy
courts to modify mortgages on primary residences, including an ability to reduce
outstanding mortgage balances. Such actions by bankruptcy courts may
impact the ratings and valuation of our residential mortgage-backed investment
securities.
The
determination of the amount of allowances and impairments taken on our
investments is highly subjective and could materially impact our results of
operations or financial position.
The
determination of the amount of allowances and impairments varies by investment
type and is based upon our periodic evaluation and assessment of known and
inherent risks associated with the respective asset class. Such
evaluations and assessments are revised as conditions change and new information
becomes available. Management updates its evaluations regularly and
reflects changes in allowances and impairments in operations as such evaluations
are revised. There can be no assurance that our management has
accurately assessed the level of impairments taken and allowances reflected in
our financial statements. Furthermore, additional impairments may
need to be taken or allowances provided for in the future. Historical
trends may not be indicative of future impairments or allowances.
We
adopted updates to the Investments – Debt and Equity
Securities Topic of
the FASB ASC for our debt securities effective January 1, 2009. This
adoption required that an other-than-temporary impairment (“OTTI”) loss be
separated into the amount representing the decrease in cash flows expected to be
collected, or “credit loss,” which is recognized in earnings, and the amount
related to all other factors, or “noncredit loss,” which is recognized in
OCI. In addition, the requirement for management to assert that it
has the intent and ability to hold an impaired security until recovery was
replaced by the requirement for management to assert if it either has the intent
to sell the debt security or if it is more likely than not the entity will be
required to sell the debt security before recovery of its amortized cost
basis.
We
regularly review our AFS securities for declines in fair value that we determine
to be other-than-temporary. For an equity security, if we do not have
the ability and intent to hold the security for a sufficient period of time to
allow for a recovery in value, we conclude that an 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 (Loss). When assessing our ability and intent to
hold the equity security to recovery, we consider, among other things, the
severity and duration of the decline in fair value of the equity security as
well as the cause of decline, a fundamental analysis of the liquidity, business
prospects and overall financial condition of the issuer.
For a
debt security, if we intend to sell a security or it is more likely than not we
will be required to sell a debt security before recovery of its amortized cost
basis and the fair value of the debt security is below amortized cost, we
conclude than an OTTI has occurred and the amortized cost is written down to
current fair value, with a corresponding charge to realized loss on our
Consolidated Statements of Income. If we do not intend to sell a debt
security or it is not more likely than not we will be required to sell a debt
security before recovery of its amortized cost basis but the present value of
the cash flows expected to be collected is less than the amortized cost of the
debt security (referred to as the credit loss), we conclude that an OTTI has
occurred and the amortized cost is written down to the estimated recovery value
with a corresponding charge to realized loss on our Consolidated Statements of
Income (Loss), as this is also deemed the credit portion of the
OTTI. The remainder of the decline to fair value is recorded in OCI
to unrealized OTTI on AFS securities on our Consolidated Statements of
Stockholders’ Equity, as this is considered a noncredit (i.e., recoverable)
impairment. Net OTTI recognized in net income (loss) was $392
million, $851 million and $261 million, pre-tax, for the years ended December
31, 2009, 2008 and 2007, respectively. The portion of OTTI recognized
in OCI for the year ended December 31, 2009, was $275 million,
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 operations and financial
position.
We
will be required to pay interest on our capital securities with proceeds from
the issuance of qualifying securities if we fail to achieve capital adequacy or
net income and stockholders’ equity levels.
As of
December 31, 2009, we had approximately $1.5 billion in principal amount of
capital securities outstanding. All of the capital securities contain
covenants that require us to make interest payments in accordance with an
alternative coupon satisfaction mechanism (“ACSM”) if we determine that one of
the following triggers exists as of the 30th day prior to an interest payment
date, or the “determination date”:
1. LNL’s
RBC ratio is less than 175% (based on the most recent annual financial statement
filed with the State of Indiana); or
2. (i)
The sum of our consolidated net income for the four trailing fiscal quarters
ending on the quarter that is two quarters prior to the most recently completed
quarter prior to the determination date is zero or negative, and (ii) our
consolidated stockholders’ equity (excluding accumulated OCI and any increase in
stockholders’ equity resulting from the issuance of preferred stock during a
quarter), or “adjusted stockholders’ equity,” as of (x) the most recently
completed quarter and (y) the end of the quarter that is two quarters before the
most recently completed quarter, has declined by 10% or more as compared to the
quarter that is ten fiscal quarters prior to the last completed quarter, or the
“benchmark quarter.”
The ACSM
would generally require us to use commercially reasonable efforts to satisfy our
obligation to pay interest in full on the capital securities with the net
proceeds from sales of our common stock and warrants to purchase our common
stock with an exercise price greater than the market price. We would
have to utilize the ACSM until the trigger events above no longer existed, and,
in the case of test 2 above, our adjusted stockholders’ equity amount increased
or declined by less than 10% as compared to the adjusted stockholders’ equity at
the end of the benchmark quarter for each interest payment date as to which
interest payment restrictions were imposed by test 2 above.
If we
were required to utilize the ACSM and were successful in selling sufficient
shares of common stock or warrants to satisfy the interest payment, we would
dilute the current holders of our common stock. Furthermore, while a
trigger event is occurring and if we do not pay accrued interest in full, we may
not, among other things, pay dividends on or repurchase our capital
stock. Our failure to pay interest pursuant to the ACSM will not
result in an event of default with respect to the capital securities, nor will a
nonpayment of interest, unless it lasts for ten consecutive years, although such
breaches may result in monetary damages to the holders of the capital
securities.
In recent
quarters, we have triggered the net income test as a result of quarterly
consolidated net losses, and we may continue to trigger the net income test
looking forward to future quarters. However, our efforts to raise
capital in the form of equity in the second and third quarters of 2009 resulted
in no trigger of the overall stockholders’ equity test looking forward to the
quarters ending March 31, 2010, and June 30, 2010.
The
calculations of RBC, net income (loss) and adjusted stockholders’ equity are
subject to adjustments and the capital securities are subject to additional
terms and conditions as further described in supplemental indentures filed as
exhibits to our Forms 8-K filed on March 13, 2007, May 17, 2006, and April 20,
2006.
A
decrease in the capital and surplus of our insurance subsidiaries may result in
a downgrade to our credit and insurer financial strength ratings.
In any
particular year, statutory surplus amounts and RBC ratios may increase or
decrease depending on a variety of factors, including the amount of statutory
income or losses generated by our insurance subsidiaries (which itself is
sensitive to equity market and credit market conditions), the amount of
additional capital our insurance subsidiaries must hold to support business
growth, changes in reserving requirements, such as VACARVM and principles based
reserving, our inability to secure capital market solutions to provide reserve
relief, such as issuing letters of credit to support captive reinsurance
structures, changes in equity market levels, the value of certain fixed-income
and equity securities in our investment portfolio, the value of certain
derivative instruments that do not get hedge accounting, changes in interest
rates and foreign currency exchange rates, as well as changes to the NAIC RBC
formulas. The RBC ratio is also affected by the product mix of the in-force book
of business (i.e., the amount of business without guarantees is not subject to
the same level of reserves as the business with guarantees). Most of
these factors are outside of our control. Our credit and insurer
financial strength ratings are significantly influenced by the statutory surplus
amounts and RBC ratios of our insurance company subsidiaries. The RBC
ratio of LNL is an important factor in the determination of the credit and
financial strength ratings of LNC and its subsidiaries. In addition,
rating agencies may implement changes to their internal models that have the
effect of increasing or decreasing the amount of statutory capital we must hold
in order to maintain our current ratings. In addition, in extreme
scenarios of equity market declines, the amount of additional statutory reserves
that we are required to hold for our variable annuity guarantees may increase at
a rate greater than the rate of change of the markets. Increases in
reserves reduce the statutory surplus used in calculating our RBC
ratios. To the extent that our statutory capital resources are deemed
to be insufficient to maintain a particular rating by one or more rating
agencies, we may seek to raise additional capital through public or private
equity or debt financing, which may be on terms not as favorable as in the
past. Alternatively, if we were not to raise additional capital in
such a scenario, either at our discretion or because we were unable to do so,
our financial strength and credit ratings might be downgraded by one or more
rating agencies. For more information on risks regarding our ratings,
see “A downgrade in our financial strength or credit ratings could limit our
ability to market products, increase the number or value of policies being
surrendered and/or hurt our relationships with creditors” below.
A
downgrade in our financial strength or credit ratings could limit our ability to
market products, increase the number or value of policies being surrendered
and/or hurt our relationships with creditors.
Nationally
recognized rating agencies rate the financial strength of our principal
insurance subsidiaries and rate our debt. Ratings are not
recommendations to buy our securities. Each of the rating agencies
reviews its ratings periodically, and our current ratings may not be maintained
in the future. In late September and early October of 2008, A.M.
Best, Fitch, Moody’s and S&P each revised their outlook for the U.S. life
insurance sector from stable to negative. We believe that the rating
agencies continue to have the life insurance industry on negative outlook
until a sustained recovery in the general economy.
Our
financial strength ratings, which are intended to measure our ability to meet
contract holder obligations, are an important factor affecting public confidence
in most of our products and, as a result, our competitiveness. A
downgrade of the financial strength rating of one of our principal insurance
subsidiaries could affect our competitive position in the insurance industry by
making it more difficult for us to market our products as potential customers
may select companies with higher financial strength ratings and by leading to
increased withdrawals by current customers seeking companies with higher
financial strength ratings. This
could lead to a decrease in fees as net outflows of assets increase, and
therefore, result in lower fee income. Furthermore, sales of assets
to meet customer withdrawal demands could also result in losses, depending on
market conditions. The interest rates we pay on our borrowings are
largely dependent on our credit ratings. 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.
As a
result of raising capital of approximately $2.1 billion in the second and third
quarters of 2009, Moody’s, S&P, Fitch and A.M. Best affirmed our debt
ratings and the financial strength ratings of LNL, LLANY and FPP. Our
ratings outlook remains negative, with the exception of S&P, which revised
its outlook to stable from negative. All of our ratings and ratings
of our principal insurance subsidiaries are subject to revision or withdrawal at
any time by the rating agencies, and therefore, no assurance can be given that
our principal insurance subsidiaries or we can maintain these
ratings. See “Item 1. Business – Ratings” for a complete
description of our ratings.
Certain
blocks of our insurance business purchased from third-party insurers under
indemnity reinsurance agreements may require us to place assets in trust, secure
letters of credit or return the business, if the financial strength ratings
and/or capital ratios of certain insurance subsidiaries are not maintained at
specified levels.
Under
certain indemnity reinsurance agreements, one of our insurance subsidiaries,
LLANY, provides 100% indemnity reinsurance for the business assumed, however,
the third-party insurer, or the “cedent,” remains primarily liable on the
underlying insurance business. Under these types of agreements, as of
December 31, 2009, we held statutory reserves of approximately $3.4
billion. These indemnity reinsurance arrangements require that our
subsidiary, as the reinsurer, maintain certain insurer financial strength
ratings and capital ratios. If these ratings or capital ratios are
not maintained, depending upon the reinsurance agreement, the cedent may
recapture the business, or require us to place assets in trust or provide
letters of credit at least equal to the relevant statutory
reserves. Under the largest indemnity reinsurance arrangement, we
held approximately $2.2 billion of statutory reserves as of December 31,
2009. LLANY must maintain an A.M. Best financial strength rating of
at least B+, an S&P financial strength rating of at least BB+ and a Moody’s
financial strength rating of at least Ba1, as well as maintain a RBC ratio of at
least 160% or an S&P capital adequacy ratio of 100%, or the cedent may
recapture the business. Under two other arrangements, by which we
established approximately $1 billion of statutory reserves, LLANY must maintain
an A.M. Best financial strength rating of at least B++, an S&P financial
strength rating of at least BBB- and a Moody’s financial strength rating of at
least Baa3. One of these arrangements also requires LLANY to maintain
an RBC ratio of at least 185% or an S&P capital adequacy ratio of
115%. Each of these arrangements may require LLANY to place assets in
trust equal to the relevant statutory reserves. As of December 31,
2009, LLANY’s RBC ratio exceeded 600%. See “Item
1. Business – Ratings” for a complete
description of our ratings.
If the
cedent recaptured the business, LLANY would be required to release reserves and
transfer assets to the cedent. Such a recapture could adversely
impact our future profits. Alternatively, if LLANY established a
security trust for the cedent, the ability to transfer assets out of the trust
could be severely restricted, thus negatively impacting our
liquidity.
Our
businesses are heavily regulated and changes in regulation may reduce our
profitability.
Our
insurance subsidiaries are subject to extensive supervision and regulation in
the states in which we do business. The supervision and regulation
relate to numerous aspects of our business and financial
condition. The primary purpose of the supervision and regulation is
the protection of our insurance contract holders, and not our
investors. The extent of regulation varies, but generally is governed
by state statutes. These statutes delegate regulatory, supervisory
and administrative authority to state insurance departments. This
system of supervision and regulation covers, among other things:
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Standards
of minimum capital requirements and solvency, including RBC
measurements;
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Restrictions
of certain transactions between our insurance subsidiaries and their
affiliates;
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Restrictions
on the nature, quality and concentration of
investments;
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Restrictions
on the types of terms and conditions that we can include in the insurance
policies offered by our primary insurance
operations;
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Limitations
on the amount of dividends that insurance subsidiaries can
pay;
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The
existence and licensing status of the company under circumstances where it
is not writing new or renewal
business;
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Certain
required methods of accounting;
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Reserves
for unearned premiums, losses and other purposes;
and
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Assignment
of residual market business and potential assessments for the provision of
funds necessary for the settlement of covered claims under certain
policies provided by impaired, insolvent or failed insurance
companies.
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We may be
unable to maintain all required licenses and approvals and our business may not
fully comply with the wide variety of applicable laws and regulations or the
relevant authority’s interpretation of the laws and regulations, which may
change from time to time. Also, regulatory authorities have
relatively broad discretion to grant, renew or revoke licenses and
approvals. If we do not have the requisite licenses and approvals or
do not comply with applicable regulatory requirements, the insurance regulatory
authorities could preclude or temporarily suspend us from carrying on some or
all of our activities or impose substantial fines. Further, insurance
regulatory authorities have relatively broad discretion to issue orders of
supervision, which permit such authorities to supervise the business and
operations of an insurance company. As of December 31, 2009, 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. LNC, as a savings and loan holding company and NCLS are
subject to regulation and supervision by the Office of Thrift
Supervision. As a savings and loan holding company, we would also be
subject to the requirement that our activities be financially-related activities
as defined by federal law (which includes insurance
activities). 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.
Recently,
there has been an increase in potential federal initiatives that would affect
the insurance industry. In January 2010, the White House proposed as
a part of its budget proposal a new “financial crisis responsibility fee” on
certain financial institutions as a means to recoup any shortfall in revenues
resulting from the TARP program, so that the program does not add to the federal
budget deficit. As proposed, the fee would apply to financial
institutions, including bank holding companies, thrift holding companies,
insured depositories, and insurance companies that own one of these entities,
with over $50 billion in assets, regardless of whether the firm participated in
the TARP program. The fee as proposed is expected to be an assessment
of 15 basis points against a calculated “covered liabilities” amount and would
be in place for a minimum of 10 years. Details as to the precise
calculation of “covered liabilities” are still unclear. Further,
legislation implementing this fee will need to be introduced and passed by
Congress before this tax would take effect. In December 2009, the
House passed H.R. 4173, “The Wall Street Reform and Consumer Protection Act of
2009,” a wide-ranging bill that includes a number of reforms. The
bill includes, among other things, a new harmonized fiduciary standard for
broker-dealers and investment advisers, the creation of the Consumer Financial
Protection Agency, the creation of a pre-funded resolution trust to cover the
costs of winding down certain failing institutions, the creation of the Federal
Insurance Office within the Treasury Department and provisions relating to
executive compensation. The bill would require financial
institutions, including insurance companies, to contribute funds to the
resolution trust. The ultimate impact of any of these federal
initiatives on our results of operations, liquidity or capital resources is
currently indeterminable.
Many of
the foregoing regulatory or governmental bodies have the authority to review our
products and business practices and those of our agents and
employees. In recent years, there has been increased scrutiny of our
businesses by these bodies, which has included more extensive examinations,
regular sweep inquiries and more detailed review of disclosure
documents. These regulatory or governmental bodies may bring
regulatory or other legal actions against us if, in their view, our practices,
or those of our agents or employees, are improper. These actions can
result in substantial fines, penalties or prohibitions or restrictions on our
business activities and could have a material adverse effect on our business,
results of operations or financial condition.
Attempts
to mitigate the impact of Regulation XXX and Actuarial Guideline 38 may fail in
whole or in part resulting in an adverse effect on our financial condition and
results of operations.
The Model
Regulation entitled “Valuation of Life Insurance Policies,” commonly known as
“Regulation XXX” or “XXX,” requires insurers to establish additional statutory
reserves for term life insurance policies with long-term premium guarantees and
UL policies with secondary guarantees. In addition, Actuarial
Guideline 38 (“AG38”) clarifies the application of XXX with respect to certain
UL insurance policies with secondary guarantees. Virtually all of our
newly issued term and the great majority of our newly issued UL insurance
products are now affected by XXX and AG38.
As a
result of this regulation, we have established higher statutory reserves for
term and UL insurance products and changed our premium rates for term life
insurance products. We also have implemented reinsurance and capital
management actions to mitigate the capital impact of XXX and AG38, including the
use of letters of credit to support the reinsurance provided by captive
reinsurance subsidiaries. In addition, although formal details have
not been provided, we anticipate the rating agencies may require a portion of
these letters of credit to be included in our leverage calculations, which would
pressure our leverage ratios and potentially our ratings. Therefore,
we cannot provide assurance that there will not be regulatory, rating agency or
other challenges to the actions we have taken to date. The result of
those potential challenges could require us to increase statutory reserves or
incur higher operating and/or tax costs. In addition, as a result of
current capital market conditions and disruption in the credit markets, our
ability to secure additional letters of credit or to secure them at current
costs may impact the profitability of term and UL insurance
products. See “Results of Insurance Solutions – Insurance Solutions –
Life Insurance” in the MD&A for a further discussion of our capital
management in connection with XXX.
In light
of the current downturn in the credit markets and the increased spreads on
asset-backed debt securities, we also cannot provide assurance that we will be
able to continue to implement actions to mitigate the impact of XXX or AG38 on
future sales of term and UL insurance products. If we are unable to
continue to implement those actions, we may be required to increase statutory
reserves, incur higher operating costs and lower returns on products sold than
we currently anticipate or reduce our sales of these products. We
also may have to implement measures that may be disruptive to our
business. For example, because term and UL insurance are particularly
price-sensitive products, any increase in premiums charged on these products in
order to compensate us for the increased statutory reserve requirements or
higher costs of reinsurance may result in a significant loss of volume and
adversely affect our life insurance operations.
Changes
in accounting standards issued by the FASB or other standard-setting bodies may
adversely affect our financial statements.
Our
financial statements are subject to the application of GAAP, which is
periodically revised and/or expanded. Accordingly, from time to time
we are required to adopt new or revised accounting standards or guidance that
are incorporated into the FASB ASC. It is possible that future
accounting standards we are required to adopt could change the current
accounting treatment that we apply to our consolidated financial statements and
that such changes could have a material adverse effect on our financial
condition and results of operations.
For
example, the SEC has proposed that large accelerated filers in the U.S. be
required to report financial results in accordance with International Financial
Reporting Standards (“IFRS”) as issued by the International Accounting Standards
Board rather than GAAP, beginning with their fiscal year 2014 Annual Reports on
Form 10-K. The Form 10-K would include audited IFRS financial
statements for the transitional year, as well as the two preceding fiscal
years. Thus, an issuer adopting IFRS in 2014 would need to file
audited IFRS financial statements for fiscal years 2012, 2013, and 2014 in its
Form 10-K for the fiscal year ended 2014. Despite the movement toward
convergence of GAAP and IFRS, IFRS will be a complete change to our accounting
and reporting and converting to IFRS will impose special demands on issuers in
the areas of governance, employee training, internal controls, contract
fulfillment and disclosure. IFRS will affect how we manage our
business, as it will likely affect other business processes such as design of
compensation plans, product design, etc.
Legal
and regulatory actions are inherent in our businesses and could result in
financial losses or harm our businesses.
We are,
and in the future may be, subject to legal actions in the ordinary course of our
insurance and investment management operations, both domestically and
internationally. Pending legal actions include proceedings relating
to aspects of our businesses and operations that are specific to us and
proceedings that are typical of the businesses in which we
operate. Some of these proceedings have been brought on behalf of
various alleged classes of complainants. In certain of these matters,
the plaintiffs are seeking large and/or indeterminate amounts, including
punitive or exemplary damages. Substantial legal liability in these
or future legal or regulatory actions could have a material financial effect or
cause significant harm to our reputation, which in turn could materially harm
our business prospects. For more information on pending material
legal proceedings, see Note 14.
Changes
in U.S. federal income tax law could increase our tax costs and make the
products that we sell less desirable.
Changes
to the Internal Revenue Code, administrative rulings or court decisions could
increase our effective tax rate and lower our net income. For
example, on February 1, 2010, the Treasury Department released the “General
Explanations of the Administration’s Fiscal Year 2011 Revenue Proposals”
including proposals which, if enacted, would affect the taxation of life
insurance companies and certain life insurance products. The
statutory changes contemplated by the Administration’s revenue proposals would,
if enacted into law, change the method used to determine the amount of dividend
income received by a life insurance company on assets held in separate accounts
used to support products, including variable life insurance and variable annuity
contracts, that are eligible for the dividend received deduction. The
dividend received deduction reduces the amount of dividend income subject to tax
and is a significant component of the difference between our actual tax expense
and expected amount determined using the federal statutory tax rate of
35%. Our income tax provision for the year ended December 31, 2009,
included a separate account dividend received deduction benefit of $77
million. In addition, the proposals would affect the treatment of
COLI policies by limiting the availability of certain interest deductions for
companies that purchase those policies. If proposals of this type
were enacted, our sale of COLI, variable annuities and variable life products
could be adversely affected and our actual tax expense could increase, reducing
earnings.
Our
enterprise risk management policies and procedures may leave us exposed to
unidentified or unanticipated risk, which could negatively affect our businesses
or result in losses.
We have
devoted significant resources to develop our enterprise risk management policies
and procedures and expect to continue to do so in the
future. Nonetheless, our policies and procedures to identify, monitor
and manage risks may not be fully effective. Many of our methods of
managing risk and exposures are based upon our use of observed historical market
behavior or statistics based on historical models. As a result, these
methods may not predict future exposures, which could be significantly greater
than the historical measures indicate, such as the risk of pandemics causing a
large number of deaths. Other risk management methods depend upon the
evaluation of information regarding markets, clients, catastrophe occurrence or
other matters that is publicly available or otherwise accessible to us, which
may not always be accurate, complete, up-to-date or properly
evaluated. Management of operational, legal and regulatory risks
requires, among other things, policies and procedures to record properly and
verify a large number of transactions and events, and these policies and
procedures may not be fully effective.
We
face a risk of non-collectibility of reinsurance, which could materially affect
our results of operations.
We follow
the insurance practice of reinsuring with other insurance and reinsurance
companies a portion of the risks under the policies written by our insurance
subsidiaries (known as “ceding”). As of December 31, 2009, we ceded
$342.6 billion of life insurance in force to reinsurers for reinsurance
protection. Although reinsurance does not discharge our subsidiaries
from their primary obligation to pay contract holders for losses insured under
the policies we issue, reinsurance does make the assuming reinsurer liable to
the insurance subsidiaries for the reinsured portion of the risk. As
of December 31, 2009, we had $6.4 billion of reinsurance receivables from
reinsurers for paid and unpaid losses, for which they are obligated to reimburse
us under our reinsurance contracts. Of this amount, $3.0 billion
related to the sale of our reinsurance business to Swiss Re in 2001 through an
indemnity reinsurance agreement. Swiss Re has funded a trust to
support this business. The balance in the trust changes as a result
of ongoing reinsurance activity and was $1.9 billion as of December 31,
2009. As a result of Swiss Re’s S&P financial strength rating
dropping below AA-, Swiss Re was required to fund an additional trust to support
this business of approximately $1.4 billion as of December 31, 2009, which was
established during the fourth quarter of 2009. Furthermore,
approximately $1.3 billion of the Swiss Re treaties are funds withheld
structures where we have a right of offset on assets backing the reinsurance
receivables.
The
balance of the reinsurance is due from a diverse group of
reinsurers. The collectibility of reinsurance is largely a function
of the solvency of the individual reinsurers. We perform annual
credit reviews on our reinsurers, focusing on, among other things, financial
capacity, stability, trends and commitment to the reinsurance
business. We also require assets in trust, letters of credit or other
acceptable collateral to support balances due from reinsurers not authorized to
transact business in the applicable jurisdictions. Despite these
measures, a reinsurer’s insolvency, inability or unwillingness to make payments
under the terms of a reinsurance contract, especially Swiss Re, could have a
material adverse effect on our results of operations and financial
condition.
Significant
adverse mortality experience may result in the loss of, or higher prices for,
reinsurance.
We
reinsure a significant amount of the mortality risk on fully underwritten, newly
issued, individual life insurance contracts. We regularly review
retention limits for continued appropriateness and they may be changed in the
future. If we were to experience adverse mortality or morbidity
experience, a significant portion of that would be reimbursed by our
reinsurers. Prolonged or severe adverse mortality or morbidity
experience could result in increased reinsurance costs, and ultimately,
reinsurers not willing to offer coverage. If we are unable to
maintain our current level of reinsurance or purchase new reinsurance protection
in amounts that we consider sufficient, we would either have to be willing to
accept an increase in our net exposures or revise our pricing to reflect higher
reinsurance premiums. If this were to occur, we may be exposed to
reduced profitability and cash flow strain or we may not be able to price new
business at competitive rates.
Catastrophes
may adversely impact liabilities for contract holder claims and the availability
of reinsurance.
Our
insurance operations are exposed to the risk of catastrophic mortality, such as
a pandemic, an act of terrorism, natural disaster or other event that causes a
large number of deaths or injuries. Significant influenza pandemics
have occurred three times in the last century, but the likelihood, timing or
severity of a future pandemic cannot be predicted. Additionally, the
impact of climate change could cause changes in weather patterns, resulting in
more severe and more frequent natural disasters such as forest fires,
hurricanes, tornados, floods and storm surges. In our group insurance
operations, a localized event that affects the workplace of one or more of our
group insurance customers could cause a significant loss due to mortality or
morbidity claims. These events could cause a material adverse effect
on our results of operations in any period and, depending on their severity,
could also materially and adversely affect our financial condition.
The
extent of losses from a catastrophe is a function of both the total amount of
insured exposure in the area affected by the event and the severity of the
event. Pandemics, natural disasters and man-made catastrophes,
including terrorism, may produce significant damage in larger areas, especially
those that are heavily populated. Claims resulting from natural or
man-made catastrophic events could cause substantial volatility in our financial
results for any fiscal quarter or year and could materially reduce our
profitability or harm our financial condition. Also, catastrophic
events could harm the financial condition of our reinsurers and thereby increase
the probability of default on reinsurance recoveries. Accordingly,
our ability to write new business could also be affected.
Consistent
with industry practice and accounting standards, we establish liabilities for
claims arising from a catastrophe only after assessing the probable losses
arising from the event. We cannot be certain that the liabilities we
have established or applicable reinsurance will be adequate to cover actual
claim liabilities, and a catastrophic event or multiple catastrophic events
could have a material adverse effect on our business, results of operations and
financial condition.
Competition
for our employees is intense, and we may not be able to attract and retain the
highly skilled people we need to support our business.
Our
success depends, in large part, on our ability to attract and retain key
people. Intense competition exists for the key employees with
demonstrated ability, and we may be unable to hire or retain such employees,
particularly in light of compensation restrictions that will be applicable to us
in connection with our participation in the TARP CPP. The unexpected
loss of services of one or more of our key personnel could have a material
adverse effect on our operations due to their skills, knowledge of our business,
their years of industry experience and the potential difficulty of promptly
finding qualified replacement employees. We compete with other
financial institutions primarily on the basis of our products, compensation,
support services and financial position. Sales in our businesses and
our results of operations and financial condition could be materially adversely
affected if we are unsuccessful in attracting and retaining key employees,
including financial advisors, wholesalers and other employees, as well as
independent distributors of our products.
Our
sales representatives are not captive and may sell products of our
competitors.
We sell
our annuity and life insurance products through independent sales
representatives. These representatives are not captive, which means
they may also sell our competitors’ products. If our competitors
offer products that are more attractive than ours, or pay higher commission
rates to the sales representatives than we do, these representatives may
concentrate their efforts in selling our competitors’ products instead of
ours.
We
may not be able to protect our intellectual property and may be subject to
infringement claims.
We rely
on a combination of contractual rights and copyright, trademark, patent and
trade secret laws to establish and protect our intellectual
property. Although we use a broad range of measures to protect our
intellectual property rights, third parties may infringe or misappropriate our
intellectual property. We may have to litigate to enforce and protect
our copyrights, trademarks, patents, trade secrets and know-how or to determine
their scope, validity or enforceability, which represents a diversion of
resources that may be significant in amount and may not prove
successful. Additionally, complex legal and factual
determinations and evolving laws and court interpretations make the
scope of protection afforded our intellectual property uncertain,
particularly in relation to our patents. While we believe our
patents provide us with a competitive advantage, we cannot be certain that any
issued patents will be interpreted with sufficient breadth to offer
meaningful protection. In addition, our issued patents may be successfully
challenged, invalidated, circumvented or found unenforceable so that our patent
rights would not create an effective competitive barrier. The loss of
intellectual property protection or the inability to secure or enforce the
protection of our intellectual property assets could have a material adverse
effect on our business and our ability to compete.
We also
may be subject to costly litigation in the event that another party alleges our
operations or activities infringe upon another party’s intellectual property
rights. Third parties may have, or may eventually be issued, patents
that could be infringed by our products, methods, processes or
services. Any party that holds such a patent could make a claim of
infringement against us. We may also be subject to claims by third
parties for breach of copyright, trademark, trade secret or license usage
rights. Any such claims and any resulting litigation could result in
significant liability for damages. If we were found to have infringed
a third-party patent or other intellectual property rights, we could incur
substantial liability, and in some circumstances could be enjoined from
providing certain products or services to our customers or utilizing and
benefiting from certain methods, processes, copyrights, trademarks, trade
secrets or licenses, or alternatively could be required to enter into costly
licensing arrangements with third parties, all of which could have a material
adverse effect on our business, results of operations and financial
condition.
Intense
competition could negatively affect our ability to maintain or increase our
profitability.
Our
businesses are intensely competitive. We compete based on a number of
factors, including name recognition, service, the quality of investment advice,
investment performance, product features, price, perceived financial strength
and claims-paying and credit ratings. Our competitors include
insurers, broker-dealers, financial advisors, asset managers and other financial
institutions. A number of our business units face competitors that
have greater market share, offer a broader range of products or have higher
financial strength or credit ratings than we do.
In recent
years, there has been substantial consolidation and convergence among companies
in the financial services industry resulting in increased competition from
large, well-capitalized financial services firms. Many of these firms
also have been able to increase their distribution systems through mergers or
contractual arrangements. Furthermore, larger competitors may have
lower operating costs and an ability to absorb greater risk while maintaining
their financial strength ratings, thereby allowing them to price their products
more competitively. We expect consolidation to continue and perhaps
accelerate in the future, thereby increasing competitive pressure on
us.
Anti-takeover
provisions could delay, deter or prevent our change in control, even if the
change in control would be beneficial to LNC shareholders.
We are an
Indiana corporation subject to Indiana state law. Certain provisions
of Indiana law could interfere with or restrict takeover bids or other change in
control events affecting us. Also, provisions in our articles of
incorporation, bylaws and other agreements to which we are a party could delay,
deter or prevent our change in control, even if a change in control would be
beneficial to shareholders. In addition, under Indiana law, directors
may, in considering the best interests of a corporation, consider the effects of
any action on shareholders, employees, suppliers and customers of the
corporation and the communities in which offices and other facilities are
located, and other factors the directors consider pertinent. One
statutory provision prohibits, except under specified circumstances, LNC from
engaging in any business combination with any shareholder who owns 10% or more
of our common stock (which shareholder, under the statute, would be considered
an “interested shareholder”) for a period of five years following the time that
such shareholder became an interested shareholder, unless such business
combination is approved by the board of directors prior to such person becoming
an interested shareholder. In addition, our articles of incorporation
contain a provision requiring holders of at least three-fourths of our voting
shares then outstanding and entitled to vote at an election of directors, voting
together, to approve a transaction with an interested shareholder rather than
the simple majority required under Indiana law.
In
addition to the anti-takeover provisions of Indiana law, there are other factors
that may delay, deter or prevent our change in control. As an
insurance holding company, we are regulated as an insurance holding company and
are subject to the insurance holding company acts of the states in which our
insurance company subsidiaries are domiciled. The insurance holding
company acts and regulations restrict the ability of any person to obtain
control of an insurance company without prior regulatory
approval. Under those statutes and regulations, without such approval
(or an exemption), no person may acquire any voting security of a domestic
insurance company, or an insurance holding company which controls an insurance
company, or merge with such a holding company, if as a result of such
transaction such person would “control” the insurance holding company or
insurance company. “Control” is generally defined as the direct or
indirect power to direct or cause the direction of the management and policies
of a person and is presumed to exist if a person directly or indirectly owns or
controls 10% or more of the voting securities of another
person. Similarly, as a result of our ownership of NCLS, LNC is
considered to be a savings and loan holding company. Federal banking
laws generally provide that no person may acquire control of LNC, and gain
indirect control of NCLS without prior regulatory
approval. Generally, beneficial ownership of 10% or more of the
voting securities of LNC would be presumed to constitute control.
Item
1B. Unresolved Staff Comments
None.
Item
2. Properties
As of
December 31, 2009, LNC and our subsidiaries owned or leased approximately 3.7
million square feet of office space. We leased 0.3 million square
feet of office space in Philadelphia, Pennsylvania for our former Investment
Management segment and for LFN. We leased 0.2 million square feet of
office space in Radnor, Pennsylvania for our corporate center and for
LFD. We owned or leased 0.8 million square feet of office space in
Fort Wayne, Indiana, primarily for our Retirement Solutions – Annuities and
Retirements Solutions – Defined Contribution segments. We owned or
leased 0.8 million square feet of office space in Greensboro, North Carolina,
primarily for our Insurance Solutions – Life Insurance segment. We
owned or leased 0.3 million square feet of office space in Omaha, Nebraska,
primarily for our Insurance Solutions – Group Protection segment. An
additional 1.3 million square feet of office space is owned or leased in other
U.S. cities for branch offices. As provided in Note 14, the rental
expense on operating leases for office space and equipment was $55 million for
2009. This discussion regarding properties does not include
information on investment properties.
Item 3. Legal
Proceedings
For
information regarding legal proceedings, see “Regulatory and Litigation Matters”
in Note 14, which is incorporated herein by reference.
Item 4. Submission
of Matters to a Vote of Security Holders
During
the fourth quarter of 2009, no matters were submitted to security holders for a
vote.
Executive
Officers of the Registrant
Executive
Officers of the Registrant as of February 20, 2010, were as
follows:
Name
|
|
Age
(2)
|
|
Position
with LNC and Business Experience During the Past Five
Years
|
|
|
|
|
|
Dennis
R. Glass
|
|
60
|
|
President,
Chief Executive Officer and Director (since July
2007). President, Chief Operating Officer and Director (April
2006 - July 2007). President and Chief Executive Officer,
Jefferson-Pilot (2004 - April 2006). President and Chief
Operating Officer, Jefferson-Pilot (2001 - April 2006).
|
|
|
|
|
|
Lisa
M. Buckingham
|
|
44
|
|
Senior
Vice President, Chief Human Resources Officer (since December
2008). Senior Vice President, Global Talent, Thomson Reuters, a
provider of information and services for businesses and professionals
(April 2008 - November 2008). Senior Vice President, Human
Resources, Thomson Corporation (2002 - April 2008).
|
|
|
|
|
|
Charles
C. Cornelio
|
|
50
|
|
President,
Defined Contribution (since December 2009). Executive Vice
President, Chief Administrative Officer (November 2008-December
2009). Senior Vice President, Shared Services and Chief
Information Officer (April 2006 - November 2008). Executive
Vice President, Technology and Insurance Services, Jefferson-Pilot (2004 -
April 2006). Senior Vice President, Jefferson-Pilot (1997 -
2004).
|
|
|
|
|
|
Frederick
J. Crawford
|
|
46
|
|
Executive
Vice President and Chief Financial Officer (since November
2008). Senior Vice President and Chief Financial Officer (2005
- November 2008). Vice President and Treasurer (2001 -
2004).
|
|
|
|
|
|
Robert
W. Dineen
|
|
60
|
|
President,
Lincoln Financial Network, and CEO, Lincoln Financial Advisors
(1) (since 2002). Senior Vice President, Managed Asset
Group, Merrill Lynch & Co., a diversified financial services company
(2001 - 2002).
|
|
|
|
|
|
Heather
C. Dzielak
|
|
41
|
|
Senior
Vice President, Chief Marketing Officer (since January
2009). Senior Vice President, Retirement Income Security
Ventures (September 2006 - January 2009). Vice President,
Lincoln National Life Insurance Company
(1) (December 2003 - September 2006).
|
|
|
|
|
|
Wilford
H. Fuller
|
|
39
|
|
President
and CEO, Lincoln Financial Distributors
(1) (since February 2009). Head, Distribution, Global
Wealth Management, Merrill Lynch & Co., a diversified financial
services company (2007-2009). Head, Distribution, Managed
Solutions Group, Merrill Lynch & Co. (2005-2007). National
Sales Manager, Merrill Lynch & Co. (2000-2005).
|
|
|
|
|
|
Mark
E. Konen
|
|
50
|
|
President,
Insurance and Retirement Solutions (since July 2008 and February 2009
respectively). President, Individual Markets (April 2006 - July
2008). Executive Vice President, Life and Annuity
Manufacturing, Jefferson-Pilot (2004 - April 2006). Executive
Vice President, Product/Financial Management, Jefferson-Pilot (2002 -
2004).
|
|
|
|
|
|
(1)
|
Denotes
an affiliate of LNC.
|
(2)
|
Age
shown is based on the officer’s age as of February 20,
2010.
|
Item 5. Market for
Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities
(a) Stock
Market and Dividend Information
Our
common stock is traded on the New York and Chicago stock exchanges under the
symbol LNC. As of January 29, 2010, the number of shareholders of
record of our common stock was 11,183. The dividend on our common
stock is declared each quarter by our Board of Directors if we are eligible to
pay dividends and the Board determines that we will pay dividends. In
determining dividends, the Board takes into consideration items such as our
financial condition, including current and expected earnings, projected cash
flows and anticipated financing needs. For potential restrictions on
our ability to pay dividends, see “Review of Consolidated Financial Condition –
Liquidity and Capital Resources” in “Item 7. Management’s Discussion and
Analysis of Financial Condition and Results of Operations” and Note 21 in the
accompanying notes to the consolidated financial statements presented in Item
8. The following table presents the high and low prices for our
common stock on the New York Stock Exchange during the periods indicated and the
dividends declared per share during such periods:
|
|
1st
Qtr
|
|
|
2nd
Qtr
|
|
|
3rd
Qtr
|
|
|
4th
Qtr
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
|
High
|
|
$ |
25.59 |
|
|
$ |
19.99 |
|
|
$ |
27.82 |
|
|
$ |
28.10 |
|
Low
|
|
|
4.90 |
|
|
|
5.52 |
|
|
|
14.34 |
|
|
|
21.99 |
|
Dividend
declared
|
|
|
0.010 |
|
|
|
0.010 |
|
|
|
0.010 |
|
|
|
0.010 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
High
|
|
$ |
58.11 |
|
|
$ |
56.80 |
|
|
$ |
59.99 |
|
|
$ |
45.50 |
|
Low
|
|
|
45.50 |
|
|
|
45.18 |
|
|
|
39.83 |
|
|
|
4.76 |
|
Dividend
declared
|
|
|
0.415 |
|
|
|
0.415 |
|
|
|
0.415 |
|
|
|
0.210 |
|
(b) Not
Applicable
(c) Issuer
Purchases of Equity Securities
The
following table summarizes our stock repurchases during the quarter ended
December 31, 2009 (dollars in millions, except per share data):
|
|
(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
(1)
|
|
|
(or
Unit)
|
|
|
Plans
or Programs (2)
|
|
|
Plans
or Programs (3)
|
|
10/1/09
- 10/31/09
|
|
|
367 |
|
|
$ |
26.48 |
|
|
|
- |
|
|
$ |
1,204 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11/1/09
- 11/30/09
|
|
|
10,823 |
|
|
|
24.35 |
|
|
|
- |
|
|
|
1,204 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
12/1/09
- 12/31/09
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
1,204 |
|
(1)
|
Of
the total number of shares purchased, no shares were received in
connection with the exercise of stock options and related taxes and 11,190
shares were withheld for taxes on the vesting of restricted
stock. For the quarter ended December 31, 2009, there were no
shares purchased as part of publicly announced plans or
programs.
|
(2)
|
On
February 23, 2007, our Board approved a $2 billion increase to our
existing securities repurchase authorization, bringing the total
authorization at that time to $2.6 billion. At December 31,
2009, our security repurchase authorization was $1.2
billion. The security repurchase authorization does not have an
expiration date. However, in the fourth quarter of 2008, we
announced a suspension of share repurchased under this
program. 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) are not included in
our security repurchase. As required under the Troubled Asset
Relief Program Capital Purchase Program, repurchases of the Company’s
outstanding preferred and common stock are subject to certain restrictions
(unless the U.S. Treasury consents). In addition to these
restrictions, in connection with this arrangement, the Company will comply
with enhanced compensation restrictions for certain executives and
employees.
|
(3)
|
As
of the last day of the applicable
month.
|
(d) Securities
Authorized for Issuance Under Equity Compensation Plans
For
information on securities authorized for issuance under equity compensation
plans, see “Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters,” which is incorporated herein by
reference.
Item
6. Selected Financial Data
The
following selected financial data (in millions, except per share data) should be
read in conjunction with “Item 7. Management’s Discussion and Analysis of
Financial Condition and Results of Operations”and the accompanying notes to the
consolidated financial statements presented in Item 8. Some
previously reported amounts have been reclassified to conform to the
presentation as of and for the year ended December 31, 2009.
|
|
For
the Years Ended December 31,
|
|
|
|
2009
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Total
revenues
|
|
$ |
8,499 |
|
|
$ |
9,224 |
|
|
$ |
9,614 |
|
|
$ |
8,002 |
|
|
$ |
4,649 |
|
Income
(loss) from continuing operations
|
|
|
(415 |
) |
|
|
(10 |
) |
|
|
1,199 |
|
|
|
1,199 |
|
|
|
761 |
|
Net
income (loss)
|
|
|
(485 |
) |
|
|
57 |
|
|
|
1,215 |
|
|
|
1,316 |
|
|
|
831 |
|
Per
share data (1)
(2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations - basic
|
|
$ |
(1.60 |
) |
|
$ |
(0.04 |
) |
|
$ |
4.44 |
|
|
$ |
4.75 |
|
|
$ |
4.40 |
|
Income
(loss) from continuing operations - diluted
|
|
|
(1.60 |
) |
|
|
(0.04 |
) |
|
|
4.37 |
|
|
|
4.68 |
|
|
|
4.32 |
|
Net
income (loss) - basic
|
|
|
(1.85 |
) |
|
|
0.22 |
|
|
|
4.50 |
|
|
|
5.21 |
|
|
|
4.80 |
|
Net
income (loss) - diluted
|
|
|
(1.85 |
) |
|
|
0.22 |
|
|
|
4.43 |
|
|
|
5.13 |
|
|
|
4.72 |
|
Common
stock dividends
|
|
|
0.040 |
|
|
|
1.455 |
|
|
|
1.600 |
|
|
|
1.535 |
|
|
|
1.475 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of December 31,
|
|
|
|
|
2009 |
|
|
|
2008 |
|
|
|
2007 |
|
|
|
2006 |
|
|
|
2005 |
|
Assets
|
|
$ |
177,433 |
|
|
$ |
163,136 |
|
|
$ |
191,435 |
|
|
$ |
178,495 |
|
|
$ |
124,860 |
|
Long-term
debt
|
|
|
5,050 |
|
|
|
4,731 |
|
|
|
4,618 |
|
|
|
3,458 |
|
|
|
1,333 |
|
Stockholders'
equity
|
|
|
11,700 |
|
|
|
7,977 |
|
|
|
11,718 |
|
|
|
12,201 |
|
|
|
6,384 |
|
Per
common share data (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stockholders'
equity including accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
other
comprehensive income
(3)
|
|
$ |
36.02 |
|
|
$ |
31.15 |
|
|
$ |
44.32 |
|
|
$ |
44.21 |
|
|
$ |
36.69 |
|
Stockholders'
equity excluding accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
other
comprehensive income
(3)
|
|
|
36.89 |
|
|
|
42.09 |
|
|
|
43.46 |
|
|
|
41.99 |
|
|
|
33.66 |
|
Market
value of common stock
|
|
|
24.88 |
|
|
|
18.84 |
|
|
|
58.22 |
|
|
|
66.40 |
|
|
|
53.03 |
|
(1)
|
Per
share amounts were affected by the issuance of 112.3 million shares for
the acquisition of Jefferson-Pilot in 2006 and the retirement of less than
1 million, 9.3 million, 15.4 million, 16.9 million, and 2.3 million shares
of common stock during the years ended December 31, 2009, 2008, 2007, 2006
and 2005, respectively.
|
(2)
|
For
discussion of the reduction of net income (loss) available to common
shareholders see Note 15.
|
(3)
|
Per
share amounts are calculated under the assumption that our Series A
preferred stock has been converted to common stock, but exclude Series B
preferred stock balances as it is
non-convertible.
|
Item
7. Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
The
following Management’s Discussion and Analysis (“MD&A”) is intended to help
the reader understand the financial condition as of December 31, 2009, compared
with December 31, 2008, and the results of operations in 2009 and 2008, compared
with the immediately preceding year of Lincoln National Corporation and its
consolidated subsidiaries. Unless otherwise stated or the context
otherwise requires, “LNC,” “Lincoln,” “Company,” “we,” “our” or “us” refers to
Lincoln National Corporation and its consolidated subsidiaries. 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 “Part II – Item 8.
Financial Statements and Supplementary Data,” as well as “Part I – Item 1A. Risk
Factors” above.
See Note
2 for a detailed discussion of how the Financial Accounting Standards Board
(“FASB”) Accounting Standards
CodificationTM
(“ASC”) is now the single source of authoritative United States of
America generally accepted accounting principles (“GAAP”) recognized by the
FASB. Accordingly, we have revised all references to GAAP accounting
standards in this filing to reflect the appropriate references in the new FASB
ASC.
In this
report, in addition to providing consolidated revenues and net income (loss), we
also provide segment operating revenues and income (loss) from operations
because we believe they are meaningful measures of revenues and the
profitability of our operating segments. Income (loss) from
operations is net income recorded in accordance with GAAP excluding the
after-tax effects of the following items, as applicable:
·
|
Realized
gains and losses associated with the following (“excluded realized
loss”):
|
|
§
|
Sales
or disposals of securities;
|
|
§
|
Impairments
of securities;
|
|
§
|
Change
in the fair value of embedded derivatives within certain reinsurance
arrangements and the change in the fair value of our trading
securities;
|
|
§
|
Change
in the fair value of the derivatives we own to hedge our guaranteed death
benefit (“GDB”) riders within our variable annuities, which is referred to
as “GDB derivatives results”;
|
|
§
|
Change
in the fair value of the embedded derivatives of our guaranteed living
benefit (“GLB”) riders within our variable annuities accounted for under
the Derivatives and Hedging and the Fair Value Measurements and
Disclosures Topics of the FASB ASC (“embedded derivative reserves”), net
of the change in the fair value of the derivatives we own to hedge the
changes in the embedded derivative reserves, the net of which is referred
to as “GLB net derivative results”;
and
|
|
§
|
Changes
in the fair value of the embedded derivative liabilities related to index
call options we may purchase in the future to hedge contract holder index
allocations applicable to future reset periods for our indexed annuity
products accounted for under the Derivatives and Hedging and the Fair
Value Measurements and Disclosures Topics of the FASB ASC (“indexed
annuity forward-starting option”).
|
·
|
Change
in reserves accounted for under the Financial Services – Insurance – Claim
Costs and Liabilities for Future Policy Benefits Subtopic of the FASB ASC
resulting from benefit ratio unlocking on our GDB and GLB riders (“benefit
ratio unlocking”);
|
·
|
Income
(loss) from the initial adoption of new accounting
standards;
|
·
|
Income
(loss) from reserve changes (net of related amortization) on business sold
through reinsurance;
|
·
|
Gain
(loss) on early extinguishment of
debt;
|
·
|
Losses
from the impairment of intangible assets;
and
|
·
|
Income
(loss) from discontinued
operations.
|
Income
(loss) from operations available to common stockholders is net income (loss)
available to common stockholders (used in the calculation of earnings (loss) per
share) in accordance with GAAP, excluding the after-tax effects of the items
above and any acceleration of our Series B preferred stock discount as a result
of repayment prior to five years from the date of issuance.
Operating
revenues represent GAAP revenues excluding the pre-tax effects of the following
items, as applicable:
·
|
Excluded
realized loss;
|
·
|
Amortization
of deferred front-end loads (“DFEL”) arising from changes in GDB and GLB
benefit ratio unlocking;
|
·
|
Amortization
of deferred gains arising from the reserve changes on business sold
through reinsurance; and
|
·
|
Revenue
adjustments from the initial adoption of new accounting
standards.
|
Operating
revenues and income (loss) from operations are the financial performance
measures we use to evaluate and assess the results of our
segments. Accordingly, we report operating revenues and income (loss)
from operations by segment in Note 23. Our management and Board of
Directors believe that operating revenues and income (loss) from operations
explain the results of our ongoing businesses in a manner that allows for a
better understanding of the underlying trends in our current businesses because
the excluded items are unpredictable and not necessarily indicative of current
operating fundamentals or future performance of the business segments, and, in
many instances, decisions regarding these items do not necessarily relate to the
operations of the individual segments. In addition, we believe that
our 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.
We use
our prevailing corporate federal income tax rate of 35% while taking into
account any permanent differences for events recognized differently in our
financial statements and federal income tax returns when reconciling our
non-GAAP measures to the most comparable GAAP measure. Operating
revenues and income (loss) from operations do not replace revenues and net
income as the GAAP measures of our consolidated results of
operations.
Certain
reclassifications have been made to prior periods’ financial
information.
FORWARD-LOOKING STATEMENTS –
CAUTIONARY
LANGUAGE
Certain
statements made in this report and in other written or oral statements made by
us or on our behalf are “forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995 (“PSLRA”). A
forward-looking statement is a statement that is not a historical fact and,
without limitation, includes any statement that may predict, forecast, indicate
or imply future results, performance or achievements, and may contain words
like: “believe,” “anticipate,” “expect,” “estimate,” “project,”
“will,” “shall” and other words or phrases with similar meaning in connection
with a discussion of future operating or financial performance. In
particular, these include statements relating to future actions, trends in our
businesses, prospective services or products, future performance or financial
results and the outcome of contingencies, such as legal
proceedings. We claim the protection afforded by the safe harbor for
forward-looking statements provided by the PSLRA.
Forward-looking
statements involve risks and uncertainties that may cause actual results to
differ materially from the results contained in the forward-looking
statements. Risks and uncertainties that may cause actual results to
vary materially, some of which are described within the forward-looking
statements, include, among others:
·
|
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;
|
·
|
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;
|
·
|
Uncertainty
about the impact of existing or new stimulus legislation on the
economy;
|
·
|
The
cost and other consequences of our participation in the Capital Purchase
Program (“CPP”), including the impact of existing regulation and future
regulations to which we may become
subject;
|
·
|
Legislative,
regulatory or tax changes, both domestic and foreign, that affect the cost
of, or demand for, our subsidiaries’ 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;
|
·
|
The
initiation of legal or regulatory proceedings against us, 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 we 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;
|
·
|
Changes
in interest rates causing a reduction of investment income, the margins of
our subsidiaries’ fixed annuity and life insurance businesses and demand
for their products;
|
·
|
A
decline in the equity markets causing a reduction in the sales of our
subsidiaries’ products, a reduction of asset-based fees that our
subsidiaries charge on various investment and insurance products, an
acceleration of amortization of deferred acquisition costs (“DAC”), value
of business acquired (“VOBA”), deferred sales inducements (“DSI”) and DFEL
and an increase in liabilities related to guaranteed benefit features of
our subsidiaries’ variable annuity
products;
|
·
|
Ineffectiveness
of our 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 the assumptions
used in pricing our subsidiaries’ products, in establishing related
insurance reserves and in the amortization of intangibles that may cause
an increase in reserves and/or a reduction in assets, resulting in a
corresponding decrease in net
income;
|
·
|
Changes
in GAAP that may result in unanticipated changes to our net
income;
|
·
|
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;
|
·
|
Lowering
of one or more of the insurer financial strength ratings of our insurance
subsidiaries and the adverse impact such action may have on the premium
writings, policy retention, profitability of our insurance subsidiaries
and liquidity;
|
·
|
Significant
credit, accounting, fraud or corporate governance issues that may
adversely affect the value of certain investments in our portfolios
requiring that we realize losses on such
investments;
|
·
|
The
impact of acquisitions and divestitures, restructurings, product
withdrawals and other unusual items, including our ability to integrate
acquisitions and to obtain the anticipated results and synergies from
acquisitions;
|
·
|
The
adequacy and collectibility of reinsurance that we have
purchased;
|
·
|
Acts
of terrorism, a pandemic, war or other man-made and natural catastrophes
that may adversely affect our 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 our subsidiaries can charge for their
products;
|
·
|
The
unknown impact on our subsidiaries’ businesses resulting from changes in
the demographics of their client base, as aging baby-boomers move from the
asset-accumulation stage to the asset-distribution stage of life;
and
|
·
|
Loss
of key management, financial planners or
wholesalers.
|
The risks
included here are not exhaustive. Other sections of this report, our
quarterly reports on Form 10-Q, current reports on Form 8-K and other documents
filed with the Securities and Exchange Commission (“SEC”) include additional
factors that could impact our businesses and financial performance, including
“Part I – Item 1A. Risk Factors,” “Part II – Item 7A. Quantitative and
Qualitative Disclosures About Market Risk” and the risk discussions included in
this section under “Critical Accounting Policies and Estimates,” “Consolidated
Investments” and “Reinsurance,” which are incorporated herein by
reference. Moreover, we operate in a rapidly changing and competitive
environment. New risk factors emerge from time to time, and it is not
possible for management to predict all such risk factors.
Further,
it is not possible to assess the impact of all risk factors on our businesses or
the extent to which any factor, or combination of factors, may cause actual
results to differ materially from those contained in any forward-looking
statements. Given these risks and uncertainties, investors should not
place undue reliance on forward-looking statements as a prediction of actual
results. In addition, we disclaim any obligation to update any
forward-looking statements to reflect events or circumstances that occur after
the date of this report.
INTRODUCTION
Executive
Summary
We are a
holding company that operates multiple insurance and retirement businesses
through subsidiary companies. Through our business segments, we sell
a wide range of wealth protection, accumulation and retirement income products
and solutions. These products include fixed and indexed annuities,
variable annuities, universal life insurance (“UL”), variable universal life
insurance (“VUL”), linked-benefit UL, term life insurance and mutual
funds.
We
provide products and services in two operating businesses and report results
through four business segments as follows:
Business
|
|
Corresponding
Segments
|
Retirement
Solutions
|
|
Annuities
|
|
|
Defined
Contribution
|
|
|
|
Insurance
Solutions
|
|
Life
Insurance
|
|
|
Group
Protection
|
Our
individual products and services and defined contribution plans are distributed
primarily through consultants, brokers, planners, agents and other
intermediaries with sales and marketing support provided by approximately 540
wholesalers within Lincoln Financial Distributors (“LFD”), our wholesaling
distributor. Our Insurance Solutions – Group Protection segment
distributes its products and services primarily through employee benefit
brokers, third party administrators (“TPAs”) and other employee benefit firms
with sales support provided by its group and retirement sales
specialists. Our retail distributor, Lincoln Financial Network,
offers proprietary and non-proprietary products and advisory services through a
national network of approximately 7,700 active producers who placed business
with us within the last twelve months.
These
operating businesses and their segments are described in “Part I – Item 1. Business”
above.
We also
have Other Operations, which includes the financial data for operations that are
not directly related to the business segments. Other Operations also
includes investments related to the excess capital in our insurance
subsidiaries; investments in media properties and other corporate investments;
benefit plan net assets; the unamortized deferred gain on indemnity reinsurance
related to the sale of reinsurance to Swiss Re in 2001; the results of certain
disability income business due to the rescission of a reinsurance agreement with
Swiss Re; our run-off Institutional Pension business; and external
debt.
Our
former Lincoln UK and Investment Management segments are reported in
discontinued operations for all periods presented. See “Acquisitions
and Dispositions” and Note 3 below for more information.
For
information on how we derive our revenues, see the discussion in results of
operations by segment below.
Current
Market Conditions
Subsequent
to the first quarter of 2009, the capital and credit markets improved following
a period of extreme volatility and disruption that affected both equity market
returns and interest rates. During this period, credit spreads
widened across asset classes and reduced liquidity in the credit
markets. The price of our common stock increased during 2009 to close
at $24.88 on December 31, 2009, as compared to $18.84 on December 31, 2008,
after having traded at a low of $4.90 during the first quarter of
2009. Analysts and economists noted in January 2009 that the U.S.
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
primarily from February 2009 to May 2009 as depressed capital markets continued
to strain our liquidity as we prepared to fund debt maturities in the second
quarter of 2009; however, during June of 2009 and following the announcement
about our planned capital actions discussed below, all four of the major
independent rating agencies affirmed our financial strength ratings, and
Standard & Poor’s (“S&P”) improved its outlook on our company to stable
from negative. For more information about ratings, see “Part I – Item
1. Business – Ratings.”
Although
market conditions have improved, we expect earnings will continue to be
unfavorably impacted by the prior significant decline in the equity
markets. Due to these challenges, the capital markets had a
significant effect on our segment income (loss) from operations and consolidated
net loss during 2009. 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. During 2009, we experienced
modestly lower deposits but significantly higher net flows than in
2008.
The
markets have primarily impacted the following areas:
Adequacy
of Our Liquidity and Capital Positions
The
continued adequacy of our capital resources to meet requirements of our
businesses and our holding company depends upon such factors as market
conditions and our ability to access sources of liquidity. In
addition, market volatility impacts the level of capital required to support our
businesses.
Given
this dynamic and challenging environment that began in the fourth quarter of
2008, we have taken the following measures to prudently and actively manage our
liquidity and capital positions as discussed below in “Review of Consolidated
Financial Condition – Liquidity and Capital Resources”:
·
|
We
reduced our dividend in October 2008 from $0.415 to $0.21 per share, and
we further reduced the dividend in February 2009 from $0.21 to $0.01 per
share, which, along with the prior reduction, increased our cash flow by
$400 million annually.
|
·
|
We
launched an expense reduction initiative in December 2008 that was
intended primarily to adjust capacity of volume-sensitive areas to the
reduction in volumes we were experiencing related to the challenging
economic environment and to improve efficiencies across the entire
organization. We completed this initiative in June 2009 and
achieved an annualized gross general and administrative expense reduction
that will improve our capital position by $140 million to $160 million
annually, after-tax.
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·
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We
suspended any further stock repurchase activity in October
2008.
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·
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We
issued $690 million of common stock and $500 million of senior notes
during the second quarter of 2009.
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·
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We
issued $950 million of preferred stock and a common stock warrant through
the U.S. Treasury’s Troubled Asset Relief Program (“TARP”) CPP in the
third quarter of 2009, as discussed below in “TARP
CPP.”
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·
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We
also issued $300 million of senior notes during the fourth quarter of
2009, of which most of the proceeds will be used to pay the maturity of
the $250 million floating rate senior note due on March 12,
2010.
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·
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We
completed the sale of the Lincoln UK in October 2009 for proceeds of $307
million, after-tax, subject to customary post-closing
adjustments.
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·
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We
completed the sale of Delaware, our investment management operation, in
January 2010 for proceeds of approximately $405 million, after-tax,
subject to customary post-closing
adjustments.
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Earnings
from Account Values
Our
asset-gathering segments – Retirement Solutions – Annuities and Retirement
Solutions – Defined Contribution – are the most sensitive to the equity
markets. We discuss the earnings impact of the equity markets on
account values and the related asset-based earnings below in “Part II – Item
7A. Quantitative and Qualitative Disclosures About Market Risk –
Equity Market Risk – Impact of Equity Market Sensitivity.” From the
end of 2008 to December 31, 2009, our account values were up $23.2 billion
driven by strong deposits, positive net flows and recent improvements in the
equity markets. While our ending variable account values as of
December 31, 2009, were modestly higher than as of December 31, 2008, the daily
average account values were much lower than the corresponding period in the
prior year, consistent with the reduction in our asset-based
earnings. Accordingly, we may continue to report lower asset-based
fees and higher DAC and VOBA amortization relative to expectations or prior
periods.
Investment
Income on Alternative Investments
We
believe that overall market conditions in both the equity and credit markets
caused our alternative investments portfolio, which consists primarily of hedge
funds and various limited partnership investments, to under-perform relative to
our long-term return expectations. During 2009, the most significant
unfavorable impact from these investments was related to audit adjustments from
the completion of calendar-year financial statement audits of our investees,
determined and recognized during the second quarter of 2009. The
audit reports that we received for these investees reflected a lower equity
balance than the unaudited financial statements that we used as the basis for
valuation at year end 2008 and the first quarter of 2009. These
investments impact primarily our Insurance Solutions – Life Insurance segment
and to a lesser extent our other segments. See “Critical Accounting
Policies and Estimates – Investments – Valuation of Alternative Investments” and
“Consolidated Investments – Alternative Investments” for additional information
on our investment portfolio and further discussion of the nature of the audit
adjustments referred to above.
Variable
Annuity Hedge Program Results
We offer
variable annuity products with living benefit guarantees. As
described below in “Critical Accounting Policies and Estimates – Derivatives –
Guaranteed Living Benefits,” we use derivative instruments to hedge our exposure
to the risks and earnings volatility that result from the GLB embedded
derivatives 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 embedded derivative reserves.
The
non-performance risk (“NPR”) factors affect the discount rate used in the
calculation of the GLB embedded derivative reserve. The NPR factors
are impacted by our holding company’s credit default swap (“CDS”) spreads
adjusted for items, such as the liquidity of our holding company
CDS. Because the guaranteed benefit liabilities are contained within
our insurance subsidiaries, we apply items, such as the impact of our insurance
subsidiaries’ claims-paying ratings compared to holding company credit risk and
the over-collateralization of insurance liabilities, in order to determine
factors that are representative of a theoretical market participant’s view of
the NPR of the specific liability within our insurance
subsidiaries. This had an unfavorable effect during 2009 attributable
to narrowing of credit spreads. These results are excluded from the
Retirement Solutions – Annuities and Defined Contribution segments’ operating
revenues and income from operations. See “Realized Loss – Operating
Realized Gain – GLB” for information on our methodology for calculating the
NPR.
We also
offer variable products with death benefit guarantees. As described
below in “Critical Accounting Policies and Estimates – Future Contract Benefits
and Other Contract Holder Obligations – Guaranteed Death Benefits,” we use
derivative instruments to attempt to hedge the income statement impact in the
opposite direction of the GDB benefit ratio unlocking for movements in equity
markets. These results are excluded from income (loss) from
operations.
Variable
Annuity Business Model
In order
to address the realities of the current market conditions in the variable
annuity marketplace, in late January 2009, we introduced changes to our GLB
riders including increased rider fees, reduced roll-up periods and tighter
investment restrictions on new business and a large percentage of in-force
account value. Increased equity market implied volatility and falling
interest rates have increased the cost of providing GLBs. The January
product changes reduce benefits provided under the contracts while also
compensating us for increasing costs to provide the benefits. In
addition, in October 2009, we removed the ability for contract holders to double
their guaranteed amount if held for 10 years without withdrawal or an implied
7.2% roll-up.
Credit
Losses, Impairments and Unrealized Losses
Related
to our investments in fixed income and equity securities, we experienced net
realized losses that reduced net income by $286 million for 2009 and included
credit-related write-downs of securities for other-than-temporary impairments
(“OTTI”) of $255 million. Although economic conditions have improved,
we expect a continuation of some level of OTTI. If we were to
experience another period of weakness in the economic environment like we did in
late 2008 and early 2009, it could lead to increased credit defaults, resulting
in additional write-downs of securities for OTTI.
Increased
liquidity in several market segments and improved credit fundamentals (i.e.,
market improvement and narrowing credit spreads) as of December 31, 2009,
compared to December 31, 2008, have resulted in the $4.5 billion decrease in
gross unrealized losses on the available-for-sale (“AFS”) fixed maturity
securities in our general account as of December 31, 2009.
TARP
CPP
On
November 13, 2008, we filed an application to participate in the CPP that was
established under the Emergency Economic Stabilization Act of 2008
(“EESA”). On January 8, 2009, the Office of Thrift Supervision
approved our application to become a savings and loan holding company and our
acquisition of Newton County Loan & Savings, FSB, a federally regulated
savings bank, located in Indiana. We contributed $10 million to the
capital of Newton County Loan & Savings, FSB, and closed on the purchase on
January 15, 2009. On May 8, 2009, the U.S. Treasury granted us
preliminary approval to participate in the CPP. On July 10, 2009, we
issued, in a private placement, $950 million of Series B preferred stock and a
warrant for 13,049,451 shares of our common stock with an exercise price of
$10.92 per share to the U.S. Treasury under the CPP. See “Review of
Consolidated Financial Condition – Liquidity and Capital Resources – Sources of
Liquidity and Cash Flow – Financing Activities” for more information about our
preferred stock issuance.
We are
subject to certain restrictions, notably, limits on incentive compensation for
certain executives and employees for the duration of the U.S. Treasury’s
investment. We are also subject to limits on increasing the dividend
on our common stock and redeeming capital stock (unless the U.S. Treasury
consents), both of which apply until the third anniversary of the U.S.
Treasury’s investment unless we redeem the Series B preferred shares in whole or
the U.S. Treasury transfers all of the Series B preferred stock to third
parties.
Industry
Trends
We
continue to be influenced by a variety of trends that affect the
industry.
Financial
Environment
The level
of long-term interest rates and the shape of the yield curve can have a negative
impact on the demand for and the profitability of spread-based products such as
fixed annuities and UL. A flat or inverted yield curve and low
long-term interest rates will be a concern if new money rates on corporate bonds
are lower than overall life insurer investment portfolio
yields. Equity market performance can also impact the profitability
of life insurers, as product demand and fee revenue from variable annuities and
fee revenue from pension products tied to separate account balances often
reflect equity market performance. A steady economy is important as
it provides for continuing demand for insurance and investment-type
products. Insurance premium growth, with respect to group life and
disability products, for example, is closely tied to employers’ total payroll
growth. Additionally, the potential market for these products is
expanded by new business creation. See “Current Market Conditions”
above for further discussion of the current impact of volatility in the capital
markets.
Economic
Environment
The
National Bureau of Economic Research, a panel of economists charged with
officially designating business cycles, announced that a U.S. recession began in
December of 2007. While the economy is believed to have rebounded
during the third quarter of 2009, analysts believe that unemployment will remain
high well into 2010, likely restraining consumption. Analysts do not
expect the labor market to regain the jobs lost during the recession until 2012
or beyond. The slow recovery of the U.S. economy is likely to result
in businesses and consumers spending less, including on the products the
insurance industry markets and sells.
Demographics
In the
coming decade, a key driver shaping the actions of the insurance industry will
be the escalation of income protection and wealth accumulation goals and needs
of the retiring baby-boomers. As a result of increasing longevity,
retirees will need to accumulate sufficient savings to finance retirements that
may span 30 or more years. Helping the baby-boomers to accumulate
assets for retirement and subsequently to convert these assets into retirement
income represents an opportunity for the insurance industry.
Insurers
are well positioned to address the baby-boomers’ rapidly increasing need for
savings tools and for income protection. We believe that, among
insurers, those with strong brands, high financial strength ratings and broad
distribution, are best positioned to capitalize on the opportunity to offer
income protection products to baby-boomers.
Moreover,
the insurance industry’s products, and the needs they are designed to address,
are complex. We believe that individuals approaching retirement age
will need to seek information to plan for and manage their
retirements. In the workplace, as employees take greater
responsibility for their benefit options and retirement planning, they will need
information about their possible individual needs. One of the
challenges for the insurance industry will be the delivery of this information
in a cost effective manner.
Competitive
Pressures
The
insurance industry remains highly competitive, especially in this
post-recessionary environment. The product development and product
life cycles have shortened in many product segments, leading to more intense
competition with respect to product features. Larger companies have
the ability to invest in brand equity, product development, technology and risk
management, which are among the fundamentals for sustained profitable growth in
the life insurance industry. In addition, several of the industry’s
products can be quite homogeneous and subject to intense price
competition. Sufficient scale, financial strength and financial
flexibility are becoming prerequisites for sustainable growth in the life
insurance industry. Larger market participants tend to have the
capacity to invest in additional distribution capability and the information
technology needed to offer the superior customer service demanded by an
increasingly sophisticated industry client base.
Regulatory
Changes
The
insurance industry is regulated at the state level, with some products and
services also subject to federal regulation. As life insurers
introduce new and often more complex products, regulators refine capital
requirements and introduce new reserving standards for the life insurance
industry. Regulations recently adopted or currently under review can
potentially impact the reserve and capital requirements of the
industry.
Issues
and Outlook
Going
into 2010, significant issues include:
·
|
Potential
unstable credit markets that can impact our financing alternatives,
spreads and other-than-temporary securities
impairments;
|
·
|
Potential
volatile equity markets that have a significant impact on our hedge
program performance and revenues;
|
·
|
Continuation
of the low interest rate environment, which affects the investment margins
and reserve levels for many of our products, such as fixed annuities, UL
and the fixed portion of defined contribution and VUL
business;
|
·
|
Possible
additional intangible asset impairments, such as goodwill, if the
financial performance of our reporting units deteriorates, market
observable transactions of businesses similar to ours occur that imply
lower market valuations, 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) are adversely
affected;
|
·
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Achieving
continued sales success with our portfolio of products, including
marketplace acceptance of new variable annuity features, as well as
retaining management and wholesaler talent to maintain our competitive
position;
|
·
|
Maturity
of credit facilities in the first quarter of 2011 and related letters of
credit (“LOCs”) that may remain outstanding until the first quarter of
2012 that support our life insurance business, and evolving treatment of
reserve financing by rating agencies;
and
|
·
|
Continuing
focus by the government on tax and healthcare reform including potential
changes in company dividends-received deduction (“DRD”) calculations,
which may affect the value and profitability of our products and overall
earnings.
|
In the
face of these issues and potential issues, we expect to focus on the following
throughout 2010:
·
|
Increasing
our product development activities together with identifying future
product development initiatives, with a focus on further reducing risk
related to guaranteed benefit riders available with certain variable
annuity contracts;
|
·
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Making
targeted strategic investments in our businesses to grow revenues and
further spur productivity, particularly in Retirement Solutions – Defined
Contribution and Insurance Solutions – Group Protection, with technology
upgrades and new products for the voluntary market and an expanded
distribution focus for our group
business;
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·
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Managing
our expenses aggressively through process improvement initiatives combined
with continued financial discipline and execution excellence throughout
our operations;
|
·
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Executing
on financing strategies addressing the statutory reserve strain and
expiring credit facilities related to our secondary guarantee UL products
in order to manage our capital position effectively in accordance with our
pricing guidelines; and
|
·
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Closely
monitoring our capital and liquidity positions taking into account the
fragile economic recovery and changing statutory accounting and reserving
practices.
|
For
additional factors that could cause actual results to differ materially from
those set forth in this section, see “Part I – Item 1A. Risk Factors” and
“Forward-Looking Statements – Cautionary Language” above.
Critical
Accounting Policies and Estimates
We have
identified the accounting policies below as critical to the understanding of our
results of operations and our financial position. In applying these
critical accounting policies in preparing our financial statements, management
must use critical assumptions, estimates and judgments concerning future results
or other developments, including the likelihood, timing or amount of one or more
future events. Actual results may differ from these estimates under
different assumptions or conditions. On an ongoing basis, we evaluate
our assumptions, estimates and judgments based upon historical experience and
various other information that we believe to be reasonable under the
circumstances. For a detailed discussion of other significant
accounting policies, see Note 1.
DAC,
VOBA, DSI and DFEL
Accounting
for intangible assets requires numerous assumptions, such as estimates of
expected future profitability for our operations and our ability to retain
existing blocks of life and annuity business in force. Our accounting
policies for DAC, VOBA, DSI and DFEL impact the Retirement Solutions –
Annuities, Retirement Solutions – Defined Contribution, Insurance Solutions –
Life Insurance and Insurance Solutions – Group Protection segments.
Acquisition
costs for variable annuity and deferred fixed annuity contracts and UL and VUL
policies are amortized over the lives of the contracts in relation to the
incidence of estimated gross profits (“EGPs”) derived from the
contracts. Acquisition costs are those costs that vary with and are
related primarily to new or renewal business. These costs include
commissions and other expenses that vary with new business
volume. The costs that we defer are recorded as an asset on our
Consolidated Balance Sheets as DAC for products we sold or VOBA for books of
business we acquired. In addition, we defer costs associated with DSI
and revenues associated with DFEL. DSI is included within other
assets on our Consolidated Balance Sheets and, when amortized, increases
interest credited and reduces income. DFEL is a liability included
within other contract holder funds on our Consolidated Balance Sheets, and when
amortized, increases product expense charge revenues and income.
EGPs vary
based on a number of sources including policy persistency, mortality, fee
income, investment margins, expense margins and realized gains and losses on
investments, including assumptions about the expected level of credit-related
losses. Each of these sources of profit is, in turn, driven by other
factors. For example, assets under management and the spread between
earned and credited rates drive investment margins; net amount at risk (“NAR”)
drives the level of cost of insurance (“COI”) charges and reinsurance
premiums. The level of separate account assets under management is
driven by changes in the financial markets (equity and bond markets, hereafter
referred to collectively as “equity markets”) and net flows. Realized
gains and losses on investments include amounts resulting from differences in
the actual level of impairments and the levels assumed in calculating
EGPs.
Our DAC,
VOBA, DSI and DFEL balances (in millions) by business segment as of December 31,
2009, were as follows:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Retirement
Solutions
|
|
|
Insurance
Solutions
|
|
|
|
|
|
|
|
|
|
|
|
|
Defined
|
|
|
Life
|
|
|
Group
|
|
|
Other
|
|
|
|
|
|
|
Annuities
|
|
|
Contribution
|
|
|
Insurance
|
|
|
Protection
|
|
|
Operations
|
|
|
Total
|
|
DAC
and VOBA
|
|
$ |
2,381 |
|
|
$ |
538 |
|
|
$ |
6,412 |
|
|
$ |
159 |
|
|
$ |
20 |
|
|
$ |
9,510 |
|
DSI
|
|
|
320 |
|
|
|
3 |
|
|
|
- |
|
|
|
- |
|
|
|
- |
|
|
|
323 |
|
Total
|
|
|
2,701 |
|
|
|
541 |
|
|
|
6,412 |
|
|
|
159 |
|
|
|
20 |
|
|