d10q.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
_____________________
 
FORM 10-Q
_____________________
 
(Mark One)
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
For the quarterly period ended March 31, 2010
 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, Radnor, Pennsylvania
    19087   
(Address of principal executive offices)
(Zip Code)
 
(484) 583-1400
(Registrant’s telephone number, including area code)
 
Not Applicable
(Former name, former address and former fiscal year, if changed since last report.)
 
_____________________
 
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 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 Exchange Act).  Yes ¨ No  x
 
As of May 3, 2010, there were 302,482,745 shares of the registrant’s common stock outstanding.

 

 


 
 

 

PART I – FINANCIAL INFORMATION
Item 1.  Financial Statements
LINCOLN NATIONAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(in millions, except share data)


   
As of
   
As of
 
   
March 31,
   
December 31,
 
   
2010
   
2009
 
   
(Unaudited)
       
ASSETS
           
Investments:
           
Available-for-sale securities, at fair value:
           
Fixed maturity securities (amortized cost:  2010 - $61,590; 2009 - $60,757)
  $ 62,881     $ 60,818  
Variable interest entities' fixed maturity securities (amortized cost:  2010 - $566)
    579       -  
Equity securities (cost:  2010 - $377; 2009 - $382)
    310       278  
Trading securities
    2,532       2,505  
Mortgage loans on real estate
    7,013       7,178  
Real estate
    201       174  
Policy loans
    2,903       2,898  
Derivative investments
    992       1,010  
Other investments
    1,047       1,057  
Total investments
    78,458       75,918  
Cash and invested cash
    3,445       4,025  
Deferred acquisition costs and value of business acquired
    9,195       9,510  
Premiums and fees receivable
    397       321  
Accrued investment income
    940       889  
Reinsurance recoverables
    6,520       6,426  
Goodwill
    3,013       3,013  
Other assets
    3,224       3,831  
Separate account assets
    76,429       73,500  
Total assets
  $ 181,621     $ 177,433  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Liabilities
               
Future contract benefits
  $ 15,270     $ 15,287  
Other contract holder funds
    65,452       64,818  
Short-term debt
    101       350  
Long-term debt
    5,060       5,050  
Reinsurance related embedded derivatives
    47       31  
Funds withheld reinsurance liabilities
    1,216       1,261  
Deferred gain on business sold through reinsurance
    525       543  
Payables for collateral on investments
    1,828       1,907  
Variable interest entities' liabilities
    142       -  
Other liabilities
    3,183       2,986  
Separate account liabilities
    76,429       73,500  
Total liabilities
    169,253       165,733  
                 
Contingencies and Commitments (See Note 9)
               
                 
Stockholders' Equity
               
Series A preferred stock - 10,000,000 shares authorized; 11,365 and 11,497 shares
               
issued and outstanding as of March 31, 2010, and December 31, 2009, respectively
    -       -  
Series B preferred stock - 950,000 shares authorized and outstanding
               
as of March 31, 2010, and December 31, 2009
    812       806  
Common stock - 800,000,000 shares authorized; 302,467,034 and 302,223,281 shares
               
issued and outstanding as of March 31, 2010, and December 31, 2009, respectively
    7,845       7,840  
Retained earnings
    3,409       3,316  
Accumulated other comprehensive income (loss)
    302       (262 )
Total stockholders' equity
    12,368       11,700  
Total liabilities and stockholders' equity
  $ 181,621     $ 177,433  

See accompanying Notes to Consolidated Financial Statements

 
1

 

LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME (LOSS)
(Unaudited, in millions, except per share data)


   
For the Three
 
   
Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Revenues
           
Insurance premiums
  $ 532     $ 509  
Insurance fees
    788       701  
Net investment income
    1,106       1,013  
Realized loss:
               
Total other-than-temporary impairment losses on securities
    (77 )     (211 )
Portion of loss recognized in other comprehensive income (loss)
    24       89  
Net other-than-temporary impairment losses on securities
               
recognized in earnings
    (53 )     (122 )
Realized gain (loss), excluding other-than-temporary
               
impairment losses on securities
    27       (74 )
Total realized loss
    (26 )     (196 )
Amortization of deferred gain on business sold through
               
reinsurance
    19       19  
Other revenues and fees
    108       86  
Total revenues
    2,527       2,132  
Benefits and Expenses
               
Interest credited
    618       627  
Benefits
    779       921  
Underwriting, acquisition, insurance and other expenses
    714       643  
Interest and debt expense
    68       -  
Impairment of intangibles
    -       604  
Total benefits and expenses
    2,179       2,795  
Income (loss) from continuing operations before taxes
    348       (663 )
Federal income tax expense (benefit)
    93       (76 )
Income (loss) from continuing operations
    255       (587 )
Income from discontinued operations, net of federal
               
income taxes
    28       8  
Net income (loss)
    283       (579 )
Preferred stock dividends and accretion of discount
    (18 )     -  
Net income (loss) available to common stockholders
  $ 265     $ (579 )
                 
Earnings (Loss) Per Common Share - Basic
               
Income (loss) from continuing operations
  $ 0.79     $ (2.30 )
Income from discontinued operations
    0.09       0.03  
Net income (loss)
  $ 0.88     $ (2.27 )
                 
Earnings (Loss) Per Common Share - Diluted
               
Income (loss) from continuing operations
  $ 0.76     $ (2.30 )
Income from discontinued operations
    0.09       0.03  
Net income (loss)
  $ 0.85     $ (2.27 )


See accompanying Notes to Consolidated Financial Statements

 
2

 

LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited, in millions, except per share data)


   
For the Three
 
   
Months Ended
 
   
March 31,
 
   
2010
   
2009
 
             
Preferred Stock
           
Balance as of beginning-of-year
  $ 806     $ -  
Accretion of discount on Series B preferred stock
    6       -  
Balance as of end-of-period
    812       -  
                 
Common Stock
               
Balance as of beginning-of-year
    7,840       7,035  
Stock compensation/issued for benefit plans
    5       (5 )
Deferred compensation payable in stock
    -       3  
Balance as of end-of-period
    7,845       7,033  
                 
Retained Earnings
               
Balance as of beginning-of-year
    3,316       3,745  
Cumulative effect from adoption of new accounting standards
    (169 )     102  
Comprehensive income (loss)
    666       (649 )
Less other comprehensive income (loss), net of tax
    383       (70 )
Net income (loss)
    283       (579 )
Dividends declared:  Common (2010 - $0.010; 2009 - $0.010)
    (3 )     (3 )
Dividends on preferred stock
    (12 )     -  
Accretion of discount on Series B preferred stock
    (6 )     -  
Balance as of end-of-period
    3,409       3,265  
                 
Accumulated Other Comprehensive Income (Loss)
               
Balance as of beginning-of-year
    (262 )     (2,803 )
Cumulative effect from adoption of new accounting standards
    181       (102 )
Other comprehensive income (loss), net of tax
    383       (70 )
Balance as of end-of-period
    302       (2,975 )
Total stockholders' equity as of end-of-period
  $ 12,368     $ 7,323  


See accompanying Notes to Consolidated Financial Statements

 
3

 

LINCOLN NATIONAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in millions)


   
For the Three
 
   
Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Cash Flows from Operating Activities
           
Net income (loss)
  $ 283     $ (579 )
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Deferred acquisition costs, value of business acquired, deferred sales inducements
               
and deferred front-end loads deferrals and interest, net of amortization
    (48 )     (103 )
Trading securities purchases, sales and maturities, net
    2       37  
Change in premiums and fees receivable
    (27 )     37  
Change in accrued investment income
    (51 )     (49 )
Change in future contract benefits
    140       (233 )
Change in other contract holder funds
    178       (2 )
Change in reinsurance related assets and liabilities
    (139 )     (170 )
Change in federal income tax accruals
    315       36  
Realized loss
    26       196  
Gain on disposal of discontinued operations
    (64 )     -  
Gain on early extinguishment of debt
    -       (64 )
Impairment of intangibles
    -       604  
Amortization of deferred gain on business sold through reinsurance
    (19 )     (19 )
Other
    (31 )     (35 )
Net cash provided by (used in) operating activities
    565       (344 )
                 
Cash Flows from Investing Activities
               
Purchases of available-for-sale securities
    (3,418 )     (2,719 )
Sales of available-for-sale securities
    805       1,242  
Maturities of available-for-sale securities
    919       731  
Purchases of other investments
    (694 )     (1,201 )
Sales or maturities of other investments
    695       2,411  
Decrease in payables for collateral on investments
    (79 )     (1,320 )
Proceeds from sale of subsidiaries/businesses, net of cash disposed
    293       2  
Other
    (10 )     (16 )
Net cash used in investing activities
    (1,489 )     (870 )
                 
Cash Flows from Financing Activities
               
Payment of long-term debt, including current maturities
    (250 )     (22 )
Increase in commercial paper, net
    1       371  
Deposits of fixed account values, including the fixed portion of variable
    2,382       2,612  
Withdrawals of fixed account values, including the fixed portion of variable
    (1,251 )     (1,590 )
Transfers to and from separate accounts, net
    (682 )     (408 )
Common stock issued for benefit plans and excess tax benefits
    -       (8 )
Dividends paid to common and preferred stockholders
    (15 )     (54 )
Net cash provided by financing activities
    185       901  
Net decrease in cash and invested cash, including discontinued operations
    (739 )     (313 )
Cash and invested cash, including discontinued operations, as of beginning-of-year
    4,184       5,926  
Cash and invested cash, including discontinued operations, as of end-of-period
  $ 3,445     $ 5,613  


See accompanying Notes to Consolidated Financial Statements

 
4

 

LINCOLN NATIONAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.  Nature of Operations, Basis of Presentation and Summary of Significant Accounting Policies

Nature of Operations

Lincoln National Corporation and its majority-owned subsidiaries (“LNC” or the “Company,” which also may be referred to as “we,” “our” or “us”) operate multiple insurance businesses through four business segments.  See Note 14 for additional details.  The collective group of businesses uses “Lincoln Financial Group” as its marketing identity.  Through our business segments, we sell a wide range of wealth protection, accumulation and retirement income products.  These products include institutional and/or retail fixed and indexed annuities, variable annuities, universal life (“UL”) insurance, variable universal life (“VUL”) insurance, linked-benefit UL, term life insurance, mutual funds and group protection.

Basis of Presentation

The accompanying unaudited consolidated financial statements are prepared in accordance with United States of America generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions for the Securities and Exchange Commission (“SEC”) Quarterly Report on Form 10-Q, including Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements.  Therefore, the information contained in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 (“2009 Form 10-K”) should be read in connection with the reading of these interim unaudited consolidated financial statements.

In the opinion of management, these statements include all normal recurring adjustments necessary for a fair presentation of the Company’s results.  Operating results for the three month period ended March 31, 2010, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2010.  All material intercompany accounts and transactions have been eliminated in consolidation.

Certain amounts reported in prior years’ consolidated financial statements have been reclassified to conform to the presentation adopted in the current year.  These reclassifications had no effect on net income or stockholders’ equity of the prior years.

Summary of Significant Accounting Policies

Available-For-Sale Securities – Fair Valuation Methodologies and Associated Inputs

Securities classified as available-for-sale (“AFS”) consist of fixed maturity and equity securities and are stated at fair value with unrealized gains and losses included within accumulated other comprehensive income (loss) (“OCI”), net of associated deferred acquisition costs (“DAC”), value of business acquired (“VOBA”), deferred sales inducements (“DSI”), other contract holder funds and deferred income taxes.  See Notes 5 and 13 for additional details.

We measure the fair value of our securities classified as AFS based on assumptions used by market participants in pricing the security.  The most appropriate valuation methodology is selected based on the specific characteristics of the fixed maturity or equity security, and we consistently apply the valuation methodology to measure the security’s fair value.  Our fair value measurement is based on a market approach, which utilizes prices and other relevant information generated by market transactions involving identical or comparable securities.  Sources of inputs to the market approach include third-party pricing services, independent broker quotations or pricing matrices.  We do not adjust prices received from third parties; however, we do analyze the third-party pricing services’ valuation methodologies and related inputs and perform additional evaluation to determine the appropriate level within the fair value hierarchy.

We use observable and unobservable inputs in our valuation methodologies.  Observable inputs include benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data.  In addition, market indicators, industry and economic events are monitored and further market data is acquired if certain triggers are met. For certain security types, additional inputs may be used, or some of the inputs described above may not be applicable.  For broker-quoted only securities, quotes from market makers or broker-dealers are obtained from sources recognized to be market participants. In order to validate the pricing information and broker-dealer quotes, we employ, where possible, procedures that include comparisons with similar observable positions, comparisons with subsequent sales, discussions with senior business leaders and brokers and observations of general market movements for those security classes.  For those securities trading in less liquid or illiquid markets with limited or no pricing information, we use unobservable inputs in order to measure the fair value of these securities.  In cases where this information is not available, such as for privately placed securities, fair value is estimated using an internal pricing matrix.  This matrix relies on management’s judgment concerning the discount rate used in calculating expected future cash flows, credit quality, industry sector performance and expected maturity.

 
5

 

The observable and unobservable inputs to our valuation methodologies are based on a set of standard inputs that we generally use to evaluate all of our AFS securities.  The standard inputs used in order of priority are benchmark yields, reported trades, broker-dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data.  Depending on the type of security or the daily market activity, standard inputs may be prioritized differently or may not be available for all AFS securities on any given day.

The following summarizes our fair valuation methodologies and associated inputs, which are particular to the specified security type and in addition to the defined standard inputs to our valuation methodologies for all of our AFS securities discussed above:

·
Corporate bonds and U.S. Government bonds – We also use Trade Reporting and Compliance EngineTM reported tables for our corporate bonds and vendor trading platform data for our U.S. Government bonds.
·
Mortgage- and asset-backed securities – We also utilize additional inputs which include new issues data, monthly payment information and monthly collateral performance, including prepayments, severity, delinquencies, step-down features and over collateralization features for each of our mortgage-backed securities (“MBS”), which include collateralized mortgage obligations (“CMOs”), residential mortgages that back mortgage pass through securities (“MPTS”) and commercial mortgages that back commercial MBS (“CMBS”), and for our asset-backed securities (“ABS”) collateralized debt obligations (“CDOs”).
·
State and municipal bonds – We also use additional inputs which include information from the Municipal Securities Rule Making Board, as well as material event notices, new issue data, issuer financial statements and Municipal Market Data benchmark yields for our state and municipal bonds.
·
Hybrid and redeemable preferred and equity securities – We also utilize additional inputs of exchange prices (underlying and common stock of the same issuer) for our hybrid and redeemable preferred stocks and equity securities, including banking, insurance, other financial services and other securities.

2.   New Accounting Standards

Adoption of New Accounting Standards

Consolidations Topic

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” (“ASU 2009-17”), which amended the consolidation guidance for variable interest entities (“VIEs”).  For a more detailed description of ASU 2009-17, see “Future Adoption of New Accounting Standards – Consolidations Topic” in Note 2 of our 2009 Form 10-K.  In February 2010, the FASB issued ASU No. 2010-10, “Amendments for Certain Investment Funds” (“ASU 2010-10”), which deferred application of the guidance in ASU 2009-17 for reporting entities with interests in an entity that applies the specialized accounting guidance for investment companies.

Effective January 1, 2010, we adopted the amendments in ASU 2009-17 and ASU 2010-10, and accordingly reconsidered our involvement with all our VIEs and the primary beneficiary of the VIEs.  In accordance with ASU 2009-17, we are the primary beneficiary of the VIEs associated with our investments in credit-linked notes (“CLNs”), and as such, we consolidated all of the assets and liabilities of these VIEs and recorded a cumulative effect adjustment of $169 million, after-tax, to the beginning balance of retained earnings as of January 1, 2010.  In addition, we considered our investments in limited partnerships and other alternative investments, and concluded these investments are within the scope of the deferral in ASU 2010-10, and as such they are not subject to the amended consolidation guidance in ASU 2009-17.  As a result, we will continue to account for our alternative investments consistent with the accounting policy in Note 1 of our 2009 Form 10-K.  See Note 4 for more detail regarding the consolidation of our VIEs.

Fair Value Measurements and Disclosures Topic

In January 2010, the FASB issued ASU No. 2010-06, “Improving Disclosures about Fair Value Measurements” (“ASU 2010-06”), which requires us to disclose additional information related to the three-level fair value hierarchy.  For a more detailed description of ASU 2010-06, see “Future Adoption of New Accounting Standards – Fair Value Measurements and Disclosures Topic” in Note 2 of our 2009 Form 10-K.  We adopted the amendments in ASU 2010-06 effective January 1, 2010, and have prospectively included the required disclosures in Note 13.  The disclosures related to purchases, sales, issuances and settlements for Level 3 fair value measurements are effective for reporting periods beginning after December 15, 2010, and as such, these disclosures will be included in the notes to our consolidated financial statements effective January 1, 2011.


 
6

 

Transfers and Servicing Topic

In June 2009, the FASB issued ASU No. 2009-16, “Accounting for Transfers of Financial Assets” (“ASU 2009-16”), which eliminates the concept of a qualifying special-purpose entity (“SPE”) and removes the scope exception for a qualifying SPE from the Consolidations Topic of the FASB Accounting Standards CodificationTM (“ASC”).  For a more detailed description of ASU 2009-16, see “Future Adoption of New Accounting Standards – Transfers and Servicing Topic” in Note 2 of our 2009 Form 10-K.  We adopted ASU 2009-16 effective January 1, 2010.  The adoption did not have a material impact on our consolidated financial condition and results of operations.

Future Adoption of New Accounting Standards

Derivatives and Hedging Topic

In March 2010, the FASB issued ASU No. 2010-11, “Scope Exception Related to Embedded Credit Derivatives” (“ASU 2010-11”), to clarify the scope exception when evaluating an embedded credit derivative which may potentially require separate accounting.  Specifically, ASU 2010-11 states that only an embedded credit derivative feature related to the transfer of credit risk that is solely in the form of subordination of one financial instrument to another is not subject to further analysis as a potential embedded derivative under the Derivatives and Hedging Topic of the FASB ASC.  The amendments specify that embedded credit derivatives not qualifying for the scope exception, such as an embedded derivative related to a credit default swap on a referenced credit, would be subject to a bifurcation analysis even if their effects are allocated to interests in subordinated tranches of the securitized financial instrument.  ASU 2010-11 will be effective at the beginning of the first fiscal quarter beginning after June 15, 2010.  The fair value option may be elected for investments within the scope of ASU 2010-11 on an instrument-by-instrument basis.  If the fair value option is not elected, preexisting contracts acquired, issued or subject to a remeasurement event on or after January 1, 2007, must be evaluated under the guidance in ASU 2010-11.  We will adopt the amendments in ASU 2010-11 effective July 1, 2010, and are currently evaluating the impact of the adoption on our consolidated financial condition and results of operations.

Financial Services – Insurance Industry Topic

In April 2010, the FASB issued ASU No. 2010-15, “How Investments Held through Separate Accounts Affect an Insurer’s Consolidation Analysis of Those Investments” (“ASU 2010-15”), to clarify a consolidation issue for insurance entities that hold a controlling interest in an investment fund either partially or completely through separate accounts.  ASU 2010-15 concludes that an insurance entity would not be required to consider interests held in separate accounts when determining whether or not to consolidate an investment fund, unless the separate account interest is held for the benefit of a related party.  If an investment fund is consolidated, the portion of the assets representing interests held in separate accounts would be recorded as a separate account asset with a corresponding separate account liability.  The remaining investment fund assets would be consolidated in the insurance entity’s general account.  ASU 2010-15 will be applied retrospectively for fiscal years and interim periods within those fiscal years beginning after December 15, 2010, with early application permitted.  We are currently evaluating the impact of the adoption on our consolidated financial condition and results of operations.

3.  Dispositions

Discontinued Investment Management Operations

On August 18, 2009, we entered into a purchase and sale agreement with Macquarie Bank Limited (“MBL”), pursuant to which we agreed to sell to MBL all of the outstanding capital stock of Delaware Management Holdings, Inc. (“Delaware”), our subsidiary, which provided investment products and services to individuals and institutions.  This transaction closed on January 4, 2010, with cash proceeds of $452 million.

In addition, certain of our subsidiaries, including The Lincoln National Life Insurance Company (“LNL”), our primary insurance subsidiary, entered into investment advisory agreements with Delaware, 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 $82 million, the amount of which is dependent on the timing of any termination and which agreements are terminated.  The amount of the potential adjustment will decline on a pro rata basis over the 10-year term of the advisory agreements.


 
7

 

Accordingly, in the periods prior to closing, the assets and liabilities of this business have been classified as held-for-sale and were reported within other assets and other liabilities on our Consolidated Balance Sheets.  The major classes of assets and liabilities held-for-sale (in millions) were as follows:
 
   
As of
 
   
December 31,
 
   
2009
 
       
Assets
     
Cash and invested cash
  $ 159  
Premiums and fees receivable
    39  
Goodwill
    248  
Other assets
    61  
Total assets held-for-sale
  $ 507  
         
Liabilities
       
Other liabilities
  $ 116  
Total liabilities held-for-sale
  $ 116  
 
We have reclassified the results of operations of Delaware into income from discontinued operations for all periods presented on our Consolidated Statements of Income (Loss), and selected amounts (in millions) were as follows:
 
   
For the Three
 
   
Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Discontinued Operations Before Disposal
           
Revenues:
           
Investment advisory fees – external
  $ -     $ 44  
Investment advisory fees – internal
    -       20  
Other revenues and fees
    -       18  
Gain on sale of business
    -       2  
Total revenues
  $ -     $ 84  
                 
Income (loss) from discontinued operations before disposal,
               
before federal income tax expense (benefit)
  $ (17 )   $ 6  
Federal income tax expense (benefit)
    (3 )     3  
Income (loss) from discontinued operations before disposal
    (14 )     3  
                 
Disposal
               
Gain on disposal, before federal income tax expense
    37       -  
Federal income tax expense
    13       -  
Gain on disposal
    24       -  
Income from discontinued operations
  $ 10     $ 3  

The loss from discontinued operations before disposal in the first quarter of 2010 reflects stock compensation expense attributable to the acceleration of vesting of equity awards for certain Delaware employees upon the sale of Delaware.

There could be post-closing adjustments, some of which are beyond our control, and no assurance can be given as to the timing of its completion as an extension beyond 120 days is allowed in the share purchase agreement if there is disagreement during this period.


 
8

 

Discontinued U.K. Operations

On June 15, 2009, we entered into a share purchase agreement with SLF of Canada UK Limited (“SLF”) and Sun Life Assurance Company of Canada, as the guarantor, pursuant to which we agreed to sell to SLF all of the outstanding capital stock of Lincoln National (UK) plc (“Lincoln UK”), our subsidiary, which focused primarily on providing life and retirement income products in the United Kingdom.  This transaction closed on October 1, 2009, and we retained Lincoln UK’s pension plan assets and liabilities.

We have reclassified the results of operations of Lincoln UK into income from discontinued operations for all periods presented on our Consolidated Statements of Income (Loss), and selected amounts (in millions) were as follows:
 
   
For the Three
 
   
Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Discontinued Operations Before Disposal
           
Revenues:
           
Insurance premiums
  $ -     $ 10  
Insurance fees
    -       24  
Net investment income
    -       13  
Realized loss
    -       (2 )
Total revenues
  $ -     $ 45  
                 
Income from discontinued operations before disposal,
               
before federal income tax expense
  $ -     $ 8  
Federal income tax expense
    -       3  
Income from discontinued operations before disposal
    -       5  
                 
Disposal
               
Gain on disposal, before federal income tax expense
    27       -  
Federal income tax expense
    9       -  
Gain on disposal
    18       -  
Income from discontinued operations
  $ 18     $ 5  

The gain on disposal for the three months ended March 31, 2010, relates to additional consideration received attributable to a post-closing adjustment of the purchase price based upon a final actuarial appraisal of the value of the business as set forth in the share purchase agreement.

4.  Variable Interest Entities

Our involvement with VIEs is primarily to obtain financing and to invest in assets that allow us to gain exposure to a broadly diversified portfolio of asset classes. The factors used to determine whether or not we are the primary beneficiary and must consolidate a VIE where we have a variable interest changed effective January 1, 2010, upon the adoption of new accounting guidance.  See “Consolidations Topic” in Note 2 for details.  Beginning January 1, 2010, we continuously analyze the primary beneficiary of each VIE with which we are involved to determine whether we are the primary beneficiary using a qualitative approach which requires us to identify the variable interest that has the power to direct activities that most significantly impact the performance of the VIE and absorb losses or receive returns that could potentially be significant to the VIE.

Consolidated VIEs

We invested in the Class 1 Notes of two CLN structures, which represent special purpose trusts that combine asset-backed securities with credit default swaps to produce multi-class structured securities.  The Class 2 Notes are held by third parties, and, together with the Class 1 Notes, represent 100% of the outstanding notes of the CLN structures.  The entities that issued the CLNs are financed by the note holders, and, as such, the note holders participate in the expected losses and residual returns of the entities.  Because the note holders do not have voting rights or similar rights, we determined the entities issuing the CLNs are VIEs, and as a note holder, our interest represented a variable interest.  As of December 31, 2009, these VIEs were not consolidated because under the previous accounting guidance, we were not the primary beneficiary of the VIEs because the subordinated class of notes (Class 2) absorbed the majority of the expected losses under the CLN structures.  The carrying value of the CLNs as of December 31, 2009, was $322 million and was recognized as a fixed maturity security within AFS on our Consolidated Balance Sheets.

 
9

 

Effective January 1, 2010, we adopted the new accounting guidance noted above and evaluated the power of the variable interests in the CLN structures.  Based on our evaluation, we concluded that the ability to actively manage the reference portfolio underlying the credit default swaps is the most significant activity that impacts the performance of the CLN structures, because the subordination and participation in credit losses may change.  We concluded that we have the power to direct this activity.  In addition, we receive returns from the CLN structures and may absorb losses that could potentially be significant to the CLN structures.  As such, we concluded that we are the primary beneficiary of the VIEs associated with our CLNs.  We consolidated all of the assets and liabilities of the CLN structures through a cumulative effect adjustment to the beginning balance of retained earnings as of January 1, 2010, and recognized the results of operations of these VIEs on our consolidated financial statements for the first quarter of 2010.

The following summarizes the increases or (decreases) recorded effective January 1, 2010, to the categories (in millions) on our Consolidated Balance Sheets for this cumulative effect adjustment:
 
Assets
     
AFS securities, at fair value:
     
Fixed maturity securities - ABS CLNs
  $ (322 )
VIEs' fixed maturity securities
    565  
Total assets
  $ 243  
         
Liabilities
       
VIEs' liabilities:
       
Derivative instruments
  $ 225  
Federal income tax
    (91 )
Total VIEs' liabilities
    134  
Other liabilities - deferred income taxes
    97  
Total liabilities
    231  
         
Stockholders' Equity
       
Retained earnings
    (169 )
Accumulated OCI - unrealized gain (loss) on AFS securities
    181  
Total stockholders' equity
    12  
Total liabilities and stockholders' equity
  $ 243  
 
Asset and liability information (in millions) for these consolidated VIEs included on our Consolidated Balance Sheets as of March 31, 2010, was as follows:

 
   
Number
             
   
of
   
Notional
   
Carrying
 
   
Instruments
   
Amounts
   
Value
 
Assets
                 
Fixed maturity corporate asset-backed credit card loan securities
    -     $ -     $ 579  
                         
Liabilities
                       
Derivative instruments not designated and not qualifying as hedging
                       
instruments:
                       
Credit default swaps (1)
    2     $ 600     $ 238  
Contingent forwards
    -       -       (9 )
Total derivative instruments not designated and not qualifying as
                       
hedging instruments
    2       600       229  
Federal income tax
    -       -       (87 )
Total liabilities
    2     $ 600     $ 142  
 
(1)
$200 million of the notional amount matures in March 2017 and $400 million matures December 2016.

 
10

 

The carrying values of the assets and liabilities for these consolidated VIEs as of March 31, 2010, are presented on our Consolidated Balance Sheets.  For details related to the fixed maturity AFS securities for these VIEs, see Note 5.

The credit default swaps create variability in the CLN structures and expose the note holders to the credit risk of the referenced portfolio.

The contingent forwards transfer a portion of the loss in the underlying fixed maturity corporate asset-backed credit card loan securities back to the counterparty after credit losses reach our attachment point.

The settlement payments and mark-to-market adjustments for these consolidated VIEs (in millions) recorded on our Consolidated Statements of Income (Loss) were as follows:
 
   
For the
 
   
Three
 
   
Months
 
   
Ended
 
   
March 31,
 
   
2010
 
Derivative Instruments Not Designated and Not Qualifying as Hedging
     
Instruments
     
Credit default swaps (1)
  $ (5 )
Contingent forwards (1)
    1  
Total derivative instruments not designated and not qualifying as hedging
       
instruments
  $ (4 )
 
(1)
Reported in realized loss on our Consolidated Statements of Income (Loss).

As of March 31, 2010, and December 31, 2009, other contract holder funds on our Consolidated Balance Sheets included $600 million outstanding in funding agreements of LNL.  LNL invested the proceeds of $600 million received for issuing two funding agreements in 2006 and 2007 into the Class 1 Notes of the two CLN structures we are consolidating.

To date, there has been one default in the underlying collateral pool of the $400 million CLN structure and two defaults in the underlying collateral pool of the $200 million CLN structure.  There has been no event of default on the CLNs themselves.  Based upon our analysis, the remaining subordination as represented by the attachment point should be sufficient to absorb future credit losses, subject to changing market conditions.  Similar to other debt market instruments, our maximum principal loss is limited to our original investment of $600 million as of March 31, 2010.

As described more fully in Note 1 of our 2009 10-K, we regularly review our investment holdings for other-than-temporary impairments (“OTTIs”).  Based upon this review, we believe that the fixed maturity corporate asset-backed credit card loan securities were not other-than-temporarily impaired as of March 31, 2010.

The following summarizes information regarding the CLN structures (dollars in millions) as of March 31, 2010:

      Amount and Date of Issuance  
    $400   $200  
   
December
 
April
 
     2006    2007  
Original attachment point (subordination)
    5.50%     2.05%  
Current attachment point (subordination)
    4.78%     1.48%  
Maturity
 
12/20/2016
 
3/20/2017
 
Current rating of tranche
    B-  
Ba3
 
Current rating of underlying collateral pool
 
Aa1-B1
 
Aaa-B1
 
Number of entities
    123     99  
Number of countries
    19     23  



 
11

 

The following summarizes the exposure of the CLN structures’ underlying collateral by industry and rating as of March 31, 2010:

Industry
 
AAA
   
AA
      A    
BBB
   
BB
      B    
Total
 
Financial intermediaries
    0.4 %     3.5 %     7.2 %     0.5 %     0.0 %     0.0 %     11.6 %
Telecommunications
    0.0 %     0.0 %     6.4 %     3.7 %     1.1 %     0.0 %     11.2 %
Oil and gas
    0.0 %     1.4 %     1.2 %     4.9 %     0.0 %     0.0 %     7.5 %
Utilities
    0.0 %     0.0 %     2.0 %     2.5 %     0.0 %     0.0 %     4.5 %
Chemicals and plastics
    0.0 %     0.0 %     2.3 %     1.6 %     0.0 %     0.0 %     3.9 %
Drugs
    0.3 %     2.5 %     0.9 %     0.0 %     0.0 %     0.0 %     3.7 %
Retailers (except food & drug)
    0.0 %     0.0 %     0.7 %     1.7 %     1.1 %     0.0 %     3.5 %
Industrial equipment
    0.0 %     0.0 %     3.0 %     0.3 %     0.0 %     0.0 %     3.3 %
Sovereign
    0.0 %     0.3 %     1.6 %     1.3 %     0.0 %     0.0 %     3.2 %
Forest products
    0.0 %     0.0 %     0.0 %     1.7 %     1.4 %     0.0 %     3.1 %
Other industry < 3% (28 industries)
    0.0 %     3.7 %     16.8 %     18.8 %     3.4 %     1.8 %     44.5 %
Total by industry
    0.7 %     11.4 %     42.1 %     37.0 %     7.0 %     1.8 %     100.0 %

Unconsolidated VIEs

Through our investment activities, we make passive investments in structured securities issued by VIEs for which we are not the manager.  These structured securities include our MBS, which include CMOs, MPTS and CMBS and our ABS CDOs.  We have not provided financial or other support with respect to these structured securities other than our original investment.  We have determined that we are not the primary beneficiary of these structured securities due to the relative size of our investment in comparison to the principal amount of the structured securities issued by the VIEs and the level of credit subordination which reduces our obligation to absorb losses or right to receive benefits.  Our maximum exposure to loss on these structured securities, both VIEs and non-VIEs, is limited to the amortized cost for these investments.  We recognize our variable interest in these VIEs at fair value on our consolidated financial statements.  For information about these structured securities, see Note 5.  

5.  Investments

AFS Securities

Pursuant to the Fair Value Measurements and Disclosures Topic of the FASB ASC, we have categorized AFS securities into a three-level hierarchy, based on the priority of the inputs to the respective valuation technique.  The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3), as described in Note 1 in our 2009 Form 10-K, which also includes additional disclosures regarding our fair value measurements.


 
12

 

The amortized cost, gross unrealized gains, losses and OTTI and fair value of AFS securities (in millions) were as follows:

   
As of March 31, 2010
 
   
Amortized
   
Gross Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
OTTI
   
Value
 
Fixed Maturity Securities
                             
Corporate bonds
  $ 45,580     $ 2,588     $ 824     $ 60     $ 47,284  
U.S. Government bonds
    191       12       4       -       199  
Foreign government bonds
    431       29       4       -       456  
MBS:
                                       
CMOs
    6,012       295       245       157       5,905  
MPTS
    3,272       72       19       -       3,325  
CMBS
    2,374       80       318       -       2,136  
ABS CDOs
    183       14       27       9       161  
State and municipal bonds
    2,196       31       29       -       2,198  
Hybrid and redeemable preferred securities
    1,351       38       172       -       1,217  
VIEs' fixed maturity securities
    566       13       -       -       579  
Total fixed maturity securities
    62,156       3,172       1,642       226       63,460  
Equity Securities
                                       
Banking securities
    266       6       96       -       176  
Insurance securities
    31       2       -       -       33  
Other financial services securities
    19       14       -       -       33  
Other securities
    61       7       -       -       68  
Total equity securities
    377       29       96       -       310  
Total AFS securities
  $ 62,533     $ 3,201     $ 1,738     $ 226     $ 63,770  
 

 
13

 

 
   
As of December 31, 2009
 
   
Amortized
   
Gross Unrealized
   
Fair
 
   
Cost
   
Gains
   
Losses
   
OTTI
   
Value
 
Fixed Maturity Securities
                             
Corporate bonds
  $ 44,307     $ 2,260     $ 1,117     $ 71     $ 45,379  
U.S. Government bonds
    186       13       4       -       195  
Foreign government bonds
    488       26       9       -       505  
MBS:
                                       
CMOs
    6,112       258       307       157       5,906  
MPTS
    3,028       64       26       -       3,066  
CMBS
    2,436       49       354       -       2,131  
ABS:
                                       
CDOs
    189       11       33       9       158  
CLNs
    600       -       278       -       322  
State and municipal bonds
    2,009       14       55       -       1,968  
Hybrid and redeemable preferred securities
    1,402       36       250       -       1,188  
Total fixed maturity securities
    60,757       2,731       2,433       237       60,818  
Equity Securities
                                       
Banking securities
    266       -       119       -       147  
Insurance securities
    44       2       -       -       46  
Other financial services securities
    22       12       6       -       28  
Other securities
    50       7       -       -       57  
Total equity securities
    382       21       125       -       278  
Total AFS securities
  $ 61,139     $ 2,752     $ 2,558     $ 237     $ 61,096  

The amortized cost and fair value of fixed maturity AFS securities by contractual maturities (in millions) were as follows:
 
       As of March 31, 2010  
   
Amortized
   
Fair
 
   
Cost
   
Value
 
Due in one year or less
  $ 2,312     $ 2,362  
Due after one year through five years
    12,935       13,656  
Due after five years through ten years
    17,734       18,676  
Due after ten years
    17,334       17,239  
Subtotal
    50,315       51,933  
MBS
    11,658       11,366  
CDOs
    183       161  
Total fixed maturity AFS securities
  $ 62,156     $ 63,460  
 
Actual maturities may differ from contractual maturities because issuers may have the right to call or pre-pay obligations.

 
14

 

The fair value and gross unrealized losses, including the portion of OTTI recognized in other comprehensive income (loss), of AFS securities (in millions), aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:
 
   
As of March 31, 2010
 
   
Less Than or Equal
   
Greater Than
             
   
to Twelve Months
   
Twelve Months
   
Total
 
         
Gross
         
Gross
         
Gross
 
         
Unrealized
         
Unrealized
         
Unrealized
 
   
Fair
   
Losses and
   
Fair
   
Losses and
   
Fair
   
Losses and
 
   
Value
   
OTTI
   
Value
   
OTTI
   
Value
   
OTTI
 
Fixed Maturity Securities
                                   
Corporate bonds
  $ 4,402     $ 182     $ 4,689     $ 702     $ 9,091     $ 884  
U.S. Government bonds
    37       2       13       2       50       4  
Foreign government bonds
    47       1       9       3       56       4  
MBS:
                                               
CMOs
    376       150       891       252       1,267       402  
MPTS
    1,076       10       62       9       1,138       19  
CMBS
    76       9       498       309       574       318  
ABS CDOs
    13       4       129       32       142       36  
State and municipal bonds
    905       20       58       9       963       29  
Hybrid and redeemable
                                               
preferred securities
    46       10       807       162       853       172  
Total fixed maturity securities
    6,978       388       7,156       1,480       14,134       1,868  
Equity Securities
                                               
Banking securities
    1       1       146       95       147       96  
Insurance securities
    8       -       -       -       8       -  
Other financial services securities
    7       -       -       -       7       -  
Total equity securities
    16       1       146       95       162       96  
Total AFS securities
  $ 6,994     $ 389     $ 7,302     $ 1,575     $ 14,296     $ 1,964  
                                                 
Total number of AFS securities in an unrealized loss position
                              1,513  


 
15

 

 
   
As of December 31, 2009
 
   
Less Than or Equal
   
Greater Than
             
   
to Twelve Months
   
Twelve Months
   
Total
 
         
Gross
         
Gross
         
Gross
 
         
Unrealized
         
Unrealized
         
Unrealized
 
   
Fair
   
Losses and
   
Fair
   
Losses and
   
Fair
   
Losses and
 
   
Value
   
OTTI
   
Value
   
OTTI
   
Value
   
OTTI
 
Fixed Maturity Securities
                                   
Corporate bonds
  $ 4,375     $ 236     $ 5,795     $ 952     $ 10,170     $ 1,188  
U.S. Government bonds
    44       4       3       -       47       4  
Foreign government bonds
    34       -       46       9       80       9  
MBS:
                                               
CMOs
    404       159       929       305       1,333       464  
MPTS
    1,293       14       81       12       1,374       26  
CMBS
    153       13       656       341       809       354  
ABS:
                                               
CDOs
    9       7       128       35       137       42  
CLNs
    -       -       322       278       322       278  
State and municipal bonds
    1,203       46       54       9       1,257       55  
Hybrid and redeemable
                                               
preferred securities
    105       5       819       245       924       250  
Total fixed maturity securities
    7,620       484       8,833       2,186       16,453       2,670  
Equity Securities
                                               
Banking securities
    124       119       -       -       124       119  
Insurance securities
    8       -       -       -       8       -  
Other financial services securities
    4       6       -       -       4       6  
Other securities
    -       -       -       -       -       -  
Total equity securities
    136       125       -       -       136       125  
Total AFS securities
  $ 7,756     $ 609     $ 8,833     $ 2,186     $ 16,589     $ 2,795  
                                                 
Total number of AFS securities in an unrealized loss position
                              1,735  
 
For information regarding our investments in VIEs, see Note 4.

 
16

 

We perform detailed analysis on the AFS securities backed by pools that are most at risk of impairment based on factors discussed in Note 1 in our 2009 Form 10-K.  Selected information for these securities in a gross unrealized loss position (in millions) was as follows:
 
   
As of March 31, 2010
 
   
Amortized
   
Fair Value
   
Unrealized
 
   
Cost
   
Loss
 
Total
                 
AFS securities backed by pools of residential mortgages
  $ 3,901     $ 3,116     $ 785  
AFS securities backed by pools of commercial mortgages
    953       613       340  
Total
  $ 4,854     $ 3,729     $ 1,125  
                         
Subject to Detailed Analysis
                       
AFS securities backed by pools of residential mortgages
  $ 2,714     $ 1,941     $ 773  
AFS securities backed by pools of commercial mortgages
    248       109       139  
Total
  $ 2,962     $ 2,050     $ 912  
                         
                         
   
As of December 31, 2009
 
   
Amortized
   
Fair Value
   
Unrealized
 
   
Cost
   
Loss
 
Total
                       
AFS securities backed by pools of residential mortgages
  $ 4,316     $ 3,388     $ 928  
AFS securities backed by pools of commercial mortgages
    1,220       841       379  
Total
  $ 5,536     $ 4,229     $ 1,307  
                         
Subject to Detailed Analysis
                       
AFS securities backed by pools of residential mortgages
  $ 2,858     $ 1,948     $ 910  
AFS securities backed by pools of commercial mortgages
    311       164       147  
Total
  $ 3,169     $ 2,112     $ 1,057  
 
For the three months ended March 31, 2010, we recorded OTTI for AFS securities backed by pools of residential and commercial mortgages of $43 million, pre-tax, and before associated amortization expense for DAC, VOBA, DSI and deferred front-end loads (“DFEL”), of which a $5 million decrease was recognized in OCI and a $48 million increase was recognized in net income (loss).

The fair value, gross unrealized losses, the portion of OTTI recognized in OCI (in millions) and number of AFS securities where the fair value had declined and remained below amortized cost by greater than 20% were as follows:
 
   
As of March 31, 2010
 
                     
Number
 
   
Fair
   
Gross Unrealized
   
of
 
   
Value
   
Losses
   
OTTI
   
Securities (1)
 
Less than six months
  $ 222     $ 70     $ 2       44  
Six months or greater, but less than nine months
    34       13       -       16  
Nine months or greater, but less than twelve months
    193       48       79       42  
Twelve months or greater
    1,552       1,022       134       296  
Total
  $ 2,001     $ 1,153     $ 215       398  


 
17

 

 
   
As of December 31, 2009
 
                     
Number
 
   
Fair
   
Gross Unrealized
   
of
 
   
Value
   
Losses
   
OTTI
   
Securities (1)
 
Less than six months
  $ 434     $ 130     $ 4       81  
Six months or greater, but less than nine months
    118       61       -       25  
Nine months or greater, but less than twelve months
    427       165       100       96  
Twelve months or greater
    1,800       1,426