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, 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, Suite A305, Radnor, Pennsylvania
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:
 
   
Title of each class
 
 
Name of each exchange on which registered
 
 
Common Stock
New York and Chicago
$3.00 Cumulative Convertible Preferred Stock, Series A
New York and Chicago
6.75% Capital Securities
New York
Warrants, each to purchase one share of common stock
New York
 
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.  x
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 $7.7 billion.
As of February 18, 2011, 315,798,959 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 26, 2011, have been incorporated by reference into Part III of this Form 10-K.

 


 
 

 


 
Lincoln National Corporation
 
Table of Contents

Item
       
                      Page
PART I
 
1.
Business
1
   
Overview
1
   
Business Segments and Other Operations
3
     
Retirement Solutions
3
       
Retirement Solutions – Annuities
3
       
Retirement Solutions – Defined Contribution
7
     
Insurance Solutions
9
       
Insurance Solutions – Life Insurance
9
       
Insurance Solutions – Group Protection
13
     
Other Operations
14
   
Reinsurance
14
   
Reserves
15
   
Investments
15
   
Ratings
16
   
Regulatory
17
   
Employees
23
   
Available Information
23
     
1A.
Risk Factors
23
     
1B.
Unresolved Staff Comments
38
     
2.
Properties
38
     
3.
Legal Proceedings
38
     
4.
Submission of Matters to a Vote of Security Holders
38
     
 
Executive Officers of the Registrant
39
   
PART II
 
     
5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
40
     
6.
Selected Financial Data
41
     
7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
42
   
Forward-Looking Statements – Cautionary Language
43
   
Introduction
44
   
    Executive Summary
44
   
    Critical Accounting Policies and Estimates
48
   
    Acquisitions and Dispositions
66
   
Results of Consolidated Operations
67
   
Results of Retirement Solutions
72
   
    Retirement Solutions – Annuities
73
   
    Retirement Solutions – Defined Contribution
81
   
Results of Insurance Solutions
88
   
    Insurance Solutions – Life Insurance
89
   
    Insurance Solutions – Group Protection
97
 


i
 
 

 


Item
       
                       Page
  Results of Other Operations  
100
 
Realized Loss
 
104
  Consolidated Investments  
109
 
Reinsurance
 
132
  Review of Consolidated Financial Condition  
133
      Liquidity and Capital Resources  
133
  Other Matters  
141
      Other Factors Affecting Our Business
    
141
      Recent Accounting Pronouncements
 
142
   
7A.
Quantitative and Qualitative Disclosures About Market Risk
142
     
8.
Financial Statements and Supplementary Data
151
     
9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
253
     
9A.
Controls and Procedures
253
     
9B.
Other Information
253
   
PART III
 
     
10.
Directors, Executive Officers and Corporate Governance
253
     
11.
Executive Compensation
254
     
12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
254
     
13.
Certain Relationships and Related Transactions, and Director Independence
255
     
14.
Principal Accounting Fees and Services
255
   
PART IV
 
     
15.
Exhibits, Financial Statement Schedules
255
     
 
Signatures
256
     
 
Index to Financial Statement Schedules
           FS-1
     
 
Index to Exhibits
           E-1

ii
 
 

 

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, employer-sponsored defined contribution (“DC”) plans and group life, disability and dental.  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, 2010, LNC had consolidated assets of $193.8 billion and consolidated stockholders’ equity of $12.8 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.

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) for all periods presented and the assets and liabilities, prior to the sale, as held for sale on our Consolidated Balance Sheets.  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, 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, 2010, LFD had approximately 550 internal and external wholesalers (including sales managers).  As of December 31, 2010, LFN offered LNC and non-proprietary products and advisory services through a national network of approximately 8,000 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.


 
1

 

Revenues by segment (in millions) were as follows:

 
 
 
 
 
 
 
 
 
 
 
For the Years Ended December 31,
 
 
 
 
 
 
 
 
 
 
 
2010 
 
2009 
 
2008 
Revenues
 
 
 
 
 
 
 
 
Operating revenues:
 
 
 
 
 
 
 
 
 
Retirement Solutions:
 
 
 
 
 
 
 
 
 
 
Annuities
$
 2,654 
 
$
 2,301 
 
$
 2,438 
 
 
Defined Contribution
 
 988 
 
 
 926 
 
 
 932 
 
 
 
Total Retirement Solutions
 
 3,642 
 
 
 3,227 
 
 
 3,370 
 
Insurance Solutions:
 
 
 
 
 
 
 
 
 
 
Life Insurance
 
 4,590 
 
 
 4,295 
 
 
 4,261 
 
 
Group Protection
 
 1,831 
 
 
 1,713 
 
 
 1,640 
 
 
 
Total Insurance Solutions
 
 6,421 
 
 
 6,008 
 
 
 5,901 
 
Other Operations
 
 487 
 
 
 465 
 
 
 532 
Excluded realized gain (loss), pre-tax
 
 (146)
 
 
 (1,200)
 
 
 (573)
Amortization of deferred gains from reserve changes on business
 
 
 
 
 
 
 
 
 
sold through reinsurance, pre-tax
 
 3 
 
 
 3 
 
 
 3 
Amortization of deferred front-end loads ("DFEL") associated with
 
 
 
 
 
 
 
 
 
benefit ratio unlocking, pre-tax
 
 - 
 
 
 (4)
 
 
 (9)
 
 
Total revenues
$
 10,407 
 
$
 8,499 
 
$
 9,224 

Acquisitions and Dispositions

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, our former subsidiary, which provided investment products and services to individuals and institutions.  This transaction closed on January 4, 2010, with net of tax proceeds of approximately $405 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 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 $75 million in the event that all of the agreements with our subsidiaries are terminated.  The amount of the potential adjustment declines 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 net of tax proceeds of $325 million.  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 (“OTS”) 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 closed on our purchase of NCLS on January 15, 2009.  We have contributed $25 million to the capital of NCLS since acquiring it in 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,

 
2

 

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 Retirement Solutions – Annuities segment provides tax-deferred investment growth and lifetime income opportunities for its clients by offering individual fixed annuities, including indexed annuities, and variable annuities.  The Retirement Solutions – Defined Contribution segment provides employer-sponsored variable and fixed annuities, defined benefit, individual retirement accounts and mutual-fund based programs in the retirement plan marketplaces.  Products for both segments are distributed through a wide range of intermediaries including both affiliated and unaffiliated channels of advisors, consultants, brokers, banks and wirehouses.

Retirement Solutions – Annuities

Overview

The Retirement Solutions – Annuities segment provides tax-deferred investment 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 on 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.

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 or as requested.  Periodic payments can begin within 12 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.


 
3

 

The Retirement Solutions – Annuities segment’s deposits (in millions) were as follows:

 
 
 
 
 
 
 
 
 
 
For the Years Ended December 31,
 
 
 
 
 
 
 
 
 
 
 
2010 
 
2009 
 
2008 
 
Deposits
 
 
 
 
 
 
 
 
 
Variable portion of variable annuity
$
 5,099 
 
$
 4,007 
 
$
 6,690 
 
Fixed portion of variable annuity
 
 3,167 
 
 
 3,194 
 
 
 3,433 
 
 
Total variable annuity
 
 8,266 
 
 
 7,201 
 
 
 10,123 
 
Fixed indexed annuity
 
 2,027 
 
 
 2,182 
 
 
 1,078 
 
Other fixed annuity
 
 374 
 
 
 979 
 
 
 529 
 
 
 
Total annuity deposits
$
 10,667 
 
$
 10,362 
 
$
 11,730 
 

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 $68.4 billion, $59.4 billion and $44.5 billion for the years ended December 31, 2010, 2009 and 2008, respectively, including the fixed portion of variable accounts of $3.5 billion, $4.0 billion and $3.6 billion, for the years ended December 31, 2010, 2009 and 2008, 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.

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-share account values for the years ended December 31, 2010, 2009 and 2008, were $11.1 billion, $8.6 billion and $5.7 billion, respectively.
·  
A B-share has a seven year surrender charge that attaches to each deposit and 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. B-share account values for the years ended December 31, 2010, 2009 and 2008, were $30.0 billion, $26.6 billion and $21.1 billion, respectively.
·  
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.  A persistency credit is applied beginning in year eight so that the total charge to the customer is consistent with B-share levels after that time.  C-share account values for the years ended December 31, 2010, 2009 and 2008, were $2.3 billion, $2.1 billion and $1.7 billion, respectively.
·  
An L-share has a four to five year surrender charge that attaches to each deposit and 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 a specified contract duration so that the total charge to the customer is consistent with B-share levels.  L-share account values for the years ended December 31, 2010, 2009 and 2008, were $19.3 billion, $16.4 billion and $11.5 billion, respectively.
·  
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 higher than those for a B-share.  We offer bonus annuity products with persistency credits that are applied in all years after a specified contract duration so that the total charge to the customer is consistent with B-share levels.  Bonus annuity account values for the years ended December 31, 2010, 2009 and 2008, were $5.7 billion, $5.6 billion and $4.6 billion, respectively.

 
4

 

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.

Approximately 93%, 92% and 91% of variable annuity separate account values had a GDB rider as of December 31, 2010, 2009 and 2008, respectively.  The GDB features offered in 2010 included those where we contractually guarantee to the contract holder that upon death, we will return no less than: the current contract value; the total deposits made to the contract, adjusted to reflect any partial withdrawals; the highest contract value on a specified anniversary date adjusted to reflect any partial withdrawals following the contract anniversary; or the current contract value plus a specified percentage of contract earnings, not to exceed a covered earnings limit.
 
Approximately 20%, 23% and 26% of variable annuity account values as of December 31, 2010, 2009 and 2008, 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.

In 2010, we offered other product riders including the Lincoln Lifetime IncomeSM Advantage, Lincoln Lifetime IncomeSM Advantage 2.0 and Lincoln Lifetime IncomeSM Advantage Plus, which are hybrid benefit riders combining aspects of GWB and GIB.  These benefit riders allow the contract holder the ability to take income at a maximum rate of 4% or 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, Lincoln Lifetime IncomeSM Advantage 2.0 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 Lincoln Lifetime IncomeSM Advantage, Lincoln Lifetime IncomeSM Advantage 2.0 and Lincoln Lifetime IncomeSM Advantage Plus are subject to restrictions on the allocation of their account value within the various investment choices.  Approximately 24%, 17% and 8% of variable annuity account values as of December 31, 2010, 2009 and 2008, respectively, had a Lincoln Lifetime IncomeSM Advantage, Lincoln Lifetime IncomeSM Advantage 2.0 or Lincoln Lifetime IncomeSM Advantage Plus rider.

We also offered the i4LIFE® Advantage and 4LATER® Advantage.  The i4LIFE® Advantage 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 12%, 11% and 11% of variable annuity account values as of December 31, 2010, 2009 and 2008, 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 the greater of a minimum income floor set at benefit issue, or 75% of the highest income payment on a specified anniversary date (reduced for any subsequent withdrawals).  Approximately 95%, 94% and 92% of i4LIFE® Advantage account values elected the GIB feature as of December 31, 2010, 2009 and 2008, 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 to the current contract value on or after the third anniversary of rider election or of the most recent step-up, which also resets the 200% cap.

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.  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 Gain (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.”

 
5

 

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 Gain (Loss)” in the MD&A.

Individual fixed annuity account values were $17.4 billion, $15.9 billion and $14.0 billion as of December 31, 2010, 2009 and 2008, respectively.  Approximately $13.3 billion of individual fixed annuity account values as of December 31, 2010, were still within the surrender charge period.
 
Our fixed annuity product offerings as of December 31, 2010, 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, we offered the Lincoln SmartIncomeSM Inflation Annuity which 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 Lincoln ClassicSM (Single and Flexible Premium), Lincoln SelectSM, Lincoln Smart Course®, Lincoln MYGuaranteeSM Plus and Lincoln GrowSmartSM Fixed Annuity.  The fixed indexed deferred annuity products include Lincoln OptiPoint®, Lincoln OptiChoiceSM and Lincoln New Directions®.  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.

In November of 2010, we launched the Lincoln Long-Term CareSM Advantage fixed annuity.  This product combines the features of a single premium fixed annuity with a long-term care rider.  It allows a contract holder the protection of principal, while providing a way to manage the potential impact of long-term care expenses.  The long-term care rider provides the contract holder with the potential to receive long-term care benefits equal to the premium payment plus an additional amount equal to one or two times the premium payment.  In addition, the contract holder has the opportunity to increase the long-term care benefits if there are gains in the contract.  

 
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Available with certain of our fixed indexed annuities, Lincoln Living IncomeSM Advantage 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.  Individual fixed annuities with an MVA feature constituted 61%, 55% and 46% of total fixed annuity account values as of December 31, 2010, 2009 and 2008, 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 with retirement plan products and services, primarily in the defined contribution retirement plan marketplaces.  While our focus is employer-sponsored defined contribution plans, we also serve the defined benefit plan and individual retirement account (IRA) markets.  We provide a variety of plan investment vehicles, including individual and group variable annuities, group fixed annuities and mutual fund-based programs.  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 employee 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.  The types of DC plans on which the Retirement Solutions – Defined Contribution segment primarily focuses are Internal Revenue Code section 403(b) plans and section 401(k) plans.

Retirement Solutions – Defined Contribution’s 403(b) assets accounted for 58% of total assets under management in this segment as of December 31, 2010.  The mid to large market 401(k) business accounted for 17% and the small market 401(k) business accounted for 15% of this segment’s assets as of December 31, 2010 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.


 
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The Retirement Solutions – Defined Contribution segment’s deposits (in millions) were as follows:

 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Years Ended December 31,
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
2010 
 
2009 
 
2008 
 
Deposits
 
 
 
 
 
 
 
 
 
Variable portion of variable annuity
$
 1,614 
 
$
 1,586 
 
$
 2,170 
 
Fixed portion of variable annuity
 
 315 
 
 
 331 
 
 
 369 
 
 
Total variable annuity
 
 1,929 
 
 
 1,917 
 
 
 2,539 
 
Fixed annuity
 
 1,017 
 
 
 1,011 
 
 
 812 
 
Mutual fund
 
 2,355 
 
 
 2,024 
 
 
 2,196 
 
 
 
Total annuity and mutual fund deposits
$
 5,301 
 
$
 4,952 
 
$
 5,547 
 

LINCOLN DIRECTORSM and Multi-Fund® products are variable annuities.  LINCOLN ALLIANCE® and Lincoln SmartFuture® programs are mutual fund-based programs.  This suite of products and programs primarily covers the 403(b) and 401(k) marketplace.  These 403(b) and 401(k) 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; and 401(k) plans are generally available to employees of for-profit entities.  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 45%, 43% and 45% of account values for these products as of December 31, 2010, 2009 and 2008, respectively.

LINCOLN DIRECTORSM group variable annuity is a 401(k) DC retirement plan solution available to small 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 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.  LINCOLN DIRECTORSM group variable annuity has the option of being serviced through a TPA or fully serviced by Lincoln.  As of December 31, 2010, approximately 93% 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 $6.4 billion, $5.9 billion and $4.9 billion as of December 31, 2010, 2009 and 2008, 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 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.  The program allows the use of any 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 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 $15.9 billion, $13.4 billion and $9.4 billion as of December 31, 2010, 2009 and 2008, respectively.

The Lincoln SmartFuture® program is a DC retirement plan solution aimed at small to mid employers, typically those that have DC plans with between $3 million and $15 million 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 approximately 150 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 $319 million, $223 million and $104 million as of December 31, 2010, 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

 
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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.  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 funds in the underlying separate accounts.  The Multi-Fund® variable annuity is currently available in all states except New York.  Account values for the Multi-Fund® variable annuity were $11.4 billion, $10.9 billion and $9.7 billion as of December 31, 2010, 2009 and 2008, respectively.

Also within this segment, we have created the Lincoln Unifier® service offering to further assist employers in meeting 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.

During the third quarter of 2010, we partnered with a leading provider of retirement recordkeeping services to enhance our retirement plan offerings.  Through this partnership, we expect to reduce our current recordkeeping platforms from five to one over the next several years.

Distribution

DC products are primarily distributed by LFD.  Wholesalers and managers distribute these products through advisors, consultants, banks, wirehouses, TPAs and individual planners.  During 2010, LFD expanded its distribution of DC products by increasing wholesalers and managers from 44 to 49, increasing relationship management expertise and growing the number of broker dealer relationships.

The Multi-Fund® program is sold primarily by affiliated advisors.  The LINCOLN ALLIANCE® program and the Lincoln SmartFuture® program are sold primarily through consultants and affiliated advisors.  LINCOLN DIRECTORSM group variable annuity is sold in the small marketplace by intermediaries, including TPAs, planners and wirehouses.

Competition

The DC marketplace is very competitive and is comprised of many providers, with no one company dominating the market for all products.  As stated above, we compete in the small, mid and large markets.  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, client service and client compliance and fiduciary services.

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 2010, 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.  


 
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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,
 
 
 
 
 
 
 
 
 
 
 
2010 
 
2009 
 
2008 
 
Sales by Product
 
 
 
 
 
 
 
 
 
UL:
 
 
 
 
 
 
 
 
 
 
Excluding MoneyGuard®
$
 353 
 
$
 397 
 
$
 525 
 
 
MoneyGuard®
 
 108 
 
 
 67 
 
 
 50 
 
 
 
Total UL
 
 461 
 
 
 464 
 
 
 575 
 
VUL
 
 43 
 
 
 36 
 
 
 54 
 
COLI and BOLI
 
 63 
 
 
 51 
 
 
 84 
 
Term
 
 70 
 
 
 59 
 
 
 28 
 
 
 
 
Total sales
$
 637 
 
$
 610 
 
$
 741 
 

UL and VUL sales (including COLI and BOLI), represent first year commissionable premiums plus 5% of excess premiums received, including an adjustment for internal replacements of approximately 50% of commissionable premiums; 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%, 44% and 46% of total sales were in the first half of 2010, 2009 and 2008, respectively.

Life policies’ account values (in millions) were as follows:

 
 
 
 
 
 
 
 
 
 
As of December 31,
 
 
 
 
 
 
 
 
 
 
 
2010 
 
2009 
 
2008 
 
Account Values
 
 
 
 
 
 
 
 
 
UL and interest-sensitive whole life (1)
$
 28,477 
 
$
 27,276 
 
$
 27,502 
 
VUL (2)
 
 5,108 
 
 
 4,468 
 
 
 4,251 
 
 
Total account values
$
 33,585 
 
$
 31,744 
 
$
 31,753 
 

(1)  
Includes MoneyGuard® and the fixed portion of VUL.
(2)  
Excludes the fixed portion of VUL.

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, morbidity margins, and some expense assessments 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.

 
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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), less surrender charges and policy loan payoffs, 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, cost of insurance (“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 $112.0 billion, $110.4 billion and $99.0 billion or 20%, 20% and 18% of total life policies’ in-force face amount as of December 31, 2010, 2009 and 2008, respectively.  For information on the reserving requirements for this business, see “Regulatory” below and “Results of Insurance Solutions – Insurance Solutions – Life Insurance – Income (Loss) from Operations – Strategies to Address Statutory Reserve Strain” 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.

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.  The policy also provides a death benefit, the value of which is excluded from federal income tax, to the contract holder’s beneficiary if the contract holder does not accelerate the entire amount of the death benefit as long-term care benefits during his or her life.  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

 
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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.
 
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 single life and survivorship versions of our VUL products with secondary guarantees.  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 $5.7 billion, $5.3 billion and $4.9 billion or 1% of total life policies’ in-force face amount as of December 31, 2010, 2009 and 2008, 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.

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 distributes COLI and BOLI products primarily to 16 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 2009, the latest year for which data is available, there were 946 life insurance companies in the U.S. and U.S. territories, 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 2010.  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 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.

 
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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,
 
 
 
 
 
 
 
 
 
 
 
2010 
 
2009 
 
2008 
 
Insurance Premiums by Product Line
 
 
 
 
 
 
 
 
 
Life
$
 639 
 
$
 584 
 
$
 541 
 
Disability
 
 727 
 
 
 692 
 
 
 672 
 
Dental
 
 167 
 
 
 149 
 
 
 150 
 
 
Total non-medical
 
 1,533 
 
 
 1,425 
 
 
 1,363 
 
Medical
 
 149 
 
 
 154 
 
 
 154 
 
 
 
Total insurance premiums
$
 1,682 
 
$
 1,579 
 
$
 1,517 
 

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.

EXEC-U-CARE®
 
We manage employer-sponsored benefits designed to supplement a company’s major medical plan by reimbursing executives and eligible dependents for health care expenses not covered by the basic plan.  Along with medical expense reimbursement, EXEC-U-CARE plans include Accidental Death and Dismemberment coverage, EXEC-U-CARE CONCIERGE® health care assistance and TravelConnectSM travel assistance services.

Distribution

The segment’s products are marketed primarily through a national distribution system, including approximately 160 managers and marketing representatives.  The managers and marketing representatives develop business through employee benefit brokers, TPAs and other employee benefit firms.


 
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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 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 liability; the unamortized deferred gain on indemnity reinsurance related to the sale of reinsurance to Swiss Re in 2001; the results of certain disability income business due to the rescission of a reinsurance agreement with Swiss Re; our run-off Institutional 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, 2010; and debt.  We are actively managing our remaining radio station clusters to maximize performance and future value.

Revenues (in millions) from Other Operations were as follows:

 
 
 
 
 
 
 
 
 
 
 
 
For the Years Ended December 31,
 
 
 
 
 
 
 
 
 
 
 
 
 
2010 
 
 
2009 
 
 
2008 
 
Operating Revenues
 
 
 
 
 
 
 
 
 
Insurance premiums
$
 2 
 
$
 4 
 
$
 4 
 
Net investment income
 
 326 
 
 
 307 
 
 
 358 
 
Amortization of deferred gain on business
 
 
 
 
 
 
 
 
 
 
 sold through reinsurance
 
 72 
 
 
 73 
 
 
 74 
 
Media revenues (net)
 
 75 
 
 
 68 
 
 
 85 
 
Other revenues and fees
 
 12 
 
 
 13 
 
 
 11 
 
 
 
Total operating revenues
$
 487 
 
$
 465 
 
$
 532 
 

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.

 
14

 


We reinsure approximately 40% to 45% of the mortality risk on newly issued non-term life insurance contracts and approximately 35% of total mortality risk including term insurance contracts.  As of December 31, 2010 our policy for this program was to retain no more than $10 million on a single insured life issued on fixed, VUL and term life insurance contracts.  The retention per single insured life for COLI remained at $2 million.

Effective January 1, 2011, our maximum corporate retention on UL, VUL and term insurance contracts increased to $20 million for new business.  This change has no impact on our reinsurance structure at this time. 

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 reinsurance exposure.  As of December 31, 2010 and 2009, the amounts recoverable from reinsurers were $6.5 billion and $6.4 billion, respectively, of which $3.0 billion was recoverable from Swiss Re, related to the sale of our reinsurance business to Swiss Re, for both periods.

We also utilize intercompany reinsurance agreements to manage our statutory capital position as well as our hedge program for variable annuity guarantees.  These intercompany agreements do not have an effect on our consolidated financial statements.

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 and sustained low interest rates may cause interest rate spreads to decrease and changes in interest rates may also 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.

 
15

 

As of December 31, 2010 and 2009, our most significant investments in one issuer were our investments in securities issued by the Federal Home Loan Mortgage Corporation with a fair value of $5.0 billion and $4.8 billion, or 6% of our invested assets portfolio, respectively, and our investments in securities issued by Fannie Mae with a fair value of $2.9 billion and $3.0 billion, or 3% and 4% of our invested assets portfolio, respectively.

As of December 31, 2010, our most significant investments in one industry were our investment securities in the electric industry with a fair value of $6.7 billion, or 8% of our invested assets portfolio, and our investment securities in the collateralized mortgage obligation (“CMO”) industry with a fair value of $6.5 billion, or 8% of our invested assets portfolio.  As of December 31, 2009, our most significant investment in one industry was our investment securities in the CMO industry with a fair value of $6.9 billion, or 9% of the invested assets portfolio.

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:
 
·  
A.M. Best – A++ to S  
·  
Fitch – AAA to C  
·  
Moody’s – Aaa to C
·  
S&P – AAA to R

As of February 18, 2011, 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:
 
·  
A.M. Best – aaa to d
·  
Fitch – AAA to D 
·  
Moody’s – Aaa to C  
·  
S&P – AAA to D

 
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As of February 18, 2011, 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 22)
 
(9th of 21)
 
(9th of 21)
 
(7th of 21)
 

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  
·  
Fitch – F1+ to D  
·  
Moody’s – P-1 to NP  
·  
S&P – A-1+ to D
 
 
As of February 18, 2011, 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
 
F-2
 
P-2
 
A-2
 
(2nd of 6)
 
(2nd of 8)
 
(2nd of 3)
 
(2nd of 8)
 

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 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, 2010, 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

 
17

 

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.

Statutory reserves established for variable annuity contracts and riders are sensitive to changes in the equity markets and are affected by the level of account values relative to the level of any guarantees, product design and reinsurance arrangements.  As a result, the relationship between reserve changes and equity market performance is non-linear during any given reporting period.

For more information on statutory reserving 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

 
18

 

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 2010 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:

Category
 
Name
 
Description
Asset risk - affiliates
 
C-0
 
Risk of assets' default for certain affiliated investments
Asset risk - others
 
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 that
 
risk and market risk
 
 
 
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, 2010, 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.”


 
19

 

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 March 2010, the President signed into law the Patient Protection and Affordable Care Act which was subsequently amended by the Health Care and Education Reconciliation Act.  This legislation includes 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 July 2010, the President signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, H.R. 4173, (“Dodd-Frank Act”), wide ranging legislation that includes a number of reforms of the financial services industry and financial products.  Many of the provisions of the Dodd-Frank Act require substantial regulatory work prior to implementation, and we cannot predict at this time all of the ways or the extent to which financial markets in general, or our business, financial condition and results of operations, may be affected following its full implementation.

Some requirements of the Dodd-Frank Act apply to us as a result of our status as a thrift holding company.  The Dodd-Frank Act eliminates the OTS and reallocates the supervisory and regulatory authority over (i) federally chartered thrifts to the Office of the Comptroller of the Currency and (ii) thrift holding companies to the Federal Reserve Board.  Enactment of this provision ensures that we and NCLS will each have a new regulator and may be subject to additional and/or enhanced regulation, including new capital and leverage requirements.  We will also be subject to the provisions of the “Volcker Rule,” which restricts, subject to exceptions for various permitted activities, proprietary trading and certain investment activities by holding companies containing an insured depository institution.  Although we presently believe that the Volcker Rule will not require significant change in our investment and trading activities, rulemaking is not scheduled to be completed until late 2011, and the ultimate outcome of the rulemaking process cannot be predicted.

The Dodd-Frank Act also mandates a new regulatory framework for over-the-counter derivatives transactions.  Subject to applicable insurance laws, we use derivatives 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, credit, foreign exchange and equity risks.  The new regulatory scheme will impose clearing and centralized execution requirements on a wide range of derivatives transactions that are currently conducted over-the-counter, with the likely result that costs and margin requirements will increase for market participants across the board.  As rulemaking on the Dodd-Frank derivatives provisions is still in progress, it is premature to determine the extent to which our derivatives costs and strategies may change, and the extent to which those changes may ultimately affect the range of products we offer to our customers.

In addition, the Dodd-Frank Act requires new regulations governing broker-dealers and investment advisers.  In particular, the fiduciary standard rulemaking could potentially have broad implications for how our products are designed and sold in the future.  In January 2011, the U.S. Securities and Exchange Commission (“SEC”) released a study on the obligations and standards of conduct of financial professionals, as required under the Dodd-Frank Act.  The SEC staff recommended establishing a uniform fiduciary standard for investment advisers and broker-dealers when providing investment advice about securities, including guidance for principal trading and definitions of the duties of loyalty and care owed to retail customers that would be consistent with the standard that currently applies to investment advisers.  A more uniform fiduciary standard could potentially affect our business in areas including, but not limited to:  design and availability of proprietary products; commission-based compensation arrangements; advertising and other communications; use of finders or solicitors of clients (i.e., business contacts who provide referrals); and continuing education requirements for advisors.

Additional provisions of the Dodd-Frank Act include, among other things, the creation of a new Federal Insurance Office within the U.S. Department of the Treasury ( “U.S. Treasury”) to gather information regarding the insurance industry; the creation of a resolution authority to unwind failing institutions, funded on a post-event basis; the creation of a new Consumer Financial

 
20

 

Protection Bureau to protect consumers of certain financial products; and changes to executive compensation and certain corporate governance rules.  Given the current state of the rulemaking and implementation process, the ultimate impact on our business is undeterminable at this time.

Department of Labor Regulation

In October 2010, the U.S. Department of Labor (“DOL”) issued a proposed regulation that would, if finalized in current form, substantially expand the range of activities that would be considered to be fiduciary investment advice under the Employee Retirement Income Security Act of 1974 (“ERISA”) and the Internal Revenue Code.  If finalized as proposed, the investment-related information and support that our advisors and employees could provide to plan sponsors, participants and IRA holders on a non-fiduciary basis could be substantially limited beyond what is allowed under current law.  This could have a material impact on the level and type of services we can provide as well as the nature and amount of compensation and fees us and our advisors and employees may receive for investment-related services.  This proposal has generated substantial public comment and as a result, it is likely that any final regulation will be different from the proposal.  What the differences will be, as well as the timing of any final regulation, are unknown at this time.  We do not expect the DOL to issue a final regulation in 2011.

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”).

TARP 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.  On June 30, 2010, we redeemed in full the Series B preferred stock from the U.S. Treasury.  Prior to the redemption of the Series B preferred stock, we were subject to certain restrictions applicable under the CPP, including limits on incentive compensation for certain executives and employees.  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 redemption.

Federal Tax Legislation
 
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 Economic Growth and Tax Relief Reconciliation Act of 2001 ( “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.  EGTRRA also included provisions that eliminated 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.  The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 extended for two years through 2012 all of the lower individual tax rates and set the estate tax rate at 35% with a personal exemption of $5 million for the next two years.  Should these provisions not be extended beyond 2012, the higher marginal tax rates on individuals could have a positive impact upon the sale of insurance and annuity products.

On February 14, 2011, the Obama Administration submitted to Congress its fiscal year 2012 budget proposal.  Included therein are policy and tax recommendations that could have an effect upon our company and our products.  Many of these recommendations were originally proposed in last year’s budget submission to Congress.  Included among the various proposed policy recommendations are modifications to the dividends received deduction for life insurance company separate accounts.  If these proposed changes were enacted into law or, if applicable, changed administratively through the tax regulation process, they could have an adverse effect upon the Company’s profitability.  The budget also proposes changes to the tax laws that would affect purchasers of products offered and sold through our various business lines, including such items as expanding the pro-rata disallowance for COLI, 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 Congressional Budget process.  Any changes to the tax law will require legislation, which may or may not incorporate provisions found in the budget proposal, to move through both houses of Congress before being signed into law by the President.


 
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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 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, LNC is considered to be a savings and loan holding company and, along with NCLS, is subject to supervision, regulation and examination by the OTS of the U.S. Treasury, or going forward by the Federal Reserve Board or the Office of the Comptroller of the Currency, as appropriate.  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.  “Control” will be deemed to exist in the case of any person having the power to vote 25% or more of any class of “voting securities,” having the power to control the election of a majority of the Board or if the applicable regulatory authority determines that such person has the power to directly or indirectly exercise a controlling influence over the management or policies of the holding company or thrift.
 
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.
 

 
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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.

Intellectual Property

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.  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.
 
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 intend to protect them against infringement and dilution.

EMPLOYEES

As of December 31, 2010, we had a total of 8,270 employees.  In addition, we had a total of 1,230 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.

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,

 
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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.  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.

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.  Concerns over unemployment, the availability and cost of credit, the U.S. mortgage market and a declining real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward.  These 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 that occurred during 2008 and 2009, we could incur significant losses.  For example, for the year ended December 31, 2009, our earnings were unfavorably 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.

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, 2010, 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, merger and acquisitions and other relevant factors.  In addition, certain events, including a significant and adverse change in legal factors, accounting standards or the business climate, an adverse action or

 
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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).

Subsequent reviews of goodwill could result in impairment of goodwill during 2011, and such write downs could have a material adverse effect on our net income and book value, 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.  As of December 31, 2010, we had a deferred tax asset of $2.5 billion.  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.

The earnings of our insurance subsidiaries 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.  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.

 
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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.

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 $199 million were on loan under the program as of December 31, 2010.  Securities loaned under such transactions may be sold or repledged by the transferee.  We were liable for cash collateral under our control of $192 million as of December 31, 2010.

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 $294 million as of December 31, 2010.

As of December 31, 2010, 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, 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.

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.

We completed a conversion of our actuarial valuation systems to a uniform valuation platform during 2010 for certain blocks of our Retirement Solutions business, which resulted in an after-tax unfavorable prospective unlocking of $16 million.  We are in the process of completing a similar conversion for our Insurance Solutions – Life segment and also have other blocks of Retirement

 
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Solutions business that we intend to convert in 2011.  The completion of these conversions could have a financial effect.  For further information about the results of the conversion completed during 2010, see “Critical Accounting Policies and Estimates – DAC, VOBA, DSI and DFEL” in the MD&A.

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, the last time that we reset our baseline of account values from which EGPs are projected, which we refer to as our “reversion to the mean” (“RTM”) process, 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, 2010, we would have recorded a favorable prospective unlocking of approximately $375 million, pre-tax, for our Retirement Solutions business, and approximately $15 million, pre-tax, for our Insurance Solutions business, as a result of improved market conditions since our last unlock of RTM in the fourth quarter of 2008.  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

 
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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, 2010, 2009 and 2008, we experienced a breakage on our guaranteed living benefits net derivatives results of $(109) million, $(137) million and $176 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 and sustained low interest rates may cause interest rate spreads to decrease and changes in interest rates may also result in increased contract withdrawals.

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, 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.  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.

In periods of declining interest rates, we may have to reinvest the cash we receive as interest or return of principal on our investments in lower yielding instruments than currently available, without taking on additional investment risk.  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.

Currently, new money rates continue to be at low levels.  If interests rates were to remain low over a sustained period of time, this would put additional pressure on our spreads, potentially resulting in unlocking of our DAC asset and increases in reserves.  We would expect the effect to be most pronounced in our Insurance Solutions – Life Insurance segment.  For additional information on interest rate risks, see “Part II – Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk.”

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

 
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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, 2010, there were nine impaired mortgage loans, or less than 1% of total mortgage loans, and eight 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:

·  
Fixed maturity and equity securities are classified as available-for-sale (“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;
·  
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;
·  
Short-term investments include investments with remaining maturities of one year or less, but greater than three months, at the time of acquisition and are stated at amortized cost, which approximates fair value;
·  
Mortgage loans 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;
·  
Policy loans are carried at unpaid principal balances;
·  
Real estate joint ventures and other limited partnership interests are carried using the equity method of accounting; and
·  
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.

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.

 
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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 22% of the carrying value of our total cash and invested assets as of December 31, 2010.

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.


 
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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 $152 million, $392 million and $851 million, pre-tax, for the years ended December 31, 2010, 2009 and 2008, respectively.  The portion of OTTI recognized in OCI for the years ended December 31, 2010 and 2009, was $88 million and $275 million, pre-tax, respectively.

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, 2010, 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.”


 
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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.

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.  During 2010, A.M. Best, Fitch and Moody’s each revised their outlook for the U.S. life insurance sector to stable, with the exception of S&P, who maintained their outlook at stable.

Our financial strength ratings, which are intended to measure our ability to meet contract holder obligations, are an important factor affecting public confidence in most of our products and, as a result, our competitiveness.  A downgrade of 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.

 
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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, 2010, we held statutory reserves of approximately $3.2 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 $2.1 billion of statutory reserves as of December 31, 2010.  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 $1.0 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, 2010, LLANY’s RBC ratio exceeded the required ratio.  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 affect our insurance subsidiary capital requirements or reduce our profitability.

Our insurance subsidiaries are subject to extensive supervision and regulation in the states in which we do business.  The supervision and regulation relate to numerous aspects of our business and financial condition.  The primary purpose of the supervision and regulation is the protection of our insurance contract holders, and not our investors.  The extent of regulation varies, but generally is governed by state statutes.  These statutes delegate regulatory, supervisory and administrative authority to state insurance departments.  This system of supervision and regulation covers, among other things:

·  
Standards of minimum capital requirements and solvency, including RBC measurements;
·  
Restrictions of certain transactions between our insurance subsidiaries and their affiliates;
·  
Restrictions on the nature, quality and concentration of investments;
·  
Restrictions on the types of terms and conditions that we can include in the insurance policies offered by our primary insurance operations;
·  
Limitations on the amount of dividends that insurance subsidiaries can pay;
·  
The existence and licensing status of the company under circumstances where it is not writing new or renewal business;
·  
Certain required methods of accounting;
·  
Reserves for unearned premiums, losses and other purposes; and
·  
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.
 
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, 2010, 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.

 
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In addition, Lincoln Financial Advisors, Lincoln Financial Securities 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 OTS.  As a savings and loan holding company, we are also 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.

Recently, there has been an increase in potential federal initiatives that would affect the financial services industry.   On July 21, 2010, President Obama signed into law the Dodd-Frank Act, a wide-ranging Act that includes a number of reforms of the financial services industry and financial products.  The Dodd-Frank Act includes, among other things, changes to the rules governing derivatives; restrictions on proprietary trading by certain entities; the imposition of capital and leverage requirements on bank and savings and loan holding companies; a study by the SEC of the rules governing broker-dealers and investment advisers with respect to individual investors and investment advice, followed potentially by rulemaking; the creation of a new Federal Insurance Office within the U.S. Treasury to gather information regarding the insurance industry; the creation of a resolution authority to unwind failing institutions, funded on a post-event basis; the creation of a new Consumer Financial Protection Bureau to protect consumers of certain financial products; and changes to executive compensation and certain corporate governance rules, among other things.   The Dodd-Frank Act also eliminates the OTS and reallocates the supervisory and regulatory authority over federally chartered thrifts to the Office of the Comptroller of the Currency and over thrift holding companies to the Federal Reserve Board.  Enactment of this provision ensures that we and NCLS will each have a new regulator and may be subject to additional regulations.  Many of the provisions of this legislation require substantial regulatory work prior to implementation and although we do not expect the Dodd-Frank Act or the rules to be promulgated thereunder to have a material adverse effect on our results of operations, liquidity or capital resources, the ultimate impact of any of these provisions 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.  The application of both AG38 and XXX involve numerous interpretations.  At times, there may be differences of opinion between management and state insurance departments regarding the application of these and other actuarial standards.  Such differences of opinion may lead to a state insurance regulator requiring greater reserves to support insurance liabilities than management estimated.

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.

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 incur higher operating costs and lower returns on products sold than we currently anticipate or reduce our sales of these products.

For further discussion see “Results of Insurance Solutions – Insurance Solutions – Life Insurance – Income (Loss) from Operations – Strategies to Address Statutory Reserve Strain.”


 
34

 

Changes in accounting standards issued by the FASB or other standard-setting bodies may adversely affect our financial statements.

Our financial statements are prepared in accordance with GAAP as identified in the FASB ASC.  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 FASB issued Accounting Standards Update (“ASU”) No. 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”), which clarifies the types of costs that insurance companies may capitalize and amortize over the life of the business.  ASU 2010-26 significantly reduces the amount of acquisition cost that we will be able to defer in connection with sales of our insurance products.  Although this will not affect the ultimate profitability of our products, we expect it could materially alter the pattern of our earnings.  In addition, the final guidance permits companies to apply the guidance retrospectively with a cumulative effect adjustment to the balance sheet.  As of December 31, 2010, our DAC asset was $7.6 billion, pre-tax, or $4.9 billion, after-tax.  If we applied the guidance retrospectively, we would write-down a portion of our existing DAC asset that we determined did not qualify as a deferred expense.  The amount of the write-down, if any, would reduce the amount of future amortization expense.  This guidance is effective for fiscal years and interim periods beginning after December 15, 2011.  The ultimate impact to our consolidated financial position and results of operations is currently being evaluated.

In addition, the FASB is working on several projects with the International Accounting Standards Board, which could result in significant changes as GAAP converges with International Financial Reporting Standards (“IFRS”), including how we account for our insurance contracts and financial instruments and how our financial statements are presented.  Furthermore, the SEC is considering whether and how to incorporate IFRS into the U.S. financial reporting system.  The accounting changes being proposed by the FASB will be a complete change to how we account for and report significant areas of our business, such as insurance contracts and DAC.  The effective dates and transition methods are not known; however, issuers may be required to or may choose to adopt the new standards retrospectively.  In this case, the issuer will report results under the new accounting method as of the effective date, as well as for all periods presented.  The changes to GAAP and ultimate conversion to IFRS will impose special demands on issuers in the areas of governance, employee training, internal controls, contract fulfillment and disclosure and will likely 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, make our products less desirable and lower our net income.  For example, on February 14, 2011, the Obama Administration released its fiscal year 2012 budget proposal including proposals which, if enacted, would affect the taxation of life insurance companies and certain life insurance products.  If enacted into law, the statutory changes contemplated by the Administration’s revenue proposals would, among other things, 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, 2010, included a separate account dividend received deduction benefit of $94 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.


 
35

 

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, 2010, we ceded $337.8 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, 2010, we had $6.5 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 $1.7 billion as of December 31, 2010.  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 $1.5 billion as of December 31, 2010, which was established during the fourth quarter of 2009.  Furthermore, approximately $1.1 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

 
36

 

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.  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

 
37

 

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, 2010, LNC and our subsidiaries owned or leased approximately 3.5 million square feet of office space.  We leased 0.1 million square feet of office space in Philadelphia, Pennsylvania 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 $46 million for 2010.  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 2010, no matters were submitted to security holders for a vote.


 
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Executive Officers of the Registrant

Executive Officers of the Registrant as of February 20, 2011, were as follows:

Name
 
Age (1)
 
Position with LNC and Business Experience During the Past Five Years
         
Dennis R. Glass
 
61
 
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
 
 
45
 
 
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
 
51
 
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
 
47
 
Executive Vice President and Head of Corporate Development and Investments (since January 2011).  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
 
61
 
President, Lincoln Financial Network, and CEO, Lincoln Financial Advisors (2) (since 2002).  Senior Vice President, Managed Asset Group, Merrill Lynch & Co., a diversified financial services company (2001 - 2002).
         
Randal J. Freitag
 
48
 
Executive Vice President and Chief Financial Officer (since January 2011).  Senior Vice President, Chief Risk Officer (2007 - December 2010).  Senior Vice President, Chief Risk Officer and Treasurer (2007 - October 2009).  Senior Vice President, Product Risk and Profitability and Actuary (2004 - 2007).
         
 
Wilford H. Fuller
 
 
40
 
 
President and CEO, Lincoln Financial Distributors (2) (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).
         
Nicole S. Jones
 
40
 
Senior Vice President, General Counsel (since May 2010).  Deputy General Counsel, Corporate Secretary and Chief Counsel, CIGNA Corporation, a global health services company (September 2006 - May 2010).  Chief Counsel, Securities, International Paper, a global manufacturer of paper products (February 2006 - September 2006).  Vice President, Corporate and Securities, MCI Corporation, a telecommunications company (2003 - 2006).
         
Mark E. Konen
 
51
 
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)
Age shown is based on the officer’s age as of February 20, 2011.
(2)
Denotes an affiliate of LNC.

 
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PART II

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, 2011, the number of shareholders of record of our common stock was 10,608.  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. Financial Statements and Supplementary Statements,” as well as in “Part I – Item 1. Business – Regulatory – Insurance Regulation – Restriction on Subsidiaries’ Dividends and Other Payments.”  The following 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
2010 
 
 
 
 
 
 
 
 
 
 
 
High
$
 30.74 
 
$
 33.55 
 
$
 26.83 
 
$
 29.12 
Low
 
 22.52 
 
 
 23.86 
 
 
 20.65 
 
 
 23.17 
Dividend declared
 
 0.010 
 
 
 0.010 
 
 
 0.010 
 
 
 0.050 
 
 
 
 
 
 
 
 
 
 
 
 
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 

(b)    Not Applicable
 
(c)    Issuer Purchases of Equity Securities
 
The following summarizes purchases of equity securities by the issuer during the quarter ended December 31, 2010 (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)
10/1/10 - 10/31/10
 
 
 2,096 
 
$
 24.21 
 
 
 - 
 
$
 1,140.1 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
11/1/10 - 11/30/10
 
 
 715,250 
 
 
 24.00 
 
 
 715,100 
 
 
 1,122.9 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
12/1/10 - 12/31/10
 
 
 333,803 
 
 
 23.60 
 
 
 333,189 
 
 
 1,115.1 

(1)
Of the total number of shares purchased, no shares were received in connection with the exercise of stock options and related taxes and 2,860 shares were withheld for taxes on the vesting of restricted stock.  For the quarter ended December 31, 2010, there were 1,048,289 shares purchased as part of publicly announced plans or programs.
(2)
On February 23, 2007, our Board approved a $2.0 billion increase to our securities repurchase authorization, bringing the total authorization at that time to $2.6 billion.  As of December 31, 2010, our security repurchase authorization was $1.1 billion.  The security repurchase authorization does not have an expiration date.  The amount and timing of share repurchase depends on key capital ratios, rating agency expectations, the generation of free cash flow and an evaluation of the costs and benefits associated with alternative uses of capital.  The shares repurchased in connection with the awards described in Note 20 in the accompanying notes to the consolidated financial statements presented in “Item 8. Financial Statements and Supplementary Statements” are not included in our security repurchase.
(3)
As of the last day of the applicable month.

 
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(d)    Securities Authorized for Issuance Under Equity Compensation Plans

For information on securities authorized for issuance under equity compensation plans, see “Part III – 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. Financial Statements and Supplementary Statements.”  Some previously reported amounts have been reclassified to conform to the presentation as of and for the year ended December 31, 2010.

 
 
 
 
 
 
 
 
 
For the Years Ended December 31,
 
 
 
 
 
 
 
 
 
2010 
 
2009 
 
2008 
 
2007 
 
2006 
Total revenues
$
 10,407 
 
$
 8,499 
 
$
 9,224 
 
$
 9,614 
 
$
 8,002 
Income (loss) from continuing operations
 
 951 
 
 
 (415)
 
 
 (10)
 
 
 1,199 
 
 
 1,199 
Net income (loss)
 
 980 
 
 
 (485)
 
 
 57 
 
 
 1,215 
 
 
 1,316 
Per share data: (1)(2)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Income (loss) from continuing
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
operations - basic
$
 2.53 
 
$
 (1.60)
 
$
 (0.04)
 
$
 4.44 
 
$
 4.75 
 
Income (loss) from continuing
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
operations - diluted
 
 2.45 
 
 
 (1.60)
 
 
 (0.04)
 
 
 4.37 
 
 
 4.68 
 
Net income (loss) - basic
 
 2.62 
 
 
 (1.85)
 
 
 0.22 
 
 
 4.50 
 
 
 5.21 
 
Net income (loss) - diluted
 
 2.54 
 
 
 (1.85)
 
 
 0.22 
 
 
 4.43 
 
 
 5.13 
 
Common stock dividends
 
 0.080 
 
 
 0.040 
 
 
 1.455 
 
 
 1.600 
 
 
 1.535 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of December 31,
 
 
 
 
 
 
 
 
 
2010 
 
2009 
 
2008 
 
2007 
 
2006 
Assets
$
 193,824 
 
$
 177,433 
 
$
 163,136 
 
$
 191,435 
 
$
 178,495 
Long-term debt
 
 5,399 
 
 
 5,050 
 
 
 4,731 
 
 
 4,618 
 
 
 3,458 
Stockholders' equity
 
 12,806 
 
 
 11,700 
 
 
 7,977 
 
 
 11,718 
 
 
 12,201 
Per common share data: (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Stockholders' equity, including
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
accumulated other comprehensive
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
income (loss) (3)
$
 40.54 
 
$
 36.02 
 
$
 31.15 
 
$
 44.32 
 
$
 44.21 
 
Stockholders' equity, excluding
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
accumulated other comprehensive
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
income (loss) (3)
 
 38.17 
 
 
 36.89 
 
 
 42.09 
 
 
 43.46 
 
 
 41.99 
 
Market value of common stock
 
 27.81 
 
 
 24.88 
 
 
 18.84 
 
 
 58.22 
 
 
 66.40 

(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 1.1 million, less than 1 million, 9.3 million, 15.4 million and 16.9 million shares of common stock during the years ended December 31, 2010, 2009, 2008, 2007 and 2006, respectively.
(2)
For discussion of the reduction of net income (loss) available to common stockholders see Note 15 in the accompanying notes to the consolidated financial statements presented in “Item 8. Financial Statements and Supplementary Statements.”
(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 was non-convertible.

 
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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, 2010, compared with December 31, 2009, and the results of operations in 2010 and 2009, 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.

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 United States of America generally accepted accounting principles (“GAAP”) excluding the after-tax effects of the following items, as applicable:

·  
Realized gains and losses associated with the following (“excluded realized gain (loss)”):
§  
Sales or disposals of securities;
§  
Impairments of securities;
§  
Change in the fair value of derivative investments, embedded derivatives within certain reinsurance arrangements and 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 Financial Accounting Standards Board (“FASB”) Accounting Standards CodificationTM (“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 the acceleration of our Series B preferred stock discount as a result of redemption 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 gain (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 believes 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.


 
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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 that may affect account values, investment results, guaranteed benefit liabilities, premium levels, claims experience and the level of pension benefit costs, 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;
·  
Because of our holding company structure, the inability of our subsidiaries to pay dividends to the holding company in sufficient amounts could harm the holding company’s ability to meet its obligations;
·  
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 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;
·  
Uncertainty about the effect of rules and regulations to be promulgated under the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) on us and the economy and the financial services sector in particular;
·  
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 or sustained low interest rates causing reductions of investment income, estimated gross profits relating to our variable annuity and universal life products, 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 effect 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 elevated impairments on investments and amortization of intangible assets that may cause an increase in reserves and/or a reduction in assets, resulting in a corresponding decrease in net income;
·  
Changes in GAAP, including moving to International Financial Reporting Standards (“IFRS”), as well as the methodologies, estimations and assumptions thereunder, that may result in unanticipated changes to our net income;
·  
Lowering of one or more of our debt ratings issued by nationally recognized statistical rating organizations and the adverse effect such action may have on our ability to raise capital and on our liquidity and financial condition;
·  
Lowering of one or more of the insurer financial strength ratings of our insurance subsidiaries and the adverse effect such action may have on the premium writings, policy retention, profitability of our insurance subsidiaries and liquidity;

 
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·  
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 effect 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 effect 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 affect 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 effect 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, mutual funds and group life, disability and dental.

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 500 wholesalers within Lincoln Financial Distributors (“LFD”), our wholesaling distributor.  Our retail distributor, Lincoln Financial Network, offers proprietary and non-proprietary products and advisory services through a national network of approximately 8,000 active producers who placed business with us within the last twelve months.  Our Insurance Solutions – Group Protection segment distributes its products and services primarily through employee benefit brokers, third party administrators and other employee benefit firms with sales support provided by its group and retirement sales specialists.

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 liability; the unamortized deferred gain on indemnity reinsurance related to the sale of reinsurance to Swiss Re in 2001; the results of certain disability income business due to the rescission of a reinsurance agreement with Swiss Re; our run-off Institutional Pension business; and debt costs.


 
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Our former Lincoln UK and Investment Management segments are reported in discontinued operations for all periods presented.  See “Acquisitions and Dispositions” and Note 3 for more information.

For information on how we derive our revenues, see the discussion in results of operations by segment below.

Current Market Conditions

Although economic conditions have improved, the following concerns are still weighing on the U.S. economy:

·  
Persistent high unemployment; and
·  
Slow U.S. housing market.

The National Bureau of Economic Research, a panel of economists charged with officially designating business cycles, announced on September 20, 2010, that the recession that began in December 2007 ended in June 2009, lasting 18 months.  However, we are still in the midst of a somewhat fragile recovery.

In the face of these economic 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.

Significant Operational Matters

Adequacy of Our Liquidity and Capital Positions

During 2010, as a result of the improvements in the economy and capital markets, as well as the strength of our business model and our capital position, we took the following measures to address matters that we believed had been depressing our stock price, provide returns to our stockholders and/or manage our liquidity and capital positions:

·  
We funded, on June 30, 2010, the $950 million repurchase of our Series B preferred stock that we had issued to the U.S. Department of the Treasury (“U.S. Treasury”) as part of our participation in the Capital Purchase Program (“CPP”) with net proceeds of approximately $368 million from a common stock offering, proceeds from a $250 million five-year senior notes offering and cash held at our holding company that was attributable primarily to proceeds from the sale of Delaware Management Holdings, Inc. (“Delaware”);
·  
We secured $2 billion of bank credit facilities in the second quarter of 2010, to address the upcoming maturity of credit facilities in the first quarter of 2011 related to letters of credit (“LOCs”) supporting our life insurance business that could have remained outstanding until the first quarter of 2012;
·  
We completed a 30-year senior notes offering of $500 million, the proceeds of which were used in the third quarter of 2010 as part of a long-term financing solution supporting UL business with secondary guarantees;
·  
We paid $48 million to repurchase 2,899,159 warrants (each representing the right to purchase one share of our common stock) held by the U.S. Treasury during the U.S. Treasury’s public auction of our warrants during the third quarter of 2010, which were subsequently canceled;
·  
We increased the dividend on our common stock during the fourth quarter of 2010 from $0.01 to $0.05 per share;
·  
We also announced a plan to repurchase up to $125 million of common stock under our security repurchase authorization and completed $25 million of stock repurchases during the fourth quarter of 2010;
·  
We redeemed all of our outstanding 6.75% Junior Subordinated Deferrable Interest Debentures, Series F due 2052 (the “junior subordinated debentures”), which were held by Lincoln National Capital VI, during the fourth quarter of 2010; and
·  
Effective December 31, 2010, we financed, for up to 30 years, reserves supporting our life insurance business, replacing the use of $500 million in LOCs.

Certain of these matters are discussed in more detail in “Results of Insurance Solutions – Insurance Solutions – Life Insurance – Income (Loss) from Operations – Strategies to Address Statutory Reserve Strain” and “Review of Consolidated Financial Condition – Liquidity and Capital Resources – Financing Activities” below.

During May and June of 2010, Moody’s Investors Service (“Moody’s”), Fitch Ratings (“Fitch”) and A.M. Best Co. (“A.M. Best”) all improved their outlook on our company to stable from negative, and Standard & Poor’s (“S&P”) outlook remained stable.  For more information about ratings, see “Part I – Item 1. Business – Ratings.”

Interest Rate Risk on Fixed Insurance Businesses

Because the profitability of our fixed annuity, UL, VUL and defined contribution 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

 
45

 

profitability from spread businesses and our return on invested capital.  Some of our products, principally our fixed annuities, UL and VUL, have interest rate guarantees that expose us to the risk that changes in interest rates or prolonged low interest rates will reduce our spread, or the difference between the interest that we are required to credit to contracts and the yields that we are able to earn on our general account investments supporting our obligations under the contracts.  Although we have been proactive in our investment strategies, product designs, crediting rate strategies and overall asset-liability practices to mitigate the risk of unfavorable consequences in this type of environment, 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 an adverse effect on some of our businesses or results of operations.  During the third quarter of 2010, our Insurance Solutions – Life Insurance segment lowered the new money investment yield assumption to reflect the then current new money rates and to approximate the forward curve for interest rates relevant at such time.  The result was a drop in the current new money investment rate followed by a gradual annual recovery over eight years to a rate of 6.31%, 54 basis points below our previous ultimate long-term assumption of 6.85%.  As a result of this assumption revision, we recorded a $114 million, after-tax, unfavorable prospective unlocking within our Insurance Solutions – Life Insurance segment.

Given the level of interest rates as of the end of 2010, and assuming interest rates remain constant through 2012, our execution of reverse treasury locks to hedge interest rate exposure (discussed in “Results of Insurance Solutions – Insurance Solutions – Life Insurance”) and the effect of crediting rate actions that we have taken, we estimate that spread compression will have a minimal effect on earnings in 2011 and would unfavorably affect earnings by approximately $20 million during 2012 primarily in Insurance Solutions – Life Insurance.  We discuss the earnings effect of interest rates in “Part II – Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Interest Rate Risk – Interest Rate Risk on Fixed Insurance Businesses – Falling Rates” and “Part I – Item 1A. Risk Factors – Changes in interest rates and sustained low interest rates may cause interest rate spreads to decrease and changes in interest rates may also result in increased contract withdrawals.”

Elevated Loss Ratios on Group Business

During 2010, our non-medical loss ratio was 76.2%, which is above what we experienced last year and above our long-term expectation of 71% to 74%.  The primary driver of the elevated loss ratios was unfavorably high disability incidence, which affected our long-term disability, short-term disability and life waiver of premium products.  The unfavorable claims incidence experience was spread across all industry sectors, and particularly in the financial, wholesale and retail sectors, which we expect will continue in the short term.

We expect loss ratios to recover over time, but they are likely to remain above our long-term expectation well into 2011.  Management compares trends in actual loss ratios to pricing expectations because group-underwriting risks change over time.  We expect normal fluctuations in our composite non-medical loss ratios of this segment, as claims experience is inherently uncertain.  We are taking actions to manage the effects of our loss ratio results, such as implementing price adjustments on our product lines to better reflect our experience going forward.  In addition, we have been focusing on managing the higher volume of incidence through enhanced claims risk management, including contracting additional resources to help reduce caseloads and improve claim recovery experience so that incidence volumes do not detract from our claim termination efforts.  We are also employing new tools to identify and support claimants who will return to work.

Earnings from Account Values

Our asset-gathering segments – Retirement Solutions – Annuities and Retirement Solutions – Defined Contribution – are the most sensitive to the equity markets, as well as, to a lesser extent, our Insurance Solutions – Life Insurance segment.  We discuss the earnings effect 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 – Effect of Equity Market Sensitivity.”  From December 31, 2009, to December 31, 2010, our account values were up $15.9 billion driven primarily by an increase in equity markets during 2010 and positive net flows.

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.  These results are excluded from the Retirement Solutions – Annuities and Defined Contribution segments’ operating revenues and income from operations.  See “Realized Gain (Loss) – Operating Realized Gain (Loss) – GLB” below for information on our methodology for calculating the non-performance risk (“NPR”), which affects the discount rate used in the calculation of the GLB embedded derivative reserve.

The variable annuity hedge program ended 2010 with assets over $1.0 billion, which were in excess of the estimated liability of approximately $450 million as of December 31, 2010.

 
46

 

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 effect in the opposite direction of the GDB benefit ratio unlocking for movements in equity markets.  These results are excluded from income (loss) from operations.

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 $84 million for 2010 and included credit-related write-downs of securities for other-than-temporary impairments (“OTTI”) of $99 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, 2010, compared to December 31, 2009, have resulted in the $1.3 billion decrease in gross unrealized losses on the available-for-sale (“AFS”) fixed maturity securities in our general account as of December 31, 2010.

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 effect 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 our overall life insurer investment portfolio yields.  Equity market performance can also affect 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.

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.  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.


 
47

 

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, such as the Dodd-Frank Act, can potentially affect the capital requirements of the industry and result in increased regulation and oversight for the industry.  In addition, changes in GAAP, including moving to IFRS, as well as the methodologies, estimations and assumptions thereunder, may result in unanticipated changes to our net income.  See “Part I – Item 1. Business – Regulatory” for a discussion of the potential effects of regulatory changes on our industry.

Issues and Outlook

Going into 2011, significant issues include:

·  
Decrease of interest rates;
·  
Continuation of unfavorable non-medical loss ratios in our Insurance Solutions – Group Protection segment, attributable primarily to unfavorable disability incidence, which affected our main products (long-term disability, short-term disability and life waiver of premium);
·  
Implementation of new accounting requirements in 2012 that could have a significant effect on our earnings and/or business model;
·  
Continuing focus by the government on tax, financial and health care reform including potential changes in the dividends-received deduction (“DRD”) calculations, which may affect the value and profitability of our products and overall earnings;
·  
Achieving continued sales success with our portfolio of products, including marketplace acceptance of new product introductions, as well as retaining management and wholesaler talent to maintain our competitive position;
·  
Potential unstable credit markets that can affect our financing alternatives, spreads and other-than-temporary securities impairments;
·  
Potential volatile equity markets that have a significant effect on our hedge program performance and revenues; and
·  
Continuation of economic challenges.

In the face of these issues and potential issues, we expect to focus on the following throughout 2011:

·  
Taking appropriate crediting rate actions;
·  
Managing the effects of our loss ratio results, including focusing on the increase in incidence through claims risk management;
·  
Continuing to explore additional financing strategies addressing the statutory reserve strain related to our secondary guarantee UL products in order to manage our capital position effectively in accordance with our pricing guidelines;
·  
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;
·  
Evaluating opportunities for 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;
·  
Managing our expenses aggressively through process improvement initiatives combined with continued financial discipline and execution excellence throughout our operations;
·  
Closely monitoring ongoing changes in the legal and regulatory environment; and
·  
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.