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American Legacy Shareholder's Advantage
Lincoln National Variable Annuity Account H
Individual variable annuity contract
Home Office:
Lincoln National Life Insurance Company
1300 South Clinton Street
P.O. Box 7866
Fort Wayne, IN 46801
This prospectus describes the individual flexible premium deferred variable
annuity contract that is issued by Lincoln National Life Insurance Company
(Lincoln Life). It is primarily for use with nonqualified plans and retirement
plans under Section 408 (IRAs) of the tax code. Non-ERISA 403(b) business will
only be accepted for purchase payments that are either lump sum or rollovers.
Generally, you do not pay federal income tax on the contract's growth until it
is paid out. The contract is designed to accumulate contract value and to
provide retirement income that you cannot outlive or for an agreed upon time.
These benefits may be a variable or fixed amount or a combination of both. If
you die before the annuity commencement date, we will pay your beneficiary a
death benefit. In the alternative, you may choose to receive a death benefit on
the death of the annuitant.
The minimum initial gross purchase payment for the contract is:
1. $1,500 for a nonqualified plan; and
2. $300 for a qualified plan.
Additional gross purchase payments may be made to the contract and must be at
least $100 ($25 if transmitted electronically), and at least $300 annually.
You choose whether your contract value accumulates on a variable or fixed
(guaranteed) basis or both. If you put all your net purchase payments into the
fixed account, we guarantee your principal and a minimum interest rate. We
limit withdrawals and transfers from the fixed side of the contract.
All net purchase payments for benefits on a variable basis will be placed in
Lincoln National Variable Annuity Account H (variable annuity account [VAA]).
The VAA is a segregated investment account of Lincoln Life. If you put all or
some of your net purchase payments into one or more of the contract's variable
options, you take all of the investment risk on the contract value and the
retirement income. If the subaccounts you select make money, your contract
value goes up; if they lose money, your contract value goes down. How much it
goes up or down depends on the performance of the subaccounts you select. We do
not guarantee how any of the variable options or their funds will perform.
Also, neither the U.S. Government nor any federal agency insures or guarantees
your investment in the contract.
The available funds, listed below, are each part of American Variable Insurance
Series (series) Class 2 Shares:
Global Growth
Global Small Capitalization
Growth
International
New World
Growth-Income
Asset Allocation
Bond
High-Yield Bond
U.S. Government/AAA-Rated Securities
Cash Management
Net Purchase payments can be placed in the Dollar Cost Averaging (DCA) fixed
account. The DCA Fixed account is part of the general account. This Prospectus
deals only with those elements of the contracts relating to the VAA, except
where reference to the DCA fixed account is made.
This Prospectus gives you information about the contract that you should know
before you decide to buy a contract and make gross purchase payments. You
should also review the prospectuses for the funds that are attached, and keep
both prospectuses for future reference.
Neither the SEC nor any state securities commission has approved this contract
or determined that this prospectus is accurate or complete. Any representation
to the contrary is a criminal offense.
You can obtain a Statement of Additional Information (SAI) about the contracts
that has more information. Its terms are made part of this Prospectus. For a
free copy, write: Lincoln National Life Insurance Company, P.O. Box 2348, Fort
Wayne, Indiana 46801, or call 1-800-942-5500. The SAI and other information
about Lincoln Life and Account H are also available on the SEC's web site
(http:\\www.sec.gov). There is a table of contents for the SAI on the last page
of this Prospectus.
September 23, 1999
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Table of contents
<TABLE>
<CAPTION>
Page
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<S> <C>
Special terms.............................................................. 2
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Expense tables............................................................. 3
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Summary.................................................................... 5
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Investment results......................................................... 6
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Financial statements....................................................... 6
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Lincoln National Life Insurance Co......................................... 6
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DCA fixed account.......................................................... 6
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Variable annuity account (VAA)............................................. 6
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Investments of the variable annuity account................................ 7
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Charges and other deductions............................................... 9
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The contracts.............................................................. 10
</TABLE>
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<TABLE>
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<S> <C>
Annuity payouts........................................................... 14
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Federal tax matters....................................................... 15
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Voting rights............................................................. 19
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Distribution of the contracts............................................. 19
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Return privilege.......................................................... 19
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State regulation.......................................................... 19
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Restrictions under the Texas Optional Retirement Program.................. 19
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Records and reports....................................................... 20
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Other information......................................................... 20
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Statement of additional information table of contents for Variable Annuity
Account H American Legacy Shareholder's Advantage........................ 21
</TABLE>
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Special terms
(We have italicized the terms that have special meaning throughout the
Prospectus).
Account or variable annuity account (VAA)--The segregated investment account,
Account H, into which Lincoln Life sets aside and invests the assets for the
variable side of the contract offered in this Prospectus.
Accumulation unit--A measure used to calculate contract value for the variable
side of the contract before the annuity commencement date.
Annuitant--The person on whose life the annuity benefit payments are based and
upon whose death a death benefit may be paid.
Annuity commencement date--The valuation date when funds are withdrawn or
converted into annuity units or fixed dollar payout for payment of retirement
income benefits under the annuity payout option you select.
Annuity payout--An amount paid at regular intervals after the annuity
commencement date under one of several options available to the annuitant
and/or any other payee. This amount maybe paid on a variable or fixed basis,
or, a combination of both.
Annuity unit--A measure used to calculate the amount of annuity payouts after
the annuity commencement date.
Beneficiary--The person you choose to receive the death benefit that is paid if
you die before the annuity commencement date.
Contractowner (you, your, owner)--The person who has the ability to exercise
the rights within the contract decides on investment allocations, transfers,
payout option, designates the beneficiary, etc.) Usually, but not always, the
owner is the annuitant.
Contract value --At a given time before the annuity commencement date, the
total value of all accumulation units for a contract plus the value of the DCA
fixed side of the contract.
DCA fixed account--An account established to accept purchase payments or
transfers of contract value, that may only be used for dollar cost averaging
purposes. The DCA fixed account is part of the general account of Lincoln Life.
Contract year--Each one-year period starting with the effective date of the
contract and starting with each contract anniversary after that.
Death benefit (EGMDB)--The amount payable to your designated beneficiary if the
owner dies before the annuity commencement date or, if selected, to the owner
if the annuitant dies. An enhanced guaranteed minimum death benefit is also
available.
Gross purchase payments--Amounts paid into the contract before deduction of the
sales charge.
Lincoln Life (we, us, our)--Lincoln National Life Insurance Company.
Net purchase payments--The gross purchase payment amount less the sales charge.
The net purchase payment is the amount placed in the DCA fixed account and/or
the variable account.
Series--American Variable Insurance Series (series), the funds to which you
direct purchase payments.
Subaccount or American Legacy Shareholder's Advantage subaccount--The portion
of the VAA that reflects investments in accumulation and annuity units of a
class of a particular fund available under the contracts. There is a separate
subaccount which corresponds to each class of a fund.
Valuation date--Each day the New York Stock Exchange (NYSE) is open for
trading.
Valuation period--The period starting at the close of trading (currently 4:00
p.m. New York time) on each day that the NYSE is open for trading (valuation
date) and ending at the close of such trading on the next valuation date.
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Expense tables
Summary of Contractowner expenses:
The maximum sales charge, as a percentage of purchase payments: 5.75%
The sales charge percentage decreases as the value accumulated under certain of
the owner's investment increases. (See Charges and other deductions).
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Account H annual expenses for American Legacy Shareholder's Advantage
subaccounts:*
(as a percentage of average account value)
<TABLE>
<CAPTION>
With Enhanced Without Enhanced
Death Benefit Death Benefit
<S> <C> <C>
Mortality and expense risk charge 0.62% 0.50%
Administrative charge .10% .10%
----- -----
Total annual charge for each American Legacy
Shareholder's Advantage subaccounts 0.72% 0.60%
</TABLE>
Annual expenses of the funds for the year ended November 30, 1998:
(as a percentage of average account value):
<TABLE>
<CAPTION>
Management 12b-1 Other Total
fees + fees + expenses = expenses
<S> <C> <C> <C> <C> <C> <C> <C>
1. Global Growth .69% .25% .06% 1.00%
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2. Global Small
Capitalization** .79 .25 .03 1.07
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3. Growth .40 .25 .01 .66
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4. International .57 .25 .09 .91
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5. New World*** .85 .25 .08 1.18
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6. Growth-Income .35 .25 .01 .61
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7. Asset Allocation .44 .25 .01 .70
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8. Bond .51 .25 .02 .78
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9. High-Yield Bond .50 .25 .01 .76
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10. U.S. Govt./AAA Rated
Securities .49 .25 .01 .75
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11. Cash Management .44 .25 .01 .70
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</TABLE>
*The VAA is divided into separately-named subaccounts, eleven of which are
available under the contracts. Each subaccount, in turn, invests net purchase
payments in shares of a class of its respective fund.
**These expenses are annualized. The fund began operations on April 30, 1998.
***These expenses are estimated amounts for the current fiscal year. This fund
may not be available in all states.
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Examples
(expenses of the subaccounts and of the funds and the maximum sales charge):
If you surrender your contract at the end of the time period shown, you would
pay the following expenses on a $1,000 investment, assuming a 5% annual return:
<TABLE>
<CAPTION>
1 year 3 years 5 years 10 years
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<S> <C> <C> <C> <C>
1. Global Growth $74 $109 $145 $249
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2. Global Small Capitalization 72 102 134 224
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3. Growth 71 99 129 214
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4. International 73 106 141 240
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5. New World 76 114 154 267
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6. Growth-Income 70 97 126 208
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7. Asset Allocation 71 100 131 218
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8. Bond 72 102 135 227
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9. High-Yield Bond 72 102 134 224
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10. U.S. Govt./AAA Rated Securities 72 102 134 225
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11. Cash Management 71 100 131 219
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</TABLE>
We provide these examples to help you understand the direct and indirect costs
and expenses of the contract. The examples also assume that an enhanced death
benefit is in effect. Without this benefit, the expenses would be lower.
For more information, see Charges and other deductions in this Prospectus, and
in the Prospectus for the funds. Premium taxes may also apply, although they do
not appear in the examples. These examples should not be considered a
representation of past or future expenses. Actual expenses may be more or less
than those shown.
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Summary
What kind of contract am I buying? It is an individual annuity contract between
you and Lincoln Life. It may provide for a fixed annuity and/or variable
annuity. This Prospectus describes the variable side of the contract. See The
contracts.
What is the variable annuity account (VAA)? It is a separate account we
established under Indiana insurance law, and registered with the SEC as a unit
investment trust. VAA assets are allocated to one or more subaccounts,
according to your investment choices. VAA assets are not chargeable with
liabilities arising out of any other business which Lincoln Life may conduct.
See Variable annuity account.
What are my investment choices? Based upon your instruction, the VAA applies
net purchase payments to buy series shares in one or more of the investment
funds of the series: Global Growth Fund, Global Small Capitalization, Growth,
International, New World, Growth-Income, Asset Allocation, Bond, High-Yield
Bond, U.S. Government/AAA-Rated Securities and Cash Management. In turn, each
fund holds a portfolio of securities consistent with its investment policy. See
Investments of the variable annuity account and Description of the series.
Who invests my money? The investment advisor for the series is Capital Research
and Management Company (CRMC), Los Angeles, California. CRMC is registered as
an investment advisor with the SEC. See Investments of the variable annuity and
Investment advisor.
How does the contract work? If we approve your application, we will send you a
contract. When you make net purchase payments during the accumulation phase,
you buy accumulation units. If you decide to receive retirement income
payments, your accumulation units are converted to annuity units. Your
retirement income payments will be based on the number of annuity units you
received and the value of each annuity unit on payout days. See The contracts.
What charges do I pay under the contract? A front-end load is determined based
on each gross purchase payment as it is received. The amount of the sales
charge on any current gross purchase payment may be reduced based on the assets
accumulated under the terms of the contract. The maximum front-end load is
5.75% of the gross purchase payment.
We will deduct any applicable premium tax from gross purchase payments or
contract value at the time the tax is incurred or at another time we choose.
We apply an annual charge totaling 0.72% to the daily net asset value of the
VAA. This charge includes 0.10% as an administrative charge and 0.62% as a
mortality and expense risk charge. If the enhanced death benefit is not in
effect, the mortality and expense charge is 0.50%, for an annual charge
totaling 0.60%. See Charges and other deductions.
This series pays a management fee to CRMC based on the average daily net asset
value of each fund. See Investments of the variable annuity account-Investment
advisor. Each fund also has a 12b-1 fee and additional operating expenses.
These are described in the Prospectus for the series.
What purchase payments do I make, and how often? Subject to minimum and maximum
gross purchase payment amounts, your payments are completely flexible. See The
contracts--Purchase payments.
How will my annuity payouts be calculated? If you decide to annuitize, you may
select an annuity option and start receiving retirement income payments from
your contract as a fixed option or variable option or a combination of both.
See Annuity Options. Remember that participants in the VAA benefit from any
gain, and take a risk of any loss, in the value of the securities in the funds'
portfolios.
What happens if I die before I annuitize? If the enhanced death benefit is in
effect, your beneficiary will receive the greater of the guaranteed minimum
death benefit or the contract value. Your beneficiary has options as to how the
death benefit is paid or you may choose an option for your beneficiary. See
Death benefit before the annuity commencement date.
May I transfer contract value between variable options and between the fixed
side of the contract? Yes, with certain limits. See The contracts-- Transfers
on or before the annuity commencement date; and Transfers after the annuity
commencement date.
May I surrender the contract or make a withdrawal? Yes, subject to contract
requirements and to the restrictions of any qualified retirement plan for which
the contract was purchased. See Surrenders and withdrawals.
In addition, if you decide to take a distribution before age 59 1/2, a 10%
Internal Revenue Service (IRS) tax penalty may apply. A surrender or a
withdrawal also may be subject to 20% withholding. See Federal tax status and
withholding.
Do I get a free look at this contract? Yes. You can cancel the contract within
ten days (in some states longer) of the date you first receive the contract.
You need to return the contract, postage prepaid, to our home office. In most
states you assume the risk of any market drop on net purchase payments you
allocate to the variable side of the contract. See Return privilege.
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Investment results
At times, the VAA may compare its investment results to various unmanaged
indices or other variable annuities in reports to shareholders, sales
literature and advertisements. The results will be calculated on a total return
basis for various periods. Total returns include the reinvestment of all
distributions, which are reflected in changes in unit value. Results will be
calculated without sales charges. These results will be higher. See the SAI for
further information.
Financial statements
The financial statements of the VAA and the statutory-basis financial
statements of Lincoln Life are located in the SAI. If you would like a free
copy of the SAI, complete and mail the enclosed card, or call 1-800-942-5500.
Lincoln National Life Insurance Co.
Lincoln Life was founded in 1905 and is organized under Indiana law. We are one
of the largest stock life insurance companies in the United States. We are
owned by Lincoln Financial Group (LFG) which is also organized under Indiana
law. LFG's primary businesses are insurance and financial services.
DCA fixed account
Net purchase payments allocated to the DCA fixed side of the contract become
part of Lincoln Life's general account, and do not participate in the
investment experience of the VAA. The general account is subject to regulation
and supervision by the Indiana Insurance Department as well as the insurance
laws and regulations of the jurisdictions in which the contracts are
distributed.
In reliance on certain exemptions, exclusions and rules, Lincoln Life has not
registered interests in the general account as a security under the Securities
Act of 1933 and has not registered the general account as an investment company
under the 1940 Act. Accordingly, neither the general account nor any interests
in it are regulated under the 1933 Act or the 1940 Act. Lincoln Life has been
advised that the staff of the SEC has not made a review of the disclosures
which are included in this Prospectus which relate to our general account and
to the DCA fixed account under the contract. These disclosures, however, may be
subject to certain provisions of the federal securities laws relating to the
accuracy and completeness of statements made in Prospectuses. This Prospectus
is generally intended to serve as a disclosure document only for aspects of the
contract involving the VAA, and therefore contains only selected information
regarding the DCA fixed side of the contract. Complete details regarding the
DCA fixed side of the contract are in the contract.
Net purchase payments allocated to the DCA fixed side of the contract are
guaranteed to be credited with a minimum interest rate, specified in the
contract, or at least 3.0%. A net purchase payment allocated to the fixed side
of the contract is credited with interest beginning on the next calendar day
following the date of receipt if all data is complete. Lincoln Life may vary
the way in which it credits interest to the fixed side of the contract from
time to time.
ANY INTEREST IN EXCESS OF 3.0% WILL BE DECLARED IN ADVANCE AT LINCOLN LIFE'S
SOLE DISCRETION, CONTRACTOWNERS BEAR THE RISK THAT NO INTEREST IN EXCESS OF
3.0% WILL BE DECLARED.
Variable annuity account
(VAA)
On February 7, 1989, the VAA was established as an insurance company separate
account under Indiana law. It is registered with the SEC as a unit investment
trust under the provisions of the Investment Company Act of 1940 (1940 Act).
The SEC does not supervise the VAA or Lincoln Life. The VAA is a segregated
investment account, meaning that its assets may not be charged with liabilities
resulting from any other business that we may conduct. Income, gains and
losses, whether realized or not, from assets allocated to the VAA are, in
accordance with the applicable annuity contracts, credited to or charged
against the VAA. They are credited or charged without regard to any other
income, gains or losses of Lincoln Life. The VAA satisfies the definition of a
separate account under the federal securities laws. We do not guarantee the
investment performance of the VAA. Any investment gain or loss depends on the
investment performance of the funds. You assume the full investment risk for
all amounts placed in the VAA.
The VAA is used to support other annuity contracts offered by Lincoln Life in
addition to the contracts described in this prospectus. The other annuity
contracts supported by the VAA invest in the same portfolios of the series as
the contracts described in this Prospectus. These other annuity contracts may
have different charges that could affect the performance of the subaccount.
6
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Investments of the variable annuity account
You decide the subaccount(s) to which you allocate net purchase payments.
There is a separate subaccount which corresponds to each class of each fund of
the series. You may change your allocation without penalty or charges. Shares
of the funds will be sold at net asset value with no initial sales charge to
the VAA in order to fund the contracts. The series is required to redeem fund
shares at net asset value upon our request. We reserve the right to add,
delete or substitute funds.
Investment advisor
The investment advisor for the series is Capital Research and Management
Company (CRMC), 333 South Hope Street, Los Angeles, California 90071. CRMC is
one of the nation's largest and oldest investment management organizations. As
compensation for its services to the series, the investment advisor receives a
fee from the series which is accrued daily and paid monthly. This fee is based
on the net assets of each fund, as defined under Purchase and Redemption of
Shares, in the Prospectus for the series.
Description of the series
The series was organized as a Massachusetts business trust in 1983 and is
registered as a diversified, open-end management investment company under the
1940 Act. Diversified means not owning too great a percentage of the
securities of any one company. An open-end company is one which, in this case,
permits Lincoln Life to sell its shares back to the fund when you make a
withdrawal, surrender the contract or transfer from one fund to another.
Management investment company is the legal term for a mutual fund. These
definitions are very general. The precise legal definitions for these terms
are contained in the 1940 Act. The series has eleven separate portfolios of
funds. Fund assets are segregated and a shareholder's interest is limited to
those funds in which the shareholder owns shares. The series has adopted a
plan pursuant to Rule 18f-3 under the 1940 Act to permit the series to
establish a multiple class distribution system for all of its portfolios. The
series Board of Trustees may at any time establish additional funds or
classes, which may not be available to the VAA.
Under the multi-class system adopted by the series, shares of each multi-class
fund represent an equal pro rata interest in that fund and, generally, have
identical voting, dividend, liquidation, and other rights, preferences,
powers, restrictions, limitations, qualifications and terms and conditions,
except that: (1) each class has a different designation; (2) each class of
shares bears its class expenses; (3) each class has exclusive voting rights on
any matter submitted to shareholders that relates solely to its distribution
arrangement; and (4) each class has separate voting rights on any matter
submitted to shareholders in which the interests of one class differ from the
interests of any other class. Expenses currently designated as class expenses
by the series' Board of Trustees under the plan pursuant to Rule 18f-3
include, for example, service fees paid under a 12b-1 plan to cover servicing
fees paid to dealers selling the contracts as well as related expenses
incurred by Lincoln Life.
Each fund has two classes of shares, designated as Class 1 shares and Class 2
shares. Class 1 and 2 differ primarily in that Class 2 (but not Class 1)
shares are subject to a 12b-1 plan. Only Class 2 shares are available under
the contracts.
Certain funds offered as part of this contract have similar investment
objectives and policies to other portfolios, other than funds, that are
advised by the advisor. The investment results of the funds, however, may be
higher or lower than the other portfolios that are managed by the advisor.
There can be no assurance, and no representation is made, that the investment
results of any of the funds will be comparable to the investment results of
any other portfolio managed by the advisor.
Following are brief summaries of the investment objectives and policies of the
funds. Each fund is subject to certain investment policies and restrictions
which may not be changed without a majority vote of shareholders of that fund.
More detailed information may be obtained from the current Prospectus for the
series which is included in this booklet. Please be advised that there is no
assurance that any of the funds will achieve their stated objectives.
1. Global Growth Fund--The fund seeks to make your investment grow over time
by investing primarily in common stocks of companies located around the
world. The fund is designed for investors seeking capital appreciation
through stocks. Investors in the fund should have a long-term perspective
and be able to tolerate potentially wide price fluctuations.
2. Global Small Capitalization Fund--The fund seeks to make your investment
grow over time by investing primarily in stocks of smaller companies lo-
cated around the world that typically have market capitalizations of $50
million to $1.2 billion. The fund is designed for investors seeking capital
appreciation through stocks. Investors in the fund should have a long-term
perspective and be able to tolerate potentially wide price fluctuations.
3. Growth Fund--The fund seeks to make your investment grow by investing pri-
marily in common stocks of companies that appear to offer superior opportu-
nities for growth of capital. The fund is designed for investors seeking
capital appreciation through stocks. Investors in the fund should have a
long-term perspective and be able to tolerate potentially wide price fluc-
tuations.
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4. International Fund--The fund seeks to make your investment grow over time
by investing primarily in common stocks of companies located outside the
United States. The fund is designed for investors seeking capital apprecia-
tion through stocks. Investors in the fund should have a long-term perspec-
tive and be able to tolerate potentially wide price fluctuations.
5. New World Fund--The fund seeks to make your investment grow over time by
investing primarily in stocks of companies with significant exposure to
countries which have developing economies and/or markets. The fund may also
invest in debt securities of issuers, including issuers of high-yield,
high-risk bonds, in these countries. Please note: This fund may not be
available in all states. Please consult your investment dealer for current
information about its availability.
6. Growth-Income Fund--The fund seeks to make your investment grow and provide
you with income over time by investing primarily in common stocks or other
securities which demonstrate the potential for appreciation and/or divi-
dends. The fund is designed for investors seeking both capital appreciation
and income.
7. Asset Allocation Fund--The fund seeks to provide you with high total return
(including income and capital gains) consistent with preservation of capi-
tal over the long-term by investing in a diversified portfolio of common
stocks and other equity securities, bonds and other intermediate and long-
term debt securities, and money market instruments (debt securities matur-
ing in one year or less).
8. Bond Fund--The fund seeks to maximize your level of current income and pre-
serve your capital by investing primarily in bonds. The fund is designed
for investors seeking income and more price stability than stocks, and cap-
ital preservation over the long-term.
9. High-Yield Bond Fund--The fund seeks to provide you with a high level of
current income and secondarily capital appreciation by investing primarily
in lower quality debt securities (rated Ba or BB or below by Moody's In-
vestors Services, Inc. or Standard & Poor's Corporation), including those
of non-U.S. issuers. The fund may also invest in equity securities that
provide an opportunity for capital appreciation.
10. U.S. Government/AAA-Rated Securities Fund--The fund seeks to provide you
with a high level of current income, as well as preserve your investment.
The fund invests primarily in securities that are guaranteed by the "full
faith and credit" pledge of the U.S. Government and securities that are
rated AAA or Aaa by Moody's Investor's Services, Inc. or Standard & Poor's
Corporation or unrated but determined to be of equivalent quality.
11. Cash Management Fund--The fund seeks to provide you an opportunity to earn
income on your cash reserves while preserving the value of your investment
and maintaining liquidity by investing in a diversified selection of high
quality money market instruments.
Sale of fund shares
We will purchase shares of the funds at net asset value and direct them to the
appropriate subaccounts of the VAA. We will redeem sufficient shares of the
appropriate funds to pay annuity payouts, death benefits, surrender/withdrawal
proceeds or for other purposes described in the contract. If you want to
transfer all or part of your investment from one subaccount to another, we may
redeem shares held in the first and purchase shares of the other. The shares
are retired, but they may be reissued later.
Shares of the funds are not sold directly to the general public. They are sold
to Lincoln Life, and may be sold to other insurance companies, for investment
of the assets of the subaccounts established by those insurance companies to
fund variable annuity and variable life insurance contracts.
When the series sells shares in any of its funds both to variable annuity and
to variable life insurance separate accounts, it is said to engage in mixed
funding. When the series sells shares in any of its funds to separate accounts
of unaffiliated life insurance companies, it is said to engage in shared
funding.
The series currently engages in mixed and shared funding. Therefore, due to
differences in redemption rates or tax treatment, or other considerations, the
interests of various contractowners participating in a fund could conflict.
The series' Board of Trustees will monitor for the existence of any material
conflicts, and determine what action, if any, should be taken. See the
Prospectus for the series.
Reinvestment of dividends and capital gain distributions
All dividend and capital gain distributions of the funds are automatically
reinvested in shares of the distributing funds at their net asset value on the
date of distribution. Dividends are not paid out to contractowners as
additional units, but are reflected as changes in unit values.
Addition, deletion or substitution of investments
We reserve the right, within the law, to make additions, deletions and
substitutions for the series in which the VAA participates. (We may substitute
shares of other funds for shares already purchased, or to be purchased in the
future, under the contract. This
8
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substitution might occur if shares of a fund should no longer be available, or
if investment in any fund's shares should become inappropriate, in the judgment
of our management, for the purposes of the contract). We cannot substitute
shares of one fund for another without the approval by the SEC. We will also
notify you.
Charges and other deductions
We will deduct the charges described below to cover our costs and expenses,
services provided and risks assumed under the contracts. We incur certain costs
and expenses for the distribution and administration of the contracts and for
providing the benefits payable thereunder. More particularly, our
administrative services include: processing applications for and issuing the
contracts, processing purchases and redemptions of fund shares as required
(including dollar cost averaging, cross-reinvestment and automatic withdrawal
services), maintaining records, administering annuity payouts, furnishing
accounting and valuation services (including the calculation and monitoring of
daily subaccount values), reconciling and depositing cash receipts, providing
contract confirmations, providing toll-free inquiry services and furnishing
telephone fund transfer services. The risks we assume include: the risk that
annuitants receiving annuity payouts under contract live longer than we assumed
when we calculated our guaranteed rates (these rates are incorporated in the
contract and cannot be changed); the risk that death benefits paid under the
EGMDB will exceed the actual contract value; and the risk that our costs in
providing the services will exceed our revenues from the contract charges
(which we cannot change). The amount of a charge may not necessarily correspond
to the costs associated with providing the services or benefits indicated by
the description of the charge. For example, the sales charge collected may not
fully cover all of the sales and distribution expenses actually incurred by us.
Deductions from the VAA for American Legacy Shareholder's Advantage
We deduct from the VAA an amount, computed daily, which is equal to an annual
rate of 0.72% (0.60% for contracts without the EGMDB) of the daily net asset
value. The charge consists of a 0.10% administrative charge and a 0.62% (0.50%
for contract without the EGMDB) mortality and expense risk charge.
Sales charge
A front-end load, or sales charge, will be applied to all initial and
subsequent gross purchase payments that you may make. The charge is a
percentage of each gross purchase payment and is based on the owner's
investment at the time each gross purchase payment is made according to the
following scale:
<TABLE>
<CAPTION>
Sales
Owner's investment charge
- --------------------------------------------------------------------------------
<S> <C>
Under $50,000............................................................ 5.75%
$ 50,000-$ 99,999...................................................... 4.50%
$ 100,000-$249,999...................................................... 3.50%
$ 250,000-$499,999...................................................... 2.50%
$ 500,000-$999,999...................................................... 2.00%
$1,000,000 or greater.................................................... 1.00%
</TABLE>
The owner's investment is defined as the sum of:
a. the account values for any of the following individual Lincoln Life
contracts owned by an eligible owner (defined below) marketed under the
names of: The American Legacy Variable Annuity, American Legacy II Variable
Annuity, American Legacy III Variable Annuity, or American Legacy
Shareholder's Advantage Variable Annuity; plus
b. the amount (in dollars) of an eligible owner's investment in existing mutual
funds in The American Funds Group in accordance with the procedures
established by the American Funds Group; plus
c. the amount of the current gross purchase payment you are making into this
contract.
The American Funds Group will determine which of the mutual funds are included
in this program. Currently, direct purchases of money market funds are
excluded.
In determining the account values for the Lincoln Life annuity contracts, the
variable account values are valued as of the close of market on the last
previous day the market was open and are adjusted for current day transactions.
The fixed accounts will include interest accrued through the close of market on
the last previous day the market was open.
An eligible owner includes you as the owner of your American Legacy
Shareholder's Advantage contract, and, if you provide us with sufficient
identifying information (name and Social Security Number), eligible owner will
also include your spouse, and any of your children under the age of 21. If the
owner of any contract under (a) above is a non-natural owner and if you, your
spouse, or any children of yours under the age of 21 are the named annuitant,
then you may include these account values in the calculation of the owner's
investment for the contracts issued in one of the following IRS defined
markets: Roth IRA, traditional IRA, non-qualified, SEP and 403(b) transfers.
The non-natural owner will include the account values from contracts in all
other markets in its calculation of owner's investment.
No sales charge will be applied on contracts issued to employees and registered
representatives of any member of the selling group and their spouses and minor
children, or to officers, directors, trustees or
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bona-fide full-time employees and their spouses and minor children, of LNC or
The Capital Group, Inc. or their affiliated or managed companies (based upon
the contractowner's status at the time the contract was purchased).
Deductions for premium taxes
Any premium tax or other tax levied by any government entity as a result of the
existence of the contracts of the VAA will be deducted from the contract value
when incurred, or at another time of our choosing.
The applicable premium tax rates that states and other governmental entities
impose on the purchase of an annuity are subject to change by legislation, by
administration interpretation or by judicial action. These premium taxes
generally depend upon the law of your state of residence. The tax ranges from
0.5% to 5.0%.
Other charges and deductions
There are deductions from and expenses paid out of the assets of the underlying
series that are more fully described in the Prospectus for the series. Among
these deductions and expenses are 12b-1 fees which reimburse Lincoln Life for
certain expenses incurred in connection with certain administrative and
distribution support service provided to the series.
Additional information
The administrative and sales charges described previously may be reduced or
eliminated for any particular contract. However, these charges will be reduced
only to the extent that we anticipate lower distribution and/or administrative
expenses, or that we perform fewer sales or administrative services than those
originally contemplated in establishing the level of those charges. Lower
distribution and administrative expenses may be the result of economies
associated with (1) the use of mass enrollment procedures, (2) the performance
of administrative or sales functions by the employer, (3) the use by an
employer of automated techniques in submitting deposits or information related
to deposits on behalf of its employees or (4) any other circumstances which
reduce distribution or administrative expenses. The exact amount of
administrative and sales charges applicable to a particular contract will be
stated in that contract.
The contracts
Purchase of contracts
If you wish to purchase a contract, you must apply for it through a sales
representative authorized by us. The completed application is sent to us and we
decide whether to accept or reject it. If the application is accepted, a
contract is prepared and executed by our legally authorized officers. The
contract is then sent to you through your sales representative. See
Distribution of the contracts.
When a completed application and all other information necessary for processing
a purchase order is received, an initial gross purchase payment will be priced
no later than two business days after we receive the order. While attempting to
finish an incomplete application, we may hold the initial gross purchase
payment for no more than five business days. If the incomplete application
cannot be completed within those five days, you will be informed of the
reasons, and the gross purchase payment will be returned immediately. Once the
application is complete, the initial gross purchase payment must be priced
within two business days.
Who can invest
To apply for a contract, you must be of legal age in a state where the
contracts may be lawfully sold and also be eligible to participate in any of
the qualified or nonqualified plans for which the contracts are designed. The
contractowner, joint owner and annuitant must be less than age 90.
Purchase Payments
Gross purchase payments are payable to us at a frequency and in an amount
selected by you in the application. The minimum initial gross purchase payment
is $1,500 for nonqualified contracts and Section 403(b) transfers/rollovers;
and $300 for qualified contracts. The minimum annual amount for additional
gross purchase payments for nonqualified and qualified contracts is $300. The
minimum payment to the contract at any one time must be at least $100 ($25 if
transmitted electronically). Gross purchase payments in total may not exceed
$2,000,000 for an owner or $1,000,000 for each joint owner. If you stop making
gross purchase payments, the contract will remain in force as a paid-up
contract. However, we may terminate the contract as allowed by your state's
non-forfeiture law for individual deferred annuities. Payments may be made or,
if stopped, resumed at any time until the annuity commencement date, the
surrender of the contract, maturity date or the payment of any death benefit,
whichever comes first.
Valuation date
Accumulation and annuity units will be valued once daily at the close of
trading (currently 4:00 p.m., New York time) on each day the New York Stock
Exchange is open (valuation date). On any date other than a valuation date, the
accumulation unit value and the annuity unit value will not change.
Allocation of purchase payments
Net purchase payments are placed into the VAA's subaccounts, each of which
invests in shares of its corresponding fund of the series, according to your
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instructions. You may also allocate net purchase payments into the DCA fixed
account.
The minimum amount of any net purchase payment that can be put into any one
subaccount is $20. Upon allocation to a subaccount, net purchase payments are
converted into accumulation units. The number of accumulation units credited is
determined by dividing the amount allocated to each subaccount by the value of
an accumulation unit for that subaccount on the valuation date on which the
gross purchase payment is received at our home office if received before 4:00
p.m., New York time. If the gross purchase payment is received at or after 4:00
p.m., New York time, we will use the accumulation unit value computed on the
next valuation date. The number of accumulation units determined in this way is
not changed by any subsequent change in the value of an accumulation unit.
However, the dollar value of an accumulation unit will vary depending not only
upon how well the underlying fund's investment perform, but also upon the
expenses of the VAA and the underlying funds.
Valuation of accumulation units
Net purchase payments allocated to the VAA are converted into accumulation
units. This is done by dividing each net purchase payment by the value of an
accumulation unit for the valuation period during which the net purchase
payment is allocated to the VAA. The accumulation unit value for each
subaccount was or will be established at the inception of the subaccount. It
may increase or decrease from valuation period to valuation period. The
accumulation unit value for a subaccount for a later valuation period is
determined as follows:
(1) The total value of the fund shares held in the subaccount is calculated by
multiplying the number of fund shares owned by the subaccount at the
beginning of the valuation period by the net asset value per share of the
fund at the end of the valuation period, and adding any dividend or other
distribution of the fund if an ex-dividend date occurs during the valuation
period; minus
(2) The liabilities of the subaccount at the end of the valuation period; these
liabilities include daily charges imposed on the subaccount, and may
include a charge or credit with respect to any taxes paid or reserved for
by us that we determine result from the operations of the VAA; and
(3) The result of (2) is divided by the number of subaccount units outstanding
at the beginning of the valuation period.
The daily charges imposed on a subaccount for any valuation period are equal to
the daily mortality and expense risk charge and the daily administrative charge
multiplied by the number of calendar days in the valuation period. Because a
different daily charge is made for contracts with the EGMDB than for those
without, each of the two types of contracts will have different corresponding
accumulation unit values on any given day.
Transfers on or before the annuity commencement date
You may transfer all or a portion of your investment from one subaccount to
another. A transfer involves the surrender of accumulation units in one
subaccount or the withdrawal of money from the DCA fixed account and the
purchase of accumulation units in the other subaccount or the application of
proceeds to the DCA fixed account. A transfer will be done using the respective
accumulation unit values determined at the end of the valuation date on which
the transfer request is received. Currently, there is no charge for a transfer.
However, we reserve the right to impose a charge in the future for transfers.
Transfers between subaccounts are restricted to six times every contract year.
We reserve the right to waive this six-time limit. This limit does not apply to
transfers made under a dollar cost averaging or cross re-investment program
elected on forms available from us. (The SAI contains more information about
these programs.) The minimum amount that may be transferred between subaccounts
is $300 (or the entire amount in the subaccount, if less than $300). If the
transfer from a subaccount would leave you with less than $300 in the
subaccount, we may transfer the entire balance of the subaccount.
A transfer may be made in writing to our home office or, if a Telephone
Exchange Authorization form (available from us) is on file with us, by a toll-
free telephone call. In order to prevent unauthorized or fraudulent telephone
transfers, we may require the caller to provide certain identifying information
before we will act upon their instructions. We may also assign the
contractowner a Personal Identification Number (PIN) to serve as
identification. We will not be liable for following telephone instructions we
reasonably believe are genuine. Telephone requests may be recorded and written
confirmation of all transfer requests will be mailed to the contractowner on
the next valuation date. Telephone transfers will be processed on the valuation
date that they are received when they are received at our customer service
center before 4 p.m. New York time.
When thinking about a transfer of contract value, you should consider the
inherent risk involved. Frequent transfers based on short-term expectations may
increase the risk that a transfer will be made at an inopportune time.
Transfers after the annuity commencement date
You may transfer all or a portion of your investment in one subaccount to
another subaccount in the VAA or to the fixed side of the contract. Those
transfers will be limited to three times per contract year. Currently, there
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<PAGE>
is no charge for those transfers. However, we reserve the right to impose a
charge. No transfers are allowed from the fixed side of the account to the
subaccounts.
Death benefit before the annuity commencement date
You may designate a beneficiary during your lifetime and change the beneficiary
by filing a written request with our home office. Each change of beneficiary
revokes any previous designation. We reserve the right to request that you send
us the contract for endorsement of a change of beneficiary.
Upon the death of the contract owner, a death benefit will be paid to the
beneficiary. Upon the death of a joint owner, the death benefit will be paid to
the surviving joint owner. Upon the death of an annuitant who is not the
contract owner or joint owner, a death benefit may be paid to the contract
owner (and joint owner, if applicable, in equal shares). If the contract owner
is a corporation or other non-individual (non-natural person), the death of the
annuitant will be treated as death of the contract owner.
If the death occurs before the annuity commencement date and the enhanced
guaranteed minimum death benefit (EGMDB) is in effect, the death benefit paid
will be the greater of: (1) the contract value as of the day on which Lincoln
Life approves the payment of the claim; or (2) the highest contract value which
the contract attains on any policy anniversary date (including the amount of
the initial gross purchase payment on the inception date) on ages up to, and
including, the deceased's age 80. The highest contract value is increased by
gross purchase payments and is decreased by partial withdrawals, partial
annuitizations, and any premium taxes made, effected or incurred subsequent to
the anniversary date on which the highest contract value is obtained. If the
EGMDB is not in effect, the death benefit will be equal to the greater of
contract value or the guaranteed minimum death benefit (GMDB). The GMDB is
equal to the sum of all gross purchase payments minus any withdrawals, partial
annuitizations or premium taxes incurred.
If there are joint owners, upon the death of the first contract owner, Lincoln
Life will pay a death benefit to the surviving joint owner. The surviving joint
owner will be treated as the primary, designated beneficiary. Any other
beneficiary designation on record at the time of death will be treated as a
contingent beneficiary. If the surviving joint owner is the spouse of the
deceased joint owner he/she may continue the contract as a sole contract owner.
Upon the death of the spouse who continues the contract, Lincoln Life will pay
a death benefit to the designated beneficiary(s).
If the beneficiary is the spouse of the contract owner, then the spouse may
elect to continue the contract as contract owner.
Upon the death of a contract owner, joint owner or annuitant, if the surviving
spouse continues the contract, any portion of the death benefit that would have
been payable (if the contract had not been continued) that exceeds the current
contract value will be credited to the contract. This provision applies only
one time for each contract.
If an annuitant who is not the contract owner or a joint owner dies, then the
contingent annuitant, if named,
becomes the annuitant and no death benefit is payable on the death of the
annuitant. If no contingent annuitant is named, the contract owner (or younger
of joint owners) becomes the annuitant. Alternatively, a death benefit may be
paid to the contract owner (and joint owner, if applicable, in equal shares) if
the annuitant named on this contract has not been changed, except on death of a
prior annuitant. Notification of the election of this death benefit must be
received by LNL within 75 days of the death of the annuitant. If no contract
owner is living on the date of death of the annuitant, the death benefit will
be available to the beneficiary. The contract terminates when any death benefit
is paid due to the death of the annuitant. A death benefit payable on the death
of the annuitant will not be paid if the annuitant has been changed subsequent
to the effective date of this contract unless the change occurred because of
the death of a prior annuitant.
The value of the death benefit will be determined as of the date on which the
death claim is approved for payment. This payment will occur upon receipt of:
(1) proof (e.g. an original certified death certificate), or any other proof of
death satisfactory to us, of the death; (2) written authorization for payment;
and (3) our receipt of all required claim forms, fully completed. If the
beneficiary is a minor, court documents appointing the guardian/custodian must
be submitted.
When applying for a contract, an applicant can request a contract without the
EGMDB. The EGMDB is not available under contracts used for qualified plans
(other than IRAs) or contracts issued to a contract owner, joint owner or
annuitant who is age 80 or older at the time of issue.
After a contract is issued, the contract owner may discontinue the EGMDB at any
time by completing the Enhanced Guaranteed Minimum Death Benefit Discontinuance
form and sending it to Lincoln Life. The benefit will be discontinued as of the
valuation date we receive the request, and we will stop deducting the charge
for the benefit as of that date. See Charges and other deductions. If you
discontinue the benefit, it cannot be reinstated.
Unless otherwise provided in the beneficiary designation, one of the following
procedures will take place on the death of a beneficiary:
(1) If any beneficiary dies before the contract owner, that beneficiary's
interest will go to any other beneficiaries
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named, according to their respective interest; and/or
(2) If no beneficiary survives the contract owner, the proceeds will be paid to
the contract owner's estate.
Unless the contractowner has already selected a settlement option, the
beneficiary may choose the method of payment of the death benefit. The death
benefit payable to the beneficiary or joint owner must be distributed within
five years of the contract owner's date of death unless the beneficiary begins
receiving within one year of the contract owner's death the distribution in the
form of a life annuity or an annuity for a designated period not extending
beyond the beneficiary's life expectancy.
The death benefit payable on the death of the annuitant will be distributed in
either a lump sum or under an annuity payout. The annuity payout must be
selected within 60 days after LNL has approved the death claim.
If a lump sum settlement is elected, the proceeds will be mailed within seven
days of approval by us of the claim, subject to the laws, regulations and tax
code governing payment of death benefits. This payment may be postponed as
permitted by the Investment Company Act of 1940.
Joint ownership
If a joint owner is named in the application, the joint owners shall be treated
as having equal undivided interests in the contract. Either owner,
independently of the other, may exercise ownership rights in this contract.
Surrenders and withdrawals
Before the annuity commencement date, we will allow the surrender of the
contract or a withdrawal of the contract value upon your written request,
subject to the rules discussed below. The surrender/withdrawal option is not
available after the annuity commencement date.
The amount available upon the surrender/withdrawal is the cash surrender value
(contract value less any applicable charges, fees and taxes) at the end of the
valuation period during which the written request for surrender/withdrawal is
received at the home office. Unless a request for withdrawal specifies
otherwise, withdrawals will be made from all subaccounts within the VAA and
from the DCA fixed account in the same proportion that the amount of withdrawal
bears to the total contract value. Unless prohibited, surrender/withdrawal
payments will be mailed within seven days after we receive a valid written
request at the home office. The payment may be postponed as permitted by the
1940 Act. Contract proceeds from the VAA will be paid within seven days, except
(i) when the NYSE is closed (except weekends and holidays); (ii) times when
market trading is restricted or the SEC declares an emergency, and we cannot
value units or the funds cannot redeem shares; or (iii) when the SEC so orders
to protect contractowners.
The tax consequences of a surrender/withdrawal are discussed late in this
booklet. See Federal tax status.
Special restrictions on surrenders/withdrawals apply if your contract is
purchased as part of a retirement plan of a public school system or 501(c)(3)
organization under Section 403(b) of the tax code. Beginning January 1, 1989,
in order for a contract to retain its tax-qualified status, Section 403(b)
prohibits a withdrawal from a 403(b) contract of post-1988 contributions (and
earnings on those contributions) pursuant to a salary reduction agreement.
However, this restriction does not apply if the annuitant (a) attains age 59
1/2, (b) separates from service, (c) dies, (d) becomes totally and permanently
disabled and/or (e) experiences financial hardship (in which event the income
attributable to those contributions may not be withdrawn).
Pre-1989 contributions and earnings through December 31, 1988, are not subject
to the previously stated restriction. Funds transferred to the contract from a
403(b)(7) custodial account will be subject to restrictions. The minimum
withdrawal is $300. Lincoln Life reserves the right to surrender this contract
if any withdrawal reduces the total contract value to a level at which this
contract may be surrendered in accordance with applicable law for individual
deferred annuities.
Participants in the Texas Optional Retirement Program should refer to the
Restrictions under the Texas Optional Retirement Program, later in this
Prospectus booklet.
Delay of payments
Contract proceeds from the VAA will be paid within seven days, except (i) when
the NYSE is closed (except weekends and holidays); (ii) times when the market
trading is restricted or the SEC declares an emergency, and we cannot value
units or the funds cannot redeem shares; or (iii) when the SEC so orders to
protect contract owners.
Reinvestment privilege
You may elect to make a reinvestment purchase with any part of the proceeds of
a surrender/withdrawal, without a new sales charge. This election must be made
within 30 days of the date of the surrender/withdrawal, and the repurchase must
be of a contract covered by this Prospectus. A representation must be made that
the proceeds being used to make the purchase have retained their tax-favored
status under an arrangement for which the contracts offered by this Prospectus
are designed. The number of accumulation units which will be credited when the
proceeds are reinvested will be based on the value of the accumulation unit(s)
on the next valuation date. This computation will occur following receipt of
the
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proceeds and request for reinvestment at the home office. You may utilize the
reinvestment privilege only once. For tax reporting purposes, we will treat a
surrender/withdrawal and a subsequent reinvestment purchase as separate
transactions. You should consult a tax advisor before you request a
surrender/withdrawal or subsequent reinvestment purchase.
Amendment of contract
We reserve the right to amend the contract to meet the requirements of the 1940
Act or other applicable federal or state laws or regulations. You will be
notified in writing of any changes, modifications or waivers.
Commissions
The commissions paid to dealers are a maximum of 5.00% of each gross purchase
payment; plus an annual continuing commission of up to 0.25% of contract value.
At times, additional sales incentives (up to 0.25% of each gross purchase
payment and an annual continuing 0.10% of contract value) may be provided to
dealers maintaining certain sales volume levels. Upon annuitization, an annual
continuing commission of up to 0.80% (or up to 0.90% for dealers maintaining
certain sales volumes levels) of statutory reserves can be paid to dealers.
These commissions are not deducted from gross purchase payments or contract
value; they are paid by us.
Ownership
As contractowner, you have all rights under the contract. According to Indiana
law, the assets of the VAA are held for the exclusive benefit of all
contractowners and their designated beneficiaries; and the assets of the VAA
are not chargeable with liabilities arising from any other business that we may
conduct. Qualified contracts may not be assigned or transferred except as
permitted by the Employee Retirement Income Security Act (ERISA) of 1974 and
upon written notification to us. Nonqualified contracts may not be collaterally
assigned. We assume no responsibility for the validity or affect of any
assignment. Consult your tax advisor about the tax consequence of an
assignment.
Contractowner questions
The obligations to purchasers under the contracts are those of Lincoln Life.
Questions about your contract should be directed to us at 1-800-942-5500.
Annuity payouts
When you apply for a contract, you may select any annuity commencement date
permitted by law. (Please note the following exception: Contracts issued under
qualified employee pension and profit-sharing trusts [described in the Section
401(a) and tax exempt under Section 501(a) of the tax code] and qualified
annuity plans [described in Section 403(a) of the tax code], including H.R. 10
trusts and plans covering self-employed individuals and their employees,
provide for annuity payouts to start at the date and under the option
specified.)
The contract provides optional forms of payouts of annuities (annuity options),
each of which is payable on a variable basis, fixed basis or a combination of
both as you specify. The contract provides that all or part of the contract
value may be used to purchase an annuity.
You may elect annuity payouts in monthly, quarterly, semiannual or annual
installments. If the payouts from any subaccount would be or become less than
$50, we have the right to reduce their frequency until the payouts are at least
$50 each. Following are explanations of the annuity options available.
Annuity options
Life Annuity. This option offers a periodic payout during the lifetime of the
annuitant and ends with the last payout before the death of the annuitant. This
option offers the highest periodic payout since there is no guarantee of a
minimum number of payouts or provision for a death benefit for beneficiaries.
However, there is the risk under this option that the recipient would receive
no payouts if the annuitant dies before the date set for the first payout; only
one payout if death occurs before the second scheduled payout, and so on.
Life Income with Payouts Guaranteed for Designated Period. This option
guarantees periodic payouts during a designated period, usually 10 or 20 years,
and then continues throughout the lifetime of the annuitant. The designated
period is selected by the contractowner.
Joint Life Annuity. This option offers a periodic payout during the joint
lifetime of the annuitant and a designated joint annuitant. The payouts
continue during the lifetime of the survivor.
Joint Life Annuity with Guaranteed Period. This option guarantees periodic
payouts during a designated period, usually 10 or 20 years, and continues
during the joint lifetime of the annuitant and a designated joint annuitant.
The payouts continue during the lifetime of the survivor. The designated period
is elected by the contractowner.
Joint and Two-Thirds Survivor Annuity. This option provides a periodic payout
during the joint lifetime of the annuitant and a designated joint annuitant.
When one of the joint annuitants dies, the survivor receives two-thirds of the
periodic payout made when both were alive.
Unit Refund Life Annuity. This option offers a periodic payout during the
lifetime of the annuitant with the guarantee that upon death a payout will be
made of the value of the number of annuity units (see Variable annuity payouts)
equal to the excess, if any, of: (a) the total amount applied under this option
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divided by the annuity unit value for the date payouts begin, divided by (b)
the annuity units represented by each payout to the annuitant multiplied by the
number of payouts paid before death. The value of the number of annuity units
is computed on the date the death claim is approved for payment by the home
office.
General Information
Under the options listed above, you may not make withdrawals. Other options,
with or without withdrawal features, may be made available by us. You may pre-
select an annuity payout option as a method of paying the death benefit to a
beneficiary. If you do, the beneficiary cannot change this payout option. At
death, options are only available to the extent they are consistent with the
requirements of the contract as well as Sections 72(s) and 401(a)(9) of the tax
code, if applicable. The mortality and expense risk charge and the charge for
administrative services will be assessed on all variable annuity payouts,
including options that may be offered that do not have a life contingency and
therefore no mortality risk.
The annuity commencement date is usually on or before the contractowner's 90th
birthday. You may change the annuity commencement date, change the annuity
option or change the allocation of the investment among subaccounts up to 30
days before the scheduled annuity commencement date, upon written notice to the
home office. You must give us at least 30 days notice before the date on which
you want payouts to begin. If proceeds become available to a beneficiary in a
lump sum, the beneficiary may choose any annuity payout option.
Unless you select another option, the contract automatically provides for a
life annuity with annuity payouts guaranteed for 10 years (on a fixed, variable
or combination fixed and variable basis, in proportion to the account
allocations at the time of annuitization) except when a joint life payout is
required by law. Under any option providing for guaranteed period payouts, the
number of payouts which remain unpaid at the date of the annuitant's death (or
surviving annuitant's death in case of joint life annuity) will be paid to you,
if living, otherwise to your beneficiary as payouts become due.
Variable annuity payouts
Variable annuity payouts will be determined using:
1. The contract value on the annuity commencement date;
2. The annuity tables contained in the contract;
3. The annuity option selected; and
4. The investment performance of the fund(s) selected.
To determine the amount of payouts, we make this calculation:
1. Determine the dollar amount of the first periodic payout; then
2. Credit the contract with a fixed number of annuity units equal to the first
periodic payout divided by the annuity unit value; and
3. Calculate the value of the annuity units each period thereafter.
We assume an investment return of 4% per year, as applied to the applicable
mortality table. The amount of each payout after the initial payout will depend
upon how the underlying fund(s) perform, relative to the 4% assumed rate. If
the actual net investment rate (annualized) exceeds 4%, the payment will
increase at a rate proportional to the amount of such excess. Conversely, if
the actual rate is less than 4%, annuity payouts will decrease. There is a more
complete explanation of this calculation in the SAI.
Federal tax matters
Introduction
The Federal income tax treatment of the contract is complex and sometimes
uncertain. The Federal income tax rules may vary with your particular
circumstances. This discussion does not include all the Federal income tax
rules that may affect you and your contract. This discussion also does not
address other Federal tax consequences, or state or local tax consequences,
associated with the contract. As a result, you should always consult a tax
advisor about the application of tax rules to your individual situation.
Taxation of nonqualified annuities
This part of the discussion describes some of the Federal income tax rules
applicable to nonqualified annuities. A nonqualified annuity is a contract not
issued in connection with a qualified retirement plan receiving special tax
treatment under the tax code, such as an IRA or a section 403(b) plan.
Tax deferral on earnings
The Federal income tax law generally does not tax any increase in your contract
value until you receive a contract distribution. However, for this general rule
to apply, certain requirements must be satisfied:
. An individual must own the contract (or the tax law must treat the contract
as owned by the individual).
. The investments of the VAA must be "adequately diversified" in accordance
with IRS regulations.
. Your right to choose particular investments for a contract must be limited.
. The annuity commencement date must not occur near the end of the annuitant's
life expectancy.
Contracts not owned by the individual
If a contract is owned by an entity (rather than an individual) the tax code
generally does not treat it as
15
<PAGE>
an annuity contract for Federal income tax purposes. This means that the entity
owning the contract pays tax currently on the excess of the contract value over
the gross purchase payments for the contract. Examples of contracts where the
owner pays current tax on the contract's earnings are contracts issued to a
corporation or a trust. Exceptions to this rule exist. For example, the tax
code treats a contract as owned by an individual if the named owner is a trust
or other entity that holds the contract as an agent for an individual. However,
this exception does not apply in the case of any employer that owns a contract
to provide deferred compensation for its employees.
Investments in the VAA must be diversified
For a contact to be treated as an annuity for Federal income tax purposes, the
investments of the VAA must be "adequately diversified." IRS regulations define
standards for determining whether the investments of the VAA are adequately
diversified. If the VAA fails to comply with these diversification standards,
you could be required to pay tax currently on the excess of the contract value
over the contract gross purchase payments. Although we do not control the
investments of the underlying investment options, we expect that the underlying
investment options will comply with the IRS regulations so that the VAA will be
considered "adequately diversified."
Restrictions
Federal income tax law limits your right to choose particular investments for
the contract. Because the IRS has not issued guidance specifying those limits,
the limits are uncertain and your right to allocate contract value among
subaccounts may exceed those limits. If so, you would be treated as the owner
of the assets of the VAA and thus subject to current taxation on the income and
gains from those assets. We do not know what limits may be set by the IRS in
any guidance that it may issue and whether any such limits will apply to
existing contracts. We reserve the right to modify the contract without your
consent to try to prevent the tax law from considering you as the owner of the
assets of the VAA.
Age at which annuity payouts begin
Federal income tax rules do not expressly identify a particular age by which
annuity payouts must begin. However, those rules do require that an annuity
contract provide for amortization, through annuity payouts, of the contract's
gross purchase payments and earnings. If annuity payouts under the contract
begin or are scheduled to begin on a date past the annuitant's 85th birthday,
it is possible that the tax law will not treat the contract as an annuity for
Federal income tax purposes. In that event, you would be currently taxable on
the excess of the contract value over the gross purchase payments of the
contract.
Tax treatment of payments
We make no guarantees regarding the tax treatment of any contract or of any
transaction involving a contract. However, the rest of this discussion assumes
that your contract will be treated as an annuity for Federal income tax
purposes and that the tax law will not tax any increase in your contract value
until there is a distribution from your contract.
Taxation of withdrawals and surrenders
You will pay tax on withdrawals to the extent your contract value exceeds your
gross purchase payments in the contract. This income (and all other income from
your contract) is considered ordinary income. A higher rate of tax is paid on
ordinary income than on capital gains. You will pay tax on a surrender to the
extent the amount you receive extends your gross purchase payments. In certain
circumstances, your gross purchase payments are reduced by amounts received
from your contract that were not included in income.
Taxation of annuity payouts
The tax code imposes tax on a portion of each annuity payout (at ordinary tax
rates) and treats a portion as a nontaxable return of your gross purchase
payments in the contract. We will notify you annually of the taxable amount of
your annuity payout. Once you have recovered the total amount of the gross
purchase payment in the contract, you will pay tax on the full amount of your
annuity payouts. If annuity payouts end because of the annuitant's death and
before the total amount of the gross purchase payments in the contract has been
received, the amount not received generally will be deductible.
Taxation of death benefits
We may distribute amounts from your contract because of the death of a
contractowner or an annuitant. The tax treatment of these amounts depends on
whether you or the annuitant dies before or after the annuity commencement
date.
. Death prior to the annuity commencement date--
. If the beneficiary receives death benefits under an annuity payout option,
they are taxed in the same manner as annuity payouts.
. If the beneficiary does not receive death benefits under an annuity payout
option, they are taxed in the same manner as withdrawal.
. Death after the annuity commencement date--
. If death benefits are received in accordance with the existing annuity
payout option, they are excludible from income if they do not exceed the
gross purchase payments not yet distributed from the contract. All annuity
payouts in excess of the gross purchase payments not previously received
are includible in income.
16
<PAGE>
. If death benefits are received in a lump sum, the tax law imposes tax on
the amount of death benefits which exceeds the amount of gross purchase
payments not previously received.
Penalty taxes payable on withdrawals, surrenders, or annuity payouts
The tax code may impose a 10% penalty tax on any distribution from your
contract which you must include in your gross income. The 10% penalty tax does
not apply if one of several exceptions exists. These exceptions include
withdrawals, surrenders or annuity payouts that:
. you receive on or after you reach age 59 1/2,
. you receive because you became disabled (as defined in the tax law),
. a beneficiary receives on or after your death, or
. you receive as a series of substantially equal periodic payments for life (or
life expectancy).
Special rules if you own more than one annuity contract
In certain circumstances, you must combine some or all of the nonqualified
annuity contracts you own in order to determine the amount of an annuity
payout, a surrender or a withdrawal that you must include in income. For
example, if you purchase two or more deferred annuity contracts from the same
life insurance company (or its affiliates) during any calendar year, the tax
code treats all such contracts as one contract. Treating two or more contracts
as one contract could affect the amount of a surrender, withdrawal or an
annuity payout that you must include in income and the amount that might be
subject to the penalty tax described above.
Loans and assignments
Except for certain qualified contracts, the tax code treats any amount received
as a loan under a contract, and any assignments or pledge (or agreement to
assign or pledge) any portion of your contract value, as withdrawal of such
amount or portion.
Gifting a contract
If you transfer ownership of your contract to a person other than your spouse
(or to your former spouse incident to divorce), and receive a payment less than
your contract's value, you will pay tax on your contract value to the extent it
exceeds your gross purchase payments not previously received. The new owner's
gross purchase payments in the contract would then be increased to reflect the
amount included in income.
Charges for a contract's death benefit
Your contract may have an EGMDB, for which you pay an annual charge, computed
daily. It is possible that the tax law may treat all or a portion of the EGMDB
charge as a contract withdrawal.
Loss of income deduction
After June 8, 1997, if a contract is issued to a taxpayer that is not an
individual, or if a contract is held for the benefit of an entity, the entity
will lose a portion of its deduction for otherwise deductible interest
expenses. This disallowance does not apply if you pay tax on the annual
increase in the contract value. Entities that are considering purchasing a
contract, or entities that will benefit from someone else's ownership of a
contract, should consult a tax advisor.
Qualified retirement plans
We also designed the contracts for use in connection with certain types of
retirement plans that receive favorable treatment under the tax code. Contracts
issued to or in connection with a qualified retirement plan are called
"qualified contracts." We issue contracts for use with different types of
qualified plans. The Federal income tax rules applicable to those plans are
complex and varied. As a result, this Prospectus does not attempt to provide
more than general information about use of the contract with various types of
qualified plans. Persons planning to use the contract in connection with a
qualified plan should obtain advice from a competent tax advisor.
Types of qualified contracts and terms of contracts
Currently, we may issue contracts in connection with the following types of
qualified plans:
. Individual Retirement Accounts and Annuities ("Traditional IRAs")
. Roth IRAs
. Simplified Employee Pensions ("SEPs")
. Savings Incentive Matched Plan for Employees ("SIMPLE 401(k) plans")
. Public School system and tax-exempt organization annuity plans ("403(b)
plans")
. Qualified corporate employee pension and profit sharing plans ("401(a)
plans") and qualified annuity plans ("403(a) plans")
. Self-employed individual plans ("H.R. 10 plans" or "Keogh Plans")
. Deferred compensation plans of state and local governments and tax-exempt
organizations ("457 plans").
Section 403(b) business will normally be accepted only for purchase payments
qualifying as a 403(b) lump sum transfer or rollover. We may issue a contract
for use with other types of qualified plans in the future.
We will amend contracts to be used with a qualified plan as generally necessary
to conform to tax law requirements for the type of plan. However, the rights
17
<PAGE>
of a person to any qualified plan benefits may be subject to the plan's terms
and conditions, regardless of the contract's terms and conditions. In addition,
we are not bound by the terms and conditions of qualified plans to the extent
such terms and conditions contradict the contract, unless we consent.
Tax treatment of qualified contracts
The Federal income tax rules applicable to qualified plans and qualified
contracts vary with the type of plan and contract. For example,
. Federal tax rules limit the amount of purchase payments that can be made, and
the tax deduction or exclusion that may be allowed for the gross purchase
payments. These limits vary depending on the type of qualified plan and the
plan participant's specific circumstances, e.g., the participant's
compensation.
. Under most qualified plans, e.g., 403(b) plans and Traditional IRAs, the
annuitant must begin receiving payments from the contract in certain minimum
amounts by a certain age, typically age 70 1/2. However, these "minimum
distribution rules" do not apply to a Roth IRA.
. Loans are allowed under certain types of qualified plans, but Federal income
tax rules prohibit loans under other types of qualified plans. For example,
Federal income tax rules permit loans under some section 403(b) plans, but
prohibit loans under Traditional and Roth IRAs. If allowed, loans are subject
to a variety of limitations, including restrictions as to the loan amount,
the loan's duration, and the manner of repayment. Your contract or plan may
or may not permit loans.
Tax treatment of payments
Federal income tax rules generally include distributions from a qualified
contract in the recipient's income as ordinary income. These taxable
distributions will include gross purchase payments that were deductible or
excludible from income. Thus, under many qualified contracts the total amount
received is included in income since a deduction or exclusion from income was
taken for gross purchase payments. There are exceptions. For example, you do
not include amounts received from a Roth IRA in income if certain conditions
are satisfied.
Failure to comply with the minimum distribution rules applicable to certain
qualified plans, such as Traditional IRAs, will result in the imposition of an
excise tax. This excise tax generally equals 50% of the amount by which a
minimum required distribution exceeds the actual distribution from the
qualified plan.
Federal penalty taxes payable on distributions
The tax code may impose a 10% penalty tax on the amount received from the
qualified contract that must be included in income. The tax code does not
impose the penalty tax if one of several exceptions applies. The exceptions
vary depending on the type of qualified contract you purchase. For example, in
the case of an IRA, exceptions provide that the penalty tax does not apply to a
withdrawal, surrender or annuity payout:
. received on or after the annuitant reaches age 59 1/2,
. received on or after the annuitant's death or because of the annuitant's
disability (as defined in the tax law),
. received as a series of substantially equal periodic payments for the
annuitant's life (or life expectancy), or
. received as reimbursement for certain amounts paid for medical care.
These exceptions, as well as certain others not described here, generally apply
to taxable distributions from other qualified plans. However, the specific
requirements of the exception may vary.
Transfers and direct rollovers
In many circumstances, money may be moved between qualified contracts and
qualified plans by means of a rollover or transfer. Special rules apply to such
rollovers and transfers. If the applicable rules are not followed, you may
suffer adverse Federal income tax consequences, including paying taxes which
might not otherwise have had to be paid. A qualified advisor should always be
consulted before you move or attempt to move funds between any qualified plan
or contract and another qualified plan or contract.
The direct rollover rules apply to certain payments (called "eligible rollover
distributions") from section 401(a) plans, section 403(a) or (b) plans, H.R. 10
plans and contracts used in connection with these types of plans. (The direct
rollover rules do not apply to distributions from IRAs or section 457 plans.)
The direct rollover rules require that we withhold Federal income tax equal to
20% of the eligible rollover distribution from the distribution amount, unless
you elect to have the amount directly transferred to certain qualified plans or
contracts. Before we send a rollover distribution, we will provide the
recipient with a notice explaining these requirements and how the 20%
withholding can be avoided by electing a direct rollover.
The EGMDB and IRAs
Pursuant to IRS regulations, IRAs may not invest in life insurance contracts.
We do not believe that these regulations prohibit the EGMDB from being provided
under the contracts when we issue the contract as Traditional IRAs or Roth
IRAs. However, the law is unclear and it is possible that the presence of the
EGMDB under a contract issued as a Traditional IRA or Roth IRA could result in
increased taxes to you.
Federal income tax withholding
We will withhold and remit to the IRS a part of the taxable portion of each
distribution made under a
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<PAGE>
contract unless the distributee notifies us at or before the time of the
distribution that tax is not to be withheld. In certain circumstances, Federal
income tax rules may require us to withhold tax. At the time a withdrawal,
surrender or annuity payout is requested, we will give the recipient an
explanation of the withholding requirements.
Tax status of Lincoln Life
Under existing Federal income tax laws, Lincoln Life does not pay tax on
investment income and realized capital gains of the VAA. Lincoln Life does not
expect that it will incur any Federal income tax liability on the income and
gains earned by the VAA. We, therefore, do not impose a charge for Federal
income taxes. If Federal income tax law changes and we must pay tax on some or
all of the income and gains earned by the VAA, we may impose a charge against
the VAA to pay the taxes.
Changes in law
The above discussion is based on the tax code, IRS regulations and
interpretations existing on the date of this Prospectus. However, Congress, The
IRS and the courts may modify these authorities, sometimes retroactively.
Voting rights
As required by law, we will vote the series shares held in the VAA at meetings
of the shareholders of the series. The voting will be done according to the
instructions of contractowners who have interests in the subaccounts which
invest in classes of funds of the series. If the 1940 Act or any regulation
under it should be amended or if present interpretations should be amended or
if present interpretations should change, and if as a result we determine that
we are permitted to vote the series shares in our own right, we may elect to do
so.
The number of votes which you have the right to cast will be determined by
applying your percentage interest in a subaccount to the total number of votes
attributable to the subaccount. In determining the number of votes, fractional
shares will be recognized.
Series shares of a class held in a subaccount for which no timely instructions
are received will be voted by us in proportion to the voting instructions which
are received for all contracts participating in that subaccount. Voting
instructions to abstain on any item to be voted on will be applied on a pro-
rata basis to reduce the number of votes eligible to be cast.
Whenever a shareholders meeting is called, each person having a voting interest
in a subaccount will receive proxy voting material, reports and other materials
relating to the series. Since the series engages in shared funding, other
persons or entities besides Lincoln Life may vote series shares. See Sale of
fund shares by the series.
Distribution of the contracts
American Funds Distributors, Inc. (AFD), 333 South Hope Street, Los Angeles, CA
90071, is the distributor and principal underwriter of the contracts. They will
be sold by properly licensed registered representatives of independent broker-
dealers which in turn have selling agreements with AFD and have been licensed
by state insurance departments to represent us. AFD is registered with the SEC
under the Securities Exchange Act of 1934 as a broker-dealer and is a member of
the National Association of Securities Dealers (NASD). Lincoln Life will offer
contracts in all states where it is licensed to do business.
Return Privilege
Within the free-look period after you receive the contract, you may cancel it
for any reason by delivering or mailing it postage prepaid, to the home office
at P.O. Box 2348, 1300 South Clinton Street, Fort Wayne, Indiana, 46801. A
contract canceled under this provision will be void. With respect to the fixed
portion of a contract, we will return gross purchase payments. With respect to
the VAA, except as explained in the following paragraph, we will return the
contract value as of the date of receipt of the cancellation, plus any premium
taxes which had been deducted. No surrender charge will be assessed. A
purchaser who participates in the VAA is subject to the risk of a market loss
during the free-look period.
For contracts written in those states whose laws require that we assume this
market risk during the free-look period, a contract may be canceled, subject to
the conditions explained before, except that we will return only the gross
purchase payment(s).
State regulation
As a life insurance company organized and operated under Indiana law, we are
subject to provisions governing life insurers and to regulation by the Indiana
Commissioner of Insurance.
Our books and accounts are subject to review and examination by the Indiana
Insurance Department at all times. A full examination of our operations is
conducted by that Department at least every five years.
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<PAGE>
Restrictions under the Texas Optional Retirement Program
Title 8, Section 830.105 of the Texas Government Code, consistent with prior
interpretations of the Attorney General of the State of Texas, permits
participants in the Texas Optional Retirement Program (ORP) to redeem their
interest in a variable annuity contract issued under the ORP only upon:
1. Termination of employment in all institutions of higher education as defined
in Texas law;
2. Retirement; or
3. Death.
Accordingly, a participant in the ORP will be required to obtain a certificate
of termination from their employer before accounts can be redeemed.
Records and reports
As presently required by the 1940 Act and applicable regulations, we are
responsible for maintaining all records and accounts relating to the VAA. We
have entered into an agreement with the Delaware Management Company, 2005
Market Street, Philadelphia, PA, 19203, to provide accounting services to the
VAA. We will mail to you, at your last known address of record at the home
office, at least semiannually after the first contract year, reports containing
information required that Act or any other applicable law or regulation.
Other information
A Registration Statement has been filed with the SEC, under the Securities Act
of 1933 as amended, for the contracts being offered here. This Prospectus does
not contain all the information in the Registration Statement, its amendments
and exhibits. Please refer to the Registration Statement for further
information about the VAA, Lincoln Life and the contracts offered. Statements
in this Prospectus about the content of contracts and other legal instruments
are summaries. For the complete text of those contracts and instruments, please
refer to those documents as files with the SEC.
We are a member of the Insurance Marketplace Standards Association ("IMSA") and
may include the IMSA logo and information about IMSA membership in our
advertisements. Companies that belong to IMSA subscribe to a set of ethical
standards covering the various aspects of sales and services for individually
sold life insurance and annuities.
Lincoln National Variable Annuity Account E and Lincoln Life Flexible Premium
Variable Life Accounts
F, G and J (all registered as investment companies under the 1940 Act) and
Lincoln National Flexible Premium Group Variable Annuity Accounts 50, 51 and 52
are all segregated investment accounts of Lincoln Life which also invest in the
fund. The fund also offers shares of the funds to other segregated investment
accounts.
Preparing for the Year 2000
Many existing computer programs use only two digits in the date field to
identify the year. If left uncorrected these programs, which were designed and
developed without considering the impact of the upcoming change in the century,
could fail to operate or could produce erroneous results when processing dates
after December 31, 1999. For example, for a bond with a stated maturity date of
July 1, 2000, a computer program could read and store the maturity date as July
1, 1900. This problem is known by many names, such as the "Year 2000 Problem",
"Y2K", and the "Millenium Bug".
The Year 2000 Problem affects virtually all computer programs worldwide. It can
cause a computer system to suddenly stop operating. It can also result in a
computer corrupting vital company records, and the problem could go undetected
for a long time. For our products, if left unchecked it could cause such
problems as gross purchase payment collection and deposit errors; claim payment
difficulties; accounting errors; erroneous unit values; and difficulties or
delays in processing transfers, surrenders and withdrawals. In a worst case
scenario, this could result in a material disruption to the operations both of
Lincoln Life and of Delaware Service Company Inc. (Delaware), the provider of
the accounting and valuation services for the VAA.
However, both companies are wholly owned by Lincoln National Corporation (LNC),
which has had Year 2000 processes in place since 1996. LNC projects aggregate
expenditures in excess of $92 million for its Y2K efforts through the year
2000. Both Lincoln Life and Delaware have dedicated Year 2000 teams and
steering committees that are answerable to their counterparts in LNC.
In light of the potential problems discussed above, Lincoln Life, as part of
its Year 2000 updating process, has assumed responsibility for correcting all
high-priority Information Technology (IT) systems which service the VAA.
Delaware is responsible for updating all its high-priority IT systems to
support these vital services. The Year 2000 effort, for both IT and non-IT
systems, is organized into four phases:
.awareness-raising and inventory of all assets (including third-party agent and
vendor relationships)
.assessment and high-level planning and strategy
.remediation of affected systems and equipment; and
.testing to verify Year 2000 readiness.
The high-priority IT processes and systems -- those Lincoln Life uses to
maintain its customers' records and
20
<PAGE>
accounts -- have been assessed and repaired, and test of those processes and
systems is more than 99% complete. Our efforts will continue through the end of
1999 to ensure they remain Y2K-ready. And, we continue to work closely with our
key business partners and suppliers so they can provide the information and
service we need from them. Both companies are currently on schedule to have
their high-priority non-IT systems (elevators, heating and ventilation,
security systems, etc.) remediated and tested by October 31, 1999.
The work on Year 2000 issues has not suffered significant delays; however, some
uncertainty remains. Specific factors that give rise to this uncertainty
include (but are certainly not limited to) a possible loss of technical
resources to perform the work; failure to identify all susceptible systems; and
non-compliance by third parties whose systems and operations impact Lincoln
Life. In a report dated February 26, 1999, entitled, Investigating the Impact
of the Year 2000 Technology Problem, S. Prt. 106-10, the U.S. Senate Special
Committee on the Year 2000 Technology Problem expressed its concern that
"Financial services firms...are particularly vulnerable to...the risk that a
material customer or business partner will fail, as a result of the computer
problems, to meet its obligations".
One important source of uncertainty is the extent to which the key trading
partners of Lincoln Life and of Delaware will be successful in their own
remediation and testing efforts. Lincoln Life and Delaware have been monitoring
the progress of their trading partners; however, the efforts of these partners
are beyond our control.
Lincoln Life and Delaware expect to have completed their necessary remediation
and testing efforts prior to December 31, 1999. However, given the nature and
complexity of the problem, there can be no guarantee by either company that
there will not be significant computer problems after December 31, 1999.
Legal proceedings
Lincoln Life is involved in various pending or threatened legal proceedings
arising from the conduct of its business. Most of those proceedings are routine
and in the ordinary course of business. In some instances they include claims
for unspecified or substantial punitive damages and similar types of relief in
addition to amounts for equitable relief. After consultation with legal counsel
and a review of available facts, it is management's opinion that the ultimate
liability, if any, under these suits will not have a material adverse effect on
the financial position of Lincoln Life.
Lincoln Life is presently defending two lawsuits in which Plaintiffs seek to
represent national classes of policyholders in connection with alleged fraud,
breach of contract and other claims relating to the sale of interest-sensitive
universal and participating whole life insurance policies. As of the date of
this prospectus, the courts have not certified a class in either of the suits.
Plaintiffs seek unspecified damages and penalties for themselves and on behalf
of the putative class. Although the relief sought in these cases is
substantial, the cases are in the preliminary stages of litigation, and it is
premature to make assessments about potential loss, if any. Management is
defending these suits vigorously. The amount of liability, if any, which may
ultimately arise as a result of these suits cannot be reasonably determined at
this time.
Statement of additional
information table of
contents for Variable Annuity Account H American Legacy Shareholder's Advantage
<TABLE>
<CAPTION>
Item
- -----------------------------------------
<S> <C>
General information and history of
Lincoln Life B-2
- -----------------------------------------
Special terms B-2
- -----------------------------------------
Services B-2
- -----------------------------------------
Principal underwriter B-2
- -----------------------------------------
Purchase of securities being offered B-2
- -----------------------------------------
</TABLE>
For a free copy of the SAI please see page one of this booklet.
<TABLE>
<CAPTION>
Item
- ---------------------------------------
<S> <C>
Calculation of investment results B-2
- ---------------------------------------
Annuity payouts B-7
- ---------------------------------------
Federal tax status B-7
- ---------------------------------------
Advertising and sales literature B-10
- ---------------------------------------
Financial statements B-12
- ---------------------------------------
</TABLE>
21
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION REQUEST CARD
AMERICAN LEGACY SHAREHOLDER'S ADVANTAGE
(LINCOLN NATIONAL VARIABLE ANNUITY ACCOUNT H)
AMERICAN VARIABLE INSURANCE SERIES
Please send me a copy of the current Statement of Additional Information for
American Legacy Shareholder's Advantage and American Variable Insurance Series
(Please print)
Name: __________________________________________________________________________
Address: _______________________________________________________________________
City: ____________________________________________________________ State: Zip:
<PAGE>
PLACE
STAMP
HERE
POSTAL SERVICES
WILL NOT
DELIVER
UNLESS STAMPED
The Lincoln National Life Insurance Company
Attn: American Legacy Customer Service
P. O. Box 2348
Fort Wayne, IN 46801-2348
<PAGE>
The American Legacy Shareholder's Advantage
Lincoln National
Variable Annuity Account H (Registrant)
The Lincoln National
Life Insurance Company (Depositor)
Statement of Additional Information (SAI)
This Statement of Additional Information should be read in conjunction with the
American Legacy Shareholder's Advantage Prospectus of Lincoln National Variable
Annuity Account H dated September 23, 1999.
You may obtain a copy of the American Legacy Shareholder's Advantage Prospectus
on request and without charge. Please write American Legacy Customer Service,
The Lincoln National Life Insurance Company, P.O. Box 2348, Fort Wayne, Indiana
46801 or call 1-800-942-5500.
Table of Contents
<TABLE>
<CAPTION>
Item Page
- -----------------------------------------------------
<S> <C>
General information and history of Lincoln Life B-2
- -----------------------------------------------------
Special terms B-2
- -----------------------------------------------------
Services B-2
- -----------------------------------------------------
Principal underwriter B-2
- -----------------------------------------------------
Purchase of securities being offered B-2
- -----------------------------------------------------
</TABLE>
This SAI is not a Prospectus.
The date of this SAI is September 23, 1999.
<TABLE>
<CAPTION>
Item Page
- ---------------------------------------
<S> <C>
Calculation of investment results B-2
- ---------------------------------------
Annuity payouts B-7
- ---------------------------------------
Federal tax status B-7
- ---------------------------------------
Advertising and sales literature B-10
- ---------------------------------------
Financial statements B-12
- ---------------------------------------
</TABLE>
B-1
<PAGE>
General information
and history of Lincoln National Life Insurance Company (Lincoln Life)
The Lincoln National Life Insurance Company (Lincoln Life), organized in 1905,
is an Indiana stock insurance corporation, engaged primarily in the direct
insurance of life insurance contracts and annuities, and is also a professional
reinsurer. Lincoln Life is wholly owned by Lincoln National Corporation (LNC),
a publicly held insurance and financial services holding company domiciled in
Indiana.
Special terms
The special terms used in this SAI are the ones defined in the Prospectus. In
connection with the term, valuation date, the New York Stock Exchange is
currently closed on weekends and on these holidays: New Year's Day, Martin
Luther King's Birthday, President's Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. If any of
these holidays occurs on a weekend day, the Exchange may also be closed on the
business day occurring just before or just after the holiday.
Services
Independent auditors
The financial statements of the variable annuity account (VAA) and the
statutory-basis financial statements of Lincoln Life appearing in this SAI and
Registration Statement have been audited by Ernst & Young LLP, independent
auditors, as set forth in their reports also appearing elsewhere in this
document and in the Registration Statement. The financial statements and
schedules audited by Ernst & Young LLP have been included in this document in
reliance on their reports given on their authority as experts in accounting and
auditing.
Keeper of records
All accounts, books, records and other documents which are required to be
maintained for the VAA are maintained by Lincoln Life or by third parties
responsible to Lincoln Life. We have entered into an agreement with the
Delaware Management Company, 2005 Market Street, Philadelphia, PA 19203, to
provide accounting services to the VAA. No separate charge against the assets
of the VAA is made by Lincoln Life for this service.
Principal underwriter
Lincoln Life has contracted with American Funds Distributors, Inc. (AFD), 333
South Hope Street, Los Angeles, California 90071, a licensed broker-dealer, to
distribute the contracts through certain legally authorized sales persons and
organizations (brokers). AFD and its brokers are compensated under a standard
compensation schedule.
Purchase of securities being offered
The contracts are offered to the public through certain securities
broker/dealers who have entered into selling agreements with AFD and whose
personnel are legally authorized to sell annuity products. Although there are
no special purchase plans for any class of prospective buyers, the sales charge
normally assessed on gross purchase payments will be waived for officers,
directors or bona fide full time employees of LNC, The Capital Group, Inc.,
their affiliated or managed companies, and certain other persons. See Charges
and other deductions in the Prospectus.
Both before and after the annuity commencement date, there are exchange
privileges between variable subaccounts, and from the VAA to the fixed side of
the contract subject to restrictions set out in the Prospectus. See The
contracts, in the Prospectus. No exchanges are permitted between the VAA and
other variable separate accounts.
The offering of the contracts is continuous.
Calculation of investment results
The paragraphs set forth below present performance information for the VAA and
the variable subaccounts calculated in several different ways. Paragraph (A)
shows the historical performance of each subaccount over the periods indicated.
The information presented in Paragraph (A) is referred to as "standard
performance" because it is calculated in accordance with formulas prescribed by
the SEC. The performance information for periods prior to the introduction of
the Class 2 shares of the series (April 30, 1997) is calculated by adjusting
the performance of the Class 1 shares of the series to reflect the 12b-1 fee
imposed on Class 2 shares. For periods after April 30, 1997, Class 2
performance is reflected. For all periods shown, historical series performance
has been adjusted to reflect the expenses of the subaccounts and the contracts.
The standard performance of each subaccount is calculated with and without the
enhanced guaranteed minimum death
B-2
<PAGE>
benefit (EGMDB). Standard performance is described in Paragraph (B). Under
rules prescribed by the SEC, standard performance must be included in certain
advertising material that discusses the performance of the VAA and the
subaccounts.
Paragraph (C) shows the performance of the series over the periods indicated in
the table adjusted to reflect the expenses of the subaccounts and the
contracts. Paragraph (D) shows additional "non-standardized" performance
information (i.e., performance information not calculated in accordance with
SEC guidelines) for each of the variable subaccounts that may be used to
advertise the performance of the VAA and the variable subaccounts. THIS
INFORMATION DOES NOT INDICATE OR REPRESENT FUTURE PERFORMANCE.
(A) Average Annual Total Return
Period ending December 31, 1998
<TABLE>
<CAPTION>
Since
1 year-period 5 year-period Inception
<S> <C> <C> <C> <C> <C> <C>
With Without With Without With Without
EGMDB EGMDB EGMDB EGMDB EGMDB EGMDB
- --------------------------------------------------------------------------
Global Growth Subaccount
(commenced activity 4/30/97) 20.75% 20.90% N/A N/A 17.29% 17.43%
- --------------------------------------------------------------------------
Global Small Capitalization
Subaccount
(commenced activity 4/30/98) N/A N/A N/A N/A (3.95) (3.87)
- --------------------------------------------------------------------------
Growth Subaccount
(commenced activity 8/1/89) 26.85 27.00 19.49% 19.64% 15.66 15.80
- --------------------------------------------------------------------------
International Subaccount
(commenced activity 5/1/90) 13.44 13.58 10.18 10.31 9.80 9.93
- --------------------------------------------------------------------------
Growth Income Subaccount
(commenced activity 8/1/89) 10.78 10.91 16.92 17.06 13.09 13.23
- --------------------------------------------------------------------------
Asset-Allocation Subaccount
(commenced activity 8/1/89) 5.87 6.00 13.16 13.29 10.99 11.12
- --------------------------------------------------------------------------
High-Yield Bond Subaccount
(commenced activity 8/1/89) (6.00) (5.89) 5.76 5.89 8.91 9.04
- --------------------------------------------------------------------------
Bond Subaccount
(commenced activity 1/2/96) (2.33) (2.21) N/A N/A 3.93 4.05
- --------------------------------------------------------------------------
U.S. Gov't./AAA Subaccount
(commenced activity 8/1/89) 1.24 1.37 3.96 4.09 6.52 6.64
- --------------------------------------------------------------------------
Cash Management Subaccount
(commenced activity 8/1/89) (1.60) (1.48) 2.99 3.12 3.65 3.78
- --------------------------------------------------------------------------
</TABLE>
There is a New World subaccount but it is not in the chart because it did not
begin activity until 1999.
(B) Formulas
Average annual total return for each period was determined by finding the
average annual compounded rate of return over each period that would equate the
initial amount invested to the ending redeemable value for that period,
according to the following formula--
P(1 + T)n = ERV
Where: P = a hypothetical initial purchase payment of $1,000
T = average annual total return for the period in question
n = number of years
ERV = redeemable value (as of the end of the period in question) of a
hypothetical $1,000 purchase payment made at the beginning of the 1-
year, 5-year, or 10-year period in question (or fractional portion
thereof)
B-3
<PAGE>
The formula assumes that: 1) all recurring fees have been charged to
contractowner accounts; 2) all applicable non-recurring charges are deducted
at the end of the period in question; and 3) there will be a complete
redemption at the end of the period in question.
(C) Fund historical performance adjusted for contract expense charges
The examples below show, for the various subaccounts of the VAA, annual total
return as of the stated periods, based upon a hypothetical initial gross
purchase payment of $1,000, calculated according to the formula provided after
the examples. The annual total return has been calculated to show the annual
total return for a hypothetical contract with EGMDB and without EGMDB.
Although the variable subaccounts did not commence activity until 1998, these
figures are calculated as if the variable subaccounts had commenced activity
at the same time as the underlying funds.
Further, the figures below are based on the performance of the class of shares
of the funds issued since the funds commenced operations in 1989, as adjusted
to reflect the fees and expenses chargeable against assets attributable to
shares of Class 2.
Fund historical performance (adjusted
for contract expense charges)
Period ending December 31, 1998
<TABLE>
<CAPTION>
10-year
1-year period 5-year period period
<S> <C> <C> <C> <C> <C> <C>
With Without With Without With Without
EGMDB EGMDB EGMDB EGMDB EGMDB EGMDB
- ----------------------------------------------------------------------------------
Global Growth Variable Subaccount
(commenced activity 4/30/97) 20.75% 20.90% N/A N/A 17.29% 17.43%
- ----------------------------------------------------------------------------------
Global Small Capitalization
Subaccount
(commenced activity 4/30/98) N/A N/A N/A N/A (3.95) (3.87)
- ----------------------------------------------------------------------------------
Growth Variable Subaccount*
(as if commenced activity 2/8/84) 26.85 27.00 19.49% 19.64% 17.62 17.77
- ----------------------------------------------------------------------------------
International Variable Subaccount
(as if commenced activity 5/1/90) 13.44 13.58 10.18 10.31 9.80 9.93
- ----------------------------------------------------------------------------------
Growth-Income Variable Subaccount*
(as if commenced activity 2/8/84) 10.78 10.91 16.92 17.06 14.51 14.65
- ----------------------------------------------------------------------------------
Asset Allocation Variable Subaccount
(as if commenced activity 8/1/89) 5.87 6.00 13.16 13.29 10.99 11.12
- ----------------------------------------------------------------------------------
High-Yield Bond Variable Subaccount*
(as if commenced activity 2/8/84) (6.00) (5.89) 5.76 5.89 9.28 9.41
- ----------------------------------------------------------------------------------
Bond Variable Subaccount
(as if commenced activity 1/2/96) (2.33) (2.21) N/A N/A 3.93 4.05
- ----------------------------------------------------------------------------------
U.S. Gov't./AAA Variable Subaccount*
(as if commenced activity 12/1/85) 1.24 1.37 3.96 4.09 6.93 7.05
- ----------------------------------------------------------------------------------
Cash Management Variable Subaccount*
(as if commenced activity 2/8/84) (1.60) (1.48) 2.99 3.12 3.92 4.04
- ----------------------------------------------------------------------------------
</TABLE>
*The lifetime of each variable subaccount is less than the complete period
indicated.
See the date the variable subaccount commenced activity under its name.
There is a New World subaccount but it is not in the chart because it did not
begin activity until 1999.
The length of the periods and the last day of each period used in the above
table are set out in the table heading and in the footnotes above.
B-4
<PAGE>
(D) Other Non-Standardized investment results:
The VAA may illustrate its results over various periods and compare its results
to indices and other variable annuities in sales materials including
advertisements, brochures and reports. Such results may be computed on a
cumulative and/or annualized basis.
Cumulative quotations are arrived at by calculating the change in the
accumulation unit value between the first and last day of the base period being
measured, and expressing the difference as a percentage of the unit value at
the beginning of the base period.
Annualized quotations are arrived at by applying a formula which determines the
level rate of return which, if earned over the entire base period, would
produce the cumulative return.
Non-Standardized investment results
Variable subaccounts of Account H*
$10,000 invested in
this fund through
American Legacy Shareholder's Advantage
this many years ago . . . . . . would have grown to this amount on
December 31, 1998**
<TABLE>
<CAPTION>
With EGMDB
Growth Growth-Income High-Yield Bond Cash Management
-------------------- ------------------- ------------------- -------------------
Compound Compound Compound Compound
Growth Growth Growth Growth
Number of Years Periods Amount Rate Amount Rate Amount Rate Amount Rate
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1 12/31/97-12/31/98 $ 13,459.06 34.59% $11,753.60 17.54% $ 9,973.05 -0.27% $10,440.48 4.40%
- --------------------------------------------------------------------------------------------------------------------
2 12/31/96-12/31/98 17,386.72 31.86% 14,685.85 21.19% 11,130.96 5.50% 10,900.90 4.41%
- --------------------------------------------------------------------------------------------------------------------
3 12/31/95-12/31/98 19,572.92 25.09% 17,314.60 20.08% 12,512.82 7.76% 11,374.27 4.39%
- --------------------------------------------------------------------------------------------------------------------
4 12/31/94-12/31/98 25,907.08 26.87% 22,869.48 22.97% 15,130.96 10.91% 11,920.94 4.49%
- --------------------------------------------------------------------------------------------------------------------
5 12/31/93-12/31/98 25,849.83 20.92% 23,178.82 18.31% 14,040.08 7.02% 12,295.04 4.22%
- --------------------------------------------------------------------------------------------------------------------
Lifetime of fund 02/08/84-12/31/98 102,920.12 16.93% 83,839.24 15.33% 49,489.20 11.33% 21,101.22 5.14%
- --------------------------------------------------------------------------------------------------------------------
<CAPTION>
Without EGMDB
Growth Growth-Income High-Yield Bond Cash Management
-------------------- ------------------- ------------------- -------------------
Compound Compound Compound Compound
Growth Growth Growth Growth
Number of Years Periods Amount Rate Amount Rate Amount Rate Amount Rate
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
1 12/31/97-12/31/98 $ 13,475.33 34.75% $11,767.81 17.68% $ 9,985.11 -0.15% $10,453.10 4.53%
- --------------------------------------------------------------------------------------------------------------------
2 12/31/96-12/31/98 17,428.78 32.02% 14,721.37 21.33% 11,157.89 5.63% 10,927.27 4.53%
- --------------------------------------------------------------------------------------------------------------------
3 12/31/95-12/31/98 19,643.98 25.24% 17,377.46 20.23% 12,558.25 7.89% 11,415.56 4.51%
- --------------------------------------------------------------------------------------------------------------------
4 12/31/94-12/31/98 26,032.57 27.02% 22,980.25 23.12% 15,204.25 11.04% 11,978.68 4.62%
- --------------------------------------------------------------------------------------------------------------------
5 12/31/93-12/31/98 26,006.43 21.06% 23,319.24 18.45% 14,125.14 7.15% 12,369.53 4.34%
- --------------------------------------------------------------------------------------------------------------------
Lifetime of fund 02/08/84-12/31/98 104,788.32 17.07% 85,361.08 15.47% 50,387.53 11.46% 21,484.25 5.26%
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
*Although the variable subaccounts for the contracts did not commence activity
until 1998, these figures are calculated as if the variable subaccounts had
commenced activity at the same time as the corresponding underlying funds.
**For purposes of determining these investment results, American Legacy
Shareholder's Advantage's 0.72% mortality and expense risk charge and
administrative fee for those contracts with EGMDB and 0.60% for those contracts
without EGMDB have been taken into account. No sales charges have been
deducted.
B-5
<PAGE>
<TABLE>
<CAPTION>
With EGMDB Without EGMDB
U.S. Govt/AAA U.S. Govt/AAA
---------------------- ----------------------
Number of Compound Compound
Years Periods Amount Growth Rate Amount Growth Rate
- ----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1 12/31/97-12/31/98 $10,742.05 7.42% $10,755.04 7.55%
- ----------------------------------------------------------------------------
2 12/31/96-12/31/98 11,567.10 7.55% 11,595.08 7.68%
- ----------------------------------------------------------------------------
3 12/31/95-12/31/98 11,841.98 5.80% 11,884.97 5.93%
- ----------------------------------------------------------------------------
4 12/31/94-12/31/98 13,568.42 7.93% 13,634.14 8.06%
- ----------------------------------------------------------------------------
5 12/31/93-12/31/98 12,886.74 5.20% 12,964.81 5.33%
- ----------------------------------------------------------------------------
Lifetime of
fund 12/01/85-12/31/98 25,854.10 7.51% 26,266.83 7.64%
<CAPTION>
Asset Allocation Asset Allocation
---------------------- ----------------------
Number of Compound Compound
Years Periods Amount Growth Rate Amount Growth Rate
- ----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1 12/31/97-12/31/98 $11,232.93 12.33% $11,246.51 12.47%
- ----------------------------------------------------------------------------
2 12/31/96-12/31/98 13,438.61 15.93% 13,471.11 16.07%
- ----------------------------------------------------------------------------
3 12/31/95-12/31/98 15,451.29 15.61% 15,507.39 15.75%
- ----------------------------------------------------------------------------
4 12/31/94-12/31/98 19,881.33 18.74% 19,977.63 18.89%
- ----------------------------------------------------------------------------
5 12/31/93-12/31/98 19,683.87 14.50% 19,803.11 14.64%
- ----------------------------------------------------------------------------
Lifetime of
fund 08/01/89-12/31/98 28,329.16 11.69% 28,653.18 11.82%
<CAPTION>
International International
---------------------- ----------------------
Number of Compound Compound
Years Periods Amount Growth Rate Amount Growth Rate
- ----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1 12/31/97-12/31/98 $12,035.91 20.36% $12,050.46 20.50%
- ----------------------------------------------------------------------------
2 12/31/96-12/31/98 13,033.06 14.16% 13,064.58 14.30%
- ----------------------------------------------------------------------------
3 12/31/95-12/31/98 15,211.44 15.01% 15,266.67 15.15%
- ----------------------------------------------------------------------------
4 12/31/94-12/31/98 17,019.99 14.22% 17,102.43 14.36%
- ----------------------------------------------------------------------------
5 12/31/93-12/31/98 17,224.26 11.49% 17,328.61 11.62%
- ----------------------------------------------------------------------------
Lifetime of
fund 04/30/90-12/31/98 23,869.08 10.55% 24,120.29 10.68%
<CAPTION>
Bond Bond
---------------------- ----------------------
Number of Compound Compound
Years Periods Amount Growth Rate Amount Growth Rate
- ----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1 12/31/97-12/31/98 $10,362.88 3.63% $10,375.41 3.75%
- ----------------------------------------------------------------------------
2 12/31/96-12/31/98 11,331.29 6.45% 11,358.70 6.58%
- ----------------------------------------------------------------------------
Lifetime of
fund 01/02/96-12/31/97 11,909.10 6.00% 11,952.30 6.13%
<CAPTION>
Global Growth Global Growth
---------------------- ----------------------
Number of Compound Compound
Years Periods Amount Growth Rate Amount Growth Rate
- ----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
1 12/31/97-12/31/98 $12,811.97 28.12% $12,827.46 28.27%
Lifetime of
fund 04/30/97-12/31/98 13,844.90 21.53% 13,872.81 21.68%
<CAPTION>
Global Small Global Small
Capitalization Capitalization
---------------------- ----------------------
Number of Compound Compound
Years Periods Amount Growth Rate Amount Growth Rate
- ----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Lifetime of
fund 04/30/98-12/31/98 $10,190.99 1.91% 10,199.24 1.99%
</TABLE>
There is also a New World subaccount but it is not in the chart because it did
not begin activity until 1999.
B-6
<PAGE>
Annuity payouts
Variable Annuity Payouts
Variable annuity payouts will be determined on the basis of: (1) the dollar
value of the contract on the annuity commencement date; (2) the annuity tables
contained in the contract; (3) the type of annuity option selected; and (4) the
investment results of the fund(s) selected. In order to determine the amount of
variable annuity payouts, Lincoln Life makes the following calculation: first,
it determines the dollar amount of the first payout; second, it credits the
contract with a fixed number of annuity units based on the amount of the first
payout; and third, it calculates the value of the annuity units each period
thereafter. These steps are explained below.
The dollar amount of the first periodic variable annuity payout is determined
by applying the total value of the accumulation units credited under the
contract valued as of the annuity commencement date (less any premium taxes) to
the annuity tables contained in the contract. The first variable annuity payout
will be paid 14 days after the annuity commencement date. This day of the month
will become the day on which all future annuity payouts will be paid. Amounts
shown in the tables are based on the 1983 Table "a" Individual Annuity
Mortality Tables, modified, with an assumed investment return at the rate of 4%
per annum. The first annuity payout is determined by multiplying the benefit
per $1,000 of value shown in the contract tables by the number of thousands of
dollars of value accumulated under the contract. These annuity tables vary
according to the form of annuity selected and the age of the annuitant at the
annuity commencement date. The 4% interest rate stated above is the measuring
point for subsequent annuity payouts. If the actual net investment rate
(annualized) exceeds 4%, the payout will increase at a rate equal to the amount
of such excess. Conversely, if the actual rate is less than 4%, annuity payouts
will decrease. If the assumed rate of interest were to be increased, annuity
payouts would start at a higher level but would decrease more rapidly or
increase more slowly.
Lincoln Life may use sex distinct annuity tables in contracts that are not
associated with employer sponsored plans and where not prohibited by law.
At an annuity commencement date, the contract is credited with annuity units
for each variable subaccount on which variable annuity payouts are based. The
number of annuity units to be credited is determined by dividing the amount of
the first periodic payout by the value of an annuity unit in each variable
subaccount selected. Although the number of annuity units is fixed by this
process, the value of such units will vary with the value of the underlying
fund. The amount of the second and subsequent periodic payouts is determined by
multiplying the contractowner's fixed number of annuity units in each variable
subaccount by the appropriate annuity unit value for the valuation date ending
14 days prior to the date that payout is due.
The value of each variable subaccount's annuity unit will be set initially at
$1.00. The annuity unit value for each variable subaccount at the end of any
valuation date is determined as follows:
1. The total value of fund shares held in a given variable subaccount is
calculated by multiplying the number of shares by the net asset value at the
end of the valuation period plus any dividend or other distribution.
2. The liabilities of the variable subaccount, including daily charges and
taxes, are subtracted.
3. The result is divided by the number of annuity units in the variable
subaccount at the beginning of the valuation period, and adjusted by a
factor to neutralize the assumed investment return in the annuity table.
The value of the annuity units is determined as of a valuation date 14 days
prior to the payment date in order to permit calculation of amounts of annuity
payouts and mailing of checks in advance of their due dates. Such checks will
normally be issued and mailed at least three days before the due date.
Proof of age, sex and survival
Lincoln Life may require proof of age, sex, or survival of any payee upon whose
age, sex, or survival payments depend.
Federal tax status
General
The operations of the VAA form a part of, and are taxed with, the operations of
Lincoln Life under the Internal Revenue Code of 1986, as amended (the Code).
VAA investment income and realized net capital gains on the assets of the VAA
are reinvested and taken into account in determining the accumulation and
annuity unit values. As a result, such investment income and realized net
capital gain are automatically retained as part of the reserves under the
contract. Under existing federal income tax law, Lincoln Life believes that the
VAA investment income and realized net capital gain are not taxed to the extent
they are retained as part of the reserves under the contract. Accordingly,
Lincoln Life does not anticipate that it will incur any federal income tax
liability attributable to the VAA, and therefore it does not intend to make any
provision for such taxes.
However, if changes in the federal tax laws or interpretations thereof result
in Lincoln Life's being taxed on income or gain attributable to the VAA, then
B-7
<PAGE>
Lincoln Life may impose a charge against the VAA (with respect to some or all
(contracts) in order to make provision for payment of such taxes.
Tax status of non-qualified contracts
Section 817(h) of the code provides that separate account investments (or the
investments of a mutual fund the shares of which are owned by separate
accounts of insurance companies) underlying the contract be adequately
diversified in accordance with Treasury regulations in order for the contract
to qualify as an annuity contract under Section 72 of the code. The VAA,
through each of the funds, intends to comply with the diversification
requirements prescribed in regulations, which affect how the assets in each of
the funds in which the VAA invests may be invested. Capital Research and
Management Company is not affiliated with Lincoln Life and Lincoln Life does
not have control over the series, or its investments. However, Lincoln Life
believes that each fund in which the VAA owns shares will meet the
diversification requirements and that therefore the contracts will be treated
as annuities under the code.
The regulations relating to diversification requirements do not provide
guidance concerning the extent to which contractowners may direct their
investments to particular variable subaccounts of a separate account. When
guidance is provided, the contract may need to be modified to comply with that
guidance. For these reasons, Lincoln Life reserves the right to modify the
contract as necessary to prevent the contractowner from being considered the
owner of the assets of the VAA.
In addition to the requirements of Section 817(h), code Section 72(s) provides
that contracts will not be treated as annuity contracts for purposes of
Section 72 unless the contract provides that (1) if any contractowner dies on
or after the annuity starting date prior to the time the entire interest in
the contract has been distributed, the remaining portion of such interest must
be distributed at least as rapidly as under the method of distribution in
effect at the time of the contractowner's death; and (2) if any contractowner
dies prior to the annuity starting date, the entire interest must be
distributed within five years after the death of the contractowner. These
requirements are considered satisfied if any portion of the contractowner's
interest that is payable to or for the benefit of a designated beneficiary is
distributed over that designated beneficiary's life, or a period not extending
beyond the designated beneficiary's life expectancy, and if that distribution
begins within one year of the contractowner's death. The designated
beneficiary must be a natural person. No regulations interpreting these
requirements have yet been issued. Thus, no assurance can be given that the
provisions contained in contracts satisfy all such code requirements. However,
Lincoln Life believes that such provisions in such contracts meet these
requirements. Lincoln Life intends to review such provisions and modify them
as necessary to assure that they comply with the requirements of Section 72(s)
when clarified by regulations or otherwise.
Tax status of contracts used with certain plans
The rules governing the tax treatment of contributions and distributions under
qualified plans, as set forth in the code and applicable rulings and
regulations, are complex and subject to change. These rules also vary
according to the type of plan and the terms and conditions of the plan itself.
Therefore, no attempt is made herein to provide more than general information
about the use of contracts with the various types of plans, based on Lincoln
Life's understanding of the current federal tax laws as interpreted by the
Internal Revenue Service. Purchasers of contracts for use with such a plan and
plan participants and beneficiaries should consult counsel and other competent
advisers as to the suitability of the plan and the contract to their specific
needs, and as to applicable code limitations and tax consequences.
Participants under such plans, as well as contractowners, annuitants, and
beneficiaries, should also be aware that the rights of any person to any
benefits under such plans may be subject to the terms and conditions of the
plans themselves regardless of the terms and conditions of the contract.
Following are brief descriptions of the various types of plans and of the use
of contracts in connection therewith.
Public school systems and 501(c)(3) organizations [Section 403(b) plans]
Payments made to purchase annuity contracts by public school systems or code
Section 501(c)(3) organizations for their employees are excludable from the
gross income of the employee to the extent that aggregate payments for the
employee do not exceed the exclusion allowance provided by Section 403(b) of
the code, the over-all limits for excludable contributions of Section 415 of
the code or the limit on elective contributions. Furthermore, the investment
results of the fund credited to the account are not taxable until benefits are
received either in the form of annuity payouts, in a single sum or a
withdrawal.
If an employee's individual account is surrendered, usually the full amount
received would be includable in income for that year at ordinary rates.
Qualified corporate employee's pension and profit-sharing trusts and qualified
annuity plans [Section 401(a) plans]
Payments made by a corporate employer and the increments on all payments for
qualified corporate plans are not taxable as income to the employee until
distributed. However, the employee may be required to
B-8
<PAGE>
include these amounts in gross income prior to distribution if the qualified
plan or trust loses its qualification. Corporate plans qualified under Sections
401(a) or 403(a) of the code are subject to extensive rules, including
limitations on maximum contributions or benefits. Distributions of amounts in
excess of non-deductible employee contributions are generally taxable as
ordinary income.
Self-employed individuals (H.R. 10 or Keogh)
Under code provisions, self-employed individuals may establish plans commonly
known as H.R. 10 or Keogh plans for themselves and their employees. The tax
consequences to participants under such plans depend upon the plan itself. Such
plans are subject to special rules in addition to those applicable to qualified
corporate plans; therefore, purchasers of the contracts for use with H.R. 10
plans should seek competent advice as to suitability of plan documents and the
funding contracts.
Individual retirement annuities (IRA)
Under Section 408 of the code, individuals may participate in a retirement
program known as Individual Retirement Annuity (IRA). An individual may make an
annual IRA contribution of up to the lesser of $2,000 (or $4,000 if IRAs are
maintained for both the individual and his spouse) or 100% of compensation.
However, IRA contributions may be non-deductible in whole or in part if (1) the
individual or his spouse is an active participant in certain other retirement
programs and (2) the income of the individual (or of the individual and his
spouse) exceeds a specified amount. Distributions from certain other IRA plans
or qualified plans may be rolled over to an IRA on a tax deferred basis without
regard to the limit on contributions, provided certain requirements are met.
Distributions from IRAs are subject to certain restrictions. Deductible IRA
contributions and all IRA earnings will be taxed as ordinary income when
distributed. The failure to satisfy certain code requirements with respect to
an IRA may result in adverse tax consequences.
Roth IRA
Beginning in 1998, Roth IRAs may be established. Non-deductible contributions
of $2,000 per year can be made to the Roth IRA. The contribution limits for
deductible and non-deductible IRAs are coordinated. In general, distributions
from a Roth IRA are not taxable and are not subject to the 10% early withdrawal
penalty that applies to Traditional IRAs. A five-year holding period as well as
other requirements must be satisfied if distributions are to be non-taxable
and/or not subject to the 10% early withdrawal penalty. Assuming certain income
restrictions are satisfied, a Traditional IRA can be converted to a Roth IRA.
This is a taxable event.
Deferred compensation plans (457 Plans)
Under the code provisions, employees and independent contractors (participants)
performing services for state and local governments and certain tax-exempt
organizations may establish deferred compensation plans. While participants in
such plans may be permitted to specify the form of investment in which their
plan accounts will participate, all such investments are owned by the
sponsoring employer and are subject to the claims of its creditors. Plans of
state and local governments established on August 20, 1996, or later, must hold
all assets and income in trust (or custodial accounts or an annuity contract)
for the exclusive benefit of participants and their beneficiaries. Section 457
plans that were in existence before August 20, 1996 are allowed until January
1, 1999 to meet this requirement. The amounts deferred under a plan which meet
the requirements of Section 457 of the code are not taxable as income to the
participant until paid or otherwise made available to the participant or
beneficiary. Deferrals are taxed as compensation from the employer when they
are actually or constructively received by the employee. As a general rule, the
maximum amount which can be deferred in any one year is the lesser of $7,500,
as increased for cost of living adjustments, or 33 1/3% of the participant's
includable compensation. However, in limited circumstances, up to $15,000 may
be deferred in each of the last three years before retirement.
Simplified employee pension plans [Section 408(k)]
An employer may make contributions on behalf of employees to a simplified
employee pension plan ("SEP") established prior to January 1, 1997, as provided
by Section 408(k) of the code. The contributions and distribution dates are
limited by the code provisions. All distributions from the plan will be taxed
as ordinary income. Any distribution before the employee attains age 59 1/2
(except in the event of death or disability) or the failure to satisfy certain
other code requirements may result in adverse tax consequences. For tax years
after 1996, salary reduction SEPs (SAR/SEP) may no longer be established.
However, SAR/SEPs in existence prior to January 1, 1997 may continue to receive
contributions.
Savings Incentive matched plan for employees (Simple)
Employers with 100 or fewer employees, who earned $5,000 during the preceding
year, may establish SIMPLEs. SIMPLE plans may be in the form of an IRA or part
of a 401(k) plan. Under a SIMPLE IRA, employees are permitted to make elective
contributions to an IRA, stated as a percentage of the employee's compensation,
but not to exceed $6,000 annually as indexed. Such deferrals are not subject to
income tax until withdrawn. Withdrawals made by an employee in the first two
years of the employee's participation are
B-9
<PAGE>
subject to a 25 percent penalty. Later withdrawals are subject to penalties
applicable to IRAs. Under a SIMPLE 401(k), employee deferrals are limited to
no more than $6,000 annually. Employer contributions are usually required for
each type of SIMPLE.
Tax on distributions from qualified contracts
The following rules generally apply to distributions from contracts purchased
in connection with the plans discussed above, other than 457 plans and Roth
IRAs.
The portion, if any, of any contribution under a contract made by or on behalf
of an individual which is not excluded from the employee's gross income
(generally, the employee's own non-deductible contributions) constitutes his
investment in the contract. If a distribution is made in the form of annuity
payouts, the employee's investment in the contract (adjusted for certain
refund provisions) divided by his life expectancy (or other period for which
annuity payouts are expected to be made) constitutes a return of capital each
year. The dollar amount of annuity payouts received in any year in excess of
such return is taxable as ordinary income. However, all distributions will be
fully taxable once the employee is deemed to have recovered the dollar amount
of his investment in the contract. Notwithstanding the above, if the
employee's annuity starting date was on or before July 1, 1986 and if his
investment in the contract will be recovered within three years of his annuity
starting date, no amount is included in income until he has fully recovered
such investment. Rules generally provide that all distributions which are not
received as an annuity will be taxed as a pro rata distribution of taxable and
non-taxable amounts (rather than as a distribution first of non-taxable
amounts).
If a surrender of or withdrawal from the contract is effected and a
distribution is made in a single payment, the proceeds may qualify for special
lump-sum distribution treatment under certain qualified plans, as discussed
above. Otherwise, the amount by which the payment exceeds the investment in
the contract (adjusted for any prior withdrawals) allocated to that payment,
if any, will be taxed as ordinary income in the year of receipt.
Distributions from Section 401(a) plans, Section 403(b) plans, IRAs, SEPs and
Keoghs will be subject to a 10% penalty tax if made before age 59 1/2 unless
certain other exceptions apply. Failure to meet certain minimum distribution
requirements for the above plans, as well as for Section 457 plans, will
result in a 50% excise tax. Various other adverse tax consequences may also be
potentially applicable in certain circumstances to these types of plans.
Upon an annuitant's death, the taxation of benefits payable to his beneficiary
generally follow these same principles, subject to a variety of special rules.
Other considerations
It should be understood that the foregoing comments about the federal tax
consequences under these contracts are not exhaustive and that special rules
are provided with respect to other tax situations not discussed herein.
Further, the foregoing discussion does not address any applicable state,
local, or foreign tax laws. In recent years, numerous changes have been made
in the federal income tax treatment of contracts and retirement plans, which
are not fully discussed above. Before an investment is made in any of the
above plans, a tax adviser should be consulted.
Advertising and sales literature
As set forth in the Prospectus, Lincoln Life may refer to the following
organizations (and others) in its marketing materials:
A.M. BEST'S RATING SYSTEM is designed to evaluate the various factors
affecting the overall performance of an insurance company in order to provide
an opinion as to an insurance company's relative financial strength and
ability to meet its contractual obligations. The procedure includes both a
quantitative and qualitative review of each company. A.M. Best also provides
certain rankings, to which Lincoln Life intends to refer.
DUFF & PHELPS insurance company claims paying ability (CPA) service provides
purchasers of insurance company policies and contracts with analytical and
statistical information on the solvency and liquidity of major U.S. licensed
insurance companies, both mutual and stock.
EAFE INDEX is prepared by Morgan Stanley Capital International (MSCI). It
measures performance of equity securities in Europe, Australia and the Far
East. The index reflects the movements of world stock markets by representing
the evolution of an unmanaged portfolio. The EAFE Index offers international
diversification representing over 1,000 companies across 20 different
countries.
LIPPER VARIABLE INSURANCE PRODUCTS PERFORMANCE ANALYSIS SERVICE is a publisher
of statistical data covering the investment company industry in the United
States and overseas. Lipper is recognized as the leading source of data on
open-end and closed-end funds. Lipper currently tracks the performance of over
5,000 investment companies and publishes numerous specialized reports,
including reports on performance and portfolio analysis, fee and expense
analysis.
B-10
<PAGE>
MOODY'S insurance financial strength rating is an opinion of an insurance
company's financial strength and ability to meet financial obligations. The
purpose of Moody's ratings is to provide investors with a simple system of
gradation by which the relative quality of insurance companies may be noted.
MORNINGSTAR is an independent financial publisher offering comprehensive
statistical and analytical coverage of open-end and closed-end funds and
variable annuities.
STANDARD & POOR'S insurance claims-paying ability rating is an opinion of an
operating insurance company's financial capacity to meet obligations under an
insurance policy in accordance with the terms. The likelihood of a timely flow
of funds from the insurer to the trustee for the bondholders is a key element
in the rating determination for such debt issues.
VARDS (VARIABLE ANNUITY RESEARCH DATA SERVICE) provides a comprehensive guide
to variable annuity contract features and historical fund performance. The
service also provides a readily understandable analysis of the comparative
characteristics and market performance of funds inclusive in variable
contracts.
STANDARD & POOR'S 500 INDEX--A broad-based measurement of U.S. stock-market
performance based on the weighted average performance of 500 common stocks of
leading companies in leading industries; commonly known as the Standard &
Poor's 500 (S&P 500). The selection of stocks, their relative weightings to
reflect differences in the number of outstanding shares, and publication of the
index itself are services of Standard & Poor's Corporation, a financial
advisory, securities rating, and publishing firm.
NASDAQ-OTC PRICE INDEX -- this index is based on the National Association of
Securities Dealers Automated Quotations (NASDAQ) and represents all domestic
over-the-counter stocks except those traded on exchanges and those having only
one market maker, a total of some 3,500 stocks. It is market value- weighted
and was introduced with a base of 100.00 on February 5, 1971.
DOW JONES INDUSTRIAL AVERAGE (DJIA)--price-weighted average of 30 actively
traded blue chip stocks, primarily industrials currently including American
Express Company and American Telephone and Telegraph Company. Prepared and
published by Dow Jones & Company, it is the oldest and most widely quoted of
all the market indicators. The average is quoted in points, not dollars.
In its advertisements and other sales literature for the VAA and the series
funds, Lincoln Life intends to illustrate the advantages of the contracts in a
number of ways:
COMPOUND INTEREST ILLUSTRATIONS. These will emphasize several advantages of the
variable annuity contract. For example, but not by way of illustration, the
literature may emphasize the potential tax savings through tax deferral; the
potential advantage of the variable annuity account over the fixed account; and
the compounding effect when a client makes regular deposits to his or her
contract.
INTERNET. An electronic communications network which may be used to provide
information regarding Lincoln Life, performance of the variable subaccounts and
advertisement literature.
DOLLAR-COST AVERAGING. (DCA)--You may systematically transfer on a monthly
basis amounts from the DCA fixed account or certain variable subaccounts into
the variable subaccounts or guaranteed period subaccounts. The variable
subaccounts that are currently available for dollar cost averaging are the
variable subaccounts with the Cash Management Fund and the U.S. Government/AAA-
Rated Securities Fund. We reserve the right to change subaccounts under this
program. You may elect to participate in the DCA program at the time of
application or at anytime before the annuity commencement date by completing an
election form available from us. The minimum amount to be dollar cost averaged
is $1,500 over any period between six and 60 months. Once elected, the program
will remain in effect until the earlier of: (1) the annuity commencement date;
(2) the value of the amount being DCA'd is depleted; or (3) you cancel the
program by written request or by telephone if we have your telephone
authorization on file. Currently, there is no charge for this service. However,
we reserve the right to impose one. A transfer under this program is not
considered a transfer for purposes of limiting the number of transfers that may
be made, or assessing any charges which may apply to transfers. We reserve the
right to discontinue this program at any time. DCA does not assure a profit or
protect against loss.
AUTOMATIC WITHDRAWAL SERVICE. (AWS)--AWS provides an automatic, periodic
withdrawal of contract value to you. You may elect to participate in AWS at the
time of application or at any time before the annuity commencement date by
sending a written request to our home office. The minimum contract value
required to establish AWS is $10,000. You may cancel or make changes to your
AWS program at any time by sending a written request to our home office. If
telephone authorization has been elected, certain changes may be made by
telephone. Notwithstanding the requirements of the program, any withdrawal must
be permitted by Section 401(a)(9) of the code for qualified plans or permitted
under Section 72 for non-qualified contracts. Currently, there is no charge for
this service. However, we reserve the right to impose one. If a charge is
imposed, it will not exceed $25 per transaction or 2% of the amount withdrawn,
B-11
<PAGE>
whichever is less. We reserve the right to discontinue this service at any
time.
CROSS-REINVESTMENT SERVICE--Under this option, account value in a designated
variable subaccount or the fixed side of the contract that exceeds a certain
baseline amount is automatically transferred to another specific variable
subaccount(s) or the fixed side of the contract at specific intervals. You may
elect to participate in cross-reinvestment at the time of application or at
any time before the annuity commencement date by sending a written request to
our home office or by telephone if we have your telephone authorization on
file. You designate the holding account, the receiving account(s), and the
baseline amount. Cross-reinvestment will continue until we receive
authorization to terminate the program.
The minimum holding account value required to establish cross-reinvestment is
$10,000. Currently, there is no charge for this service. However, we reserve
the right to impose one. A transfer under this program is not considered a
transfer for purposes of limiting the number of transfers that may be made, or
assessing any charges which may apply to transfers. We reserve the right to
discontinue this service at any time.
Lincoln Life's customers. Sales literature for the VAA and the series' funds
may refer to the number of employers and the number of individual annuity
clients which Lincoln Life serves. As of the date of this SAI, Lincoln Life
was serving over 10,000 employers and more than 1 million individuals.
Lincoln Life's assets, size. Lincoln Life may discuss its general financial
condition (see, for example, the reference to A.M. Best Company, above); it
may refer to its assets; it may also discuss its relative size and/or ranking
among companies in the industry or among any sub-classification of those
companies, based upon recognized evaluation criteria (see reference to A.M.
Best Company above). For example, at year-end 1998 Lincoln Life had statutory
admitted assets of over $70 billion.
Financial statements
Financial statements of the VAA and the statutory-basis financials statements
of Lincoln Life appear on the following pages.
B-12
<PAGE>
Lincoln National Variable Annuity Account H
Statement of assets and liability
December 31, 1998
<TABLE>
<CAPTION>
Combined Legacy II Legacy III
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Assets:
Investments at Market -
Unaffiliated (cost
$14,953,846,011) $18,492,419,717 $16,856,852,844 $1,635,566,873
Liability - Payable to The
Lincoln National Life Insurance
Company 682,786 621,971 60,815
- --------------------------------- --------------- --------------- --------------
Net assets $18,491,736,931 $16,856,230,873 $1,635,506,058
- --------------------------------- =============== =============== ==============
Contract Owner Reserves:
Reserves for Redeemable Annuity
Contracts $18,431,897,255 $16,800,637,491 $1,631,259,764
Reserves for Annuity Contracts
On Benefit 59,839,676 55,593,382 4,246,294
- --------------------------------- --------------- --------------- --------------
Total contract owner reserves $18,491,736,931 $16,856,230,873 $1,635,506,058
- --------------------------------- =============== =============== ==============
</TABLE>
See accompanying notes to financial statements.
H-1
<PAGE>
Lincoln National Variable Annuity Account H
Statement of operations
Year Ended December 31, 1998
<TABLE>
<CAPTION>
Combined Legacy II Legacy III
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Net Investment Income:
. Dividends from Investment
Income $ 327,436,555 $ 304,771,813 $ 22,664,742
-------------------------------
. Dividends from Net Realized
Gains on Investments 1,862,502,131 1,708,494,963 154,007,168
-------------------------------
. Mortality and Expense
Guarantees:
-------------------------------
. Legacy w/o Guaranteed
Minimum Death Benefit Rider (207,856,018) (205,355,219) (2,500,799)
. Legacy w/ Guaranteed Minimum
Death Benefit Rider (23,721,789) (11,716,946) (12,004,843)
- -------------------------------- -------------- -------------- ------------
Net investment income 1,958,360,879 1,796,194,611 162,166,268
- --------------------------------
Net realized and unrealized gain
(loss) on investments:
. Net Realized Gain (Loss) on
Investments 448,669,912 449,057,086 (387,174)
-------------------------------
. Net Change in Unrealized
Appreciation on Investments 670,203,311 648,166,156 22,037,155
- -------------------------------- -------------- -------------- ------------
Net realized and unrealized gain
on investments 1,118,873,223 1,097,223,242 21,649,981
- -------------------------------- -------------- -------------- ------------
Net increase in net assets
resulting from operations $3,077,234,102 $2,893,417,853 $183,816,249
- -------------------------------- ============== ============== ============
</TABLE>
See accompanying notes to financial statements.
H-2
<PAGE>
Lincoln National Variable Annuity Account H
Statements of changes in net assets
<TABLE>
<CAPTION>
Combined
Year Ended December 31,
1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Net Assets at January 1 $15,810,842,079 $12,596,374,351
Changes from Operations:
. Net Investment Income 1,958,360,879 1,551,728,270
------------------------------------------
. Net Realized Gain (Loss) on Investments 448,669,912 220,798,258
------------------------------------------
. Net Change in Unrealized Appreciation or
Depreciation on Investments 670,203,311 792,118,810
------------------------------------------ --------------- ---------------
Net Increase in Net Assets Resulting from
Operations 3,077,234,102 2,564,645,338
- -------------------------------------------
Changes from unit Transactions:
Accumulation Units:
. Contract purchases 3,687,600,242 3,939,653,525
-----------------------------------------
. Terminated contracts & transfers to
annuity reserves (4,095,996,116) (3,296,881,301)
----------------------------------------- --------------- ---------------
(408,395,874) 642,772,224
Annuity Reserves:
. Transfer from accumulation units &
between accounts 20,809,984 12,854,421
-----------------------------------------
. Annuity Payments (9,098,361) (5,868,342)
-----------------------------------------
. Receipt (reimbursement) of mortality
guarantee adjustment 345,001 64,087
------------------------------------------ --------------- ---------------
12,056,624 7,050,166
Net Increase (Decrease) in net assets
resulting from unit transactions (396,339,250) 649,822,390
- ------------------------------------------- --------------- ---------------
Total Increase In Net Assets 2,680,894,852 3,214,467,728
- ------------------------------------------- --------------- ---------------
Net Assets at December 31 $18,491,736,931 $15,810,842,079
- ------------------------------------------- =============== ===============
<CAPTION>
Legacy II
Year Ended December 31,
1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Net Assets at January 1 $15,301,064,643 $12,596,374,351
Changes from Operations:
. Net Investment Income 1,796,194,611 1,511,362,102
------------------------------------------
. Net Realized Gain (Loss) on Investments 449,057,086 220,794,057
------------------------------------------
. Net Change in Unrealized Appreciation or
Depreciation on Investments 648,166,156 823,411,043
------------------------------------------ --------------- ---------------
Net Increase in Net Assets Resulting from
Operations 2,893,417,853 2,555,567,202
- -------------------------------------------
Changes from unit Transactions:
Accumulation Units:
. Contract purchases 2,584,724,414 3,412,639,843
-----------------------------------------
. Terminated contracts & transfers to
annuity reserves (3,933,739,552) (3,267,948,599)
----------------------------------------- --------------- ---------------
(1,349,015,138) 144,691,244
Annuity Reserves:
. Transfer from accumulation units &
between accounts 18,962,600 10,104,880
-----------------------------------------
. Annuity Payments (8,303,509) (5,737,862)
-----------------------------------------
. Receipt (reimbursement) of mortality
guarantee adjustment 104,424 64,828
------------------------------------------ --------------- ---------------
10,763,515 4,431,846
Net Increase (Decrease) in net assets
resulting from unit transactions (1,338,251,623) 149,123,090
- ------------------------------------------- --------------- ---------------
Total Increase In Net Assets 1,555,166,230 2,704,690,292
- ------------------------------------------- --------------- ---------------
Net Assets at December 31 $16,856,230,873 $15,301,064,643
- ------------------------------------------- =============== ===============
</TABLE>
H-3
<PAGE>
Lincoln National Variable Annuity Account H
Statements of changes in net assets continued
<TABLE>
<CAPTION>
Legacy III
Year Ended December 31,
1998 1997
- ------------------------------------------------------------------------------
<S> <C> <C>
Net Assets at January 1 $ 509,777,436 $ --
Changes from Operations:
. Net Investment Income 162,166,268 40,366,168
----------------------------------------------
. Net Realized Gain (Loss) on Investments (387,174) 4,201
----------------------------------------------
. Net Change in Unrealized Appreciation or
Depreciation on Investments 22,037,155 (31,292,233)
---------------------------------------------- -------------- ------------
Net Increase in Net Assets Resulting from
Operations 183,816,249 9,078,136
- -----------------------------------------------
Changes from unit Transactions:
Accumulation Units:
. Contract purchases 1,102,875,828 527,013,682
---------------------------------------------
. Terminated contracts & transfers to annuity
reserves (162,256,564) (28,932,702)
--------------------------------------------- -------------- ------------
940,619,264 498,080,980
Annuity Reserves:
. Transfer from accumulation units & between
accounts 1,847,384 2,749,541
---------------------------------------------
. Annuity Payments (794,852) (130,480)
---------------------------------------------
. Receipt (reimbursement) of mortality
guarantee adjustment 240,577 (741)
--------------------------------------------- -------------- ------------
1,293,109 2,618,320
Net Increase (Decrease) in net assets resulting
from unit transactions 941,912,373 500,699,300
- ----------------------------------------------- -------------- ------------
Total Increase In Net Assets 1,125,728,622 509,777,436
- ----------------------------------------------- -------------- ------------
Net Assets at December 31 $1,635,506,058 $509,777,436
- ----------------------------------------------- ============== ============
</TABLE>
See accompanying notes to financial statements.
H-4
<PAGE>
Lincoln National Variable Annuity Account H
Notes to Financial
Statements
1. Accounting Policies & Account Information
The Account: Lincoln National Variable Annuity Account H (Variable Account) is
a segregated investment account of The Lincoln National Life Insurance Company
(the Company) and is registered with the Securities and Exchange Commission
under the Investment Company Act of 1940, as amended, as a unit investment
trust. The Variable Account consists of two products, each with a Company
annuity contract offering a guaranteed minimum death benefit (GMDB) rider
option. The available contracts are as follows:
. Legacy II
. Legacy III
Effective April 30, 1997, the Legacy III contract became available to clients
of the Company.
The assets of the Variable Account are owned by the Company. The portion of the
Variable Account's assets supporting the annuity contracts may not be used to
satisfy liabilities arising out of any other business of the Company.
Basis of Presentation: The accompanying financial statements have been prepared
in accordance with generally accepted accounting principles for unit investment
trusts.
Investments: The Variable Account invests in the American Variable Insurance
Series (AVIS) which consists of the following funds: Growth Income Fund, Growth
Fund, Asset Allocation Fund, High-Yield Bond Fund, U.S. Government/AAA-Rated
Securities Fund, Cash Management Fund, International Fund, Bond Fund, Global
Growth Fund and Global Small Capitalization Fund (the Funds). Avis is
registered as an open-ended management investment company. Legacy II and Legacy
III invest in different classes of shares of the Funds and these investments
are stated at the closing net asset value per share on December 31, 1998, which
approximates fair value. The difference between cost and fair value is
reflected as unrealized appreciation and depreciation of investments.
Investment transactions are accounted for on a trade date basis. The cost of
investments sold is determined by the average cost method.
Dividends: Dividends paid to the Variable Account are automatically reinvested
in shares of the Funds on the payable date. Dividend income is recorded on the
ex-dividend date.
Federal Income Taxes: Operations of the Variable Account form a part of and are
taxed with operations of the Company, which is taxed as a "life insurance
company" under the Internal Revenue Code. The Variable Account will not be
taxed as a regulated investment company under Subchapter M of the Internal
Revenue Code. Under current federal income tax law, no federal income taxes are
payable with respect to the Variable Account's net investment income and the
net realized gain on investments.
Annuity Reserves: Reserves on contracts not involving life contingencies are
calculated using an assumed investment rate of 4%. Reserves on contracts
involving life contingencies are calculated using a modification of the 1971
Individual Annuitant Mortality Table and an assumed investment rate of 4%.
2. Mortality and Expense Guarantees & Other Transactions with Affiliates
Amounts are paid to the Company for mortality and expense guarantees at a
percentage of the current value of the Variable Account each day. The rates are
as follows for the two contract types and the corresponding rider options
within the Variable Account:
. Legacy II at a daily rate of .0036986% (1.35% on an annual basis),
. Legacy II with GMDB rider at a daily rate of .0041096% (1.50% on an annual
basis),
. Legacy III at a daily rate of .0034247% (1.25% on an annual basis),
. Legacy III with GMDB rider at a daily rate of .0038356% (1.40% on an annual
basis).
In addition, amounts retained by the Company from the proceeds of the sales of
annuity contracts for contract charges and surrender charges were as follows
during 1998:
<TABLE>
<CAPTION>
Legacy II Legacy III
- --------------------------------------------------------------------
<S> <C> <C>
Growth Account $ 5,016,671 $ 96,685
International Account 2,801,128 39,856
Growth-Income Account 6,575,431 168,940
Asset Allocation Account 1,539,707 46,940
Bond Account 153,202 11,805
High-Yield Bond Account 766,173 21,598
U.S. Government/AAA-Rated Securities Account 507,271 5,530
Cash Management Account 1,314,046 22,939
Global Growth Account 76,722 42,693
Global Small Capitalization Account 11,612 860
- -------------------------------------------- ----------- --------
$18,761,963 $457,846
=========== ========
</TABLE>
Accordingly, the Company is responsible for all sales, general and
administrative expenses applicable to the Variable Account.
H-5
<PAGE>
Lincoln National Variable Annuity Account H
Notes To Financial Statements continued
3. Purchases and Sales of Investments
The aggregate cost of investments purchased and the aggregate proceeds from
investments sold were as follows for 1998:
<TABLE>
<CAPTION>
Combined
Aggregate
Aggregate Cost of Proceeds
Purchases from Sales
- ---------------------------------------------------------------------------
<S> <C> <C>
Growth Fund $ 987,243,030 $ 539,549,321
International Fund 160,077,085 435,006,968
Growth Income Fund 1,445,836,998 671,090,637
Asset Allocation Fund 315,244,129 118,419,933
Bond Fund 101,985,296 17,180,033
High-Yield Bond Fund 149,044,098 104,170,715
U.S. Government/AAA-Rated Securities Fund 138,629,187 62,132,582
Cash Management Fund 282,561,898 235,821,854
Global Growth Fund 110,304,909 13,450,235
Global Small Capitalization Fund 70,500,859 2,487,333
- ----------------------------------------- -------------- --------------
$3,761,427,489 $2,199,309,611
============== ==============
<CAPTION>
Legacy II
Aggregate
Aggregate Cost of Proceeds
Purchases from Sales
- ---------------------------------------------------------------------------
<S> <C> <C>
Growth Fund $ 746,862,578 $ 538,911,970
International Fund 90,221,331 433,688,228
Growth Income Fund 1,001,183,593 670,384,982
Asset Allocation Fund 177,608,419 118,344,082
Bond Fund 65,566,988 15,667,224
High-Yield Bond Fund 95,567,584 102,540,471
U.S. Government/AAA-Rated Securities Fund 109,573,580 58,633,998
Cash Management Fund 240,469,305 213,367,641
Global Growth Fund 46,222,980 12,541,151
Global Small Capitalization Fund 51,245,275 2,444,402
- ----------------------------------------- -------------- --------------
$2,624,521,633 $2,166,524,149
============== ==============
<CAPTION>
Legacy III
Aggregate
Aggregate Cost of Proceeds
Purchases from Sales
- ---------------------------------------------------------------------------
<S> <C> <C>
Growth Fund $ 240,380,452 $ 637,351
International Fund 69,855,754 1,318,740
Growth Income Fund 444,653,405 705,655
Asset Allocation Fund 137,635,710 75,851
Bond Fund 36,418,308 1,512,809
High-Yield Bond Fund 53,476,514 1,630,244
U.S. Government/AAA-Rated Securities Fund 29,055,607 3,498,584
Cash Management Fund 42,092,593 22,454,213
Global Growth Fund 64,081,929 909,084
Global Small Capitalization Fund 19,255,584 42,931
- ----------------------------------------- -------------- --------------
$1,136,905,856 $ 32,785,462
============== ==============
</TABLE>
H-6
<PAGE>
Lincoln National Variable Annuity Account H
Notes to Financial Statements continued
4. Summary of Changes From Unit Transactions
<TABLE>
<CAPTION>
Legacy II Legacy III
Amount Amount Amount
1998 1997 1998 Amount 1997
- ----------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Growth Account
Accumulation Units:
Contract purchases $ 551,914,456 $ 728,546,239 $217,793,895 $90,888,019
- ------------------------------------------------
Terminated contracts & transfers to annuity
reserves (982,427,432) (776,465,942) (22,967,104) (1,946,987)
- ------------------------------------------------ -------------- ------------- ------------ -----------
(430,512,976) (47,919,703) 194,826,791 88,941,032
Annuity Reserves:
Transfers from accum. units & between accts. 4,395,770 1,980,548 234,503 676,526
- ------------------------------------------------
Annuity payments (1,831,321) (1,158,554) (226,163) (36,798)
- ------------------------------------------------
Receipt (payment) of mortality guarantee adj. 24,785 47,626 73,099 --
- ------------------------------------------------ -------------- ------------- ------------ -----------
2,589,234 869,620 81,439 639,728
-------------- ------------- ------------ -----------
Account Total: (427,923,742) (47,050,083) 194,908,230 89,580,760
- ------------------------------------------------
International Account
Accumulation Units:
Contract purchases 238,711,087 563,896,305 78,349,055 59,737,776
- ------------------------------------------------
Terminated contracts & transfers to annuity
reserves (627,305,056) (559,225,049) (12,270,273) (2,024,029)
- ------------------------------------------------ -------------- ------------- ------------ -----------
(388,593,969) 4,671,256 66,078,782 57,713,747
Annuity Reserves:
Transfers from accum. units & between accts. 3,860,451 1,901,955 274,690 204,394
- ------------------------------------------------
Annuity payments (1,301,839) (976,576) (47,154) (7,992)
- ------------------------------------------------
Receipt (payment) of mortality guarantee adj. 9,854 12,677 19,785 (105)
- ------------------------------------------------ -------------- ------------- ------------ -----------
2,568,466 938,056 247,321 196,297
-------------- ------------- ------------ -----------
Account Total: (386,025,503) 5,609,312 66,326,103 57,910,044
- ------------------------------------------------
Growth-Income Account
Accumulation Units:
Contract purchases 580,662,940 986,854,299 391,845,842 191,858,393
- ------------------------------------------------
Terminated contracts & transfers to annuity
reserves (1,145,406,574) (905,566,078) (35,431,367) (3,799,497)
- ------------------------------------------------ -------------- ------------- ------------ -----------
(564,743,634) 81,288,221 356,414,475 188,058,896
Annuity Reserves:
Transfers from accum. units & between accts. 5,153,286 3,337,569 895,860 899,607
- ------------------------------------------------
Annuity payments (2,717,517) (1,900,756) (356,520) (49,315)
- ------------------------------------------------
Receipt (payment) of mortality guarantee adj. 44,580 33,680 88,801 (414)
- ------------------------------------------------ -------------- ------------- ------------ -----------
2,480,349 1,470,493 628,141 849,878
-------------- ------------- ------------ -----------
Account Total: (562,263,285) 82,758,714 357,042,616 188,908,774
- ------------------------------------------------
Asset Allocation Account
Accumulation Units:
Contract purchases 192,171,653 253,359,668 132,102,805 51,111,537
- ------------------------------------------------
Terminated contracts & transfers to annuity
reserves (260,845,905) (201,113,144) (9,974,982) (1,659,971)
- ------------------------------------------------ -------------- ------------- ------------ -----------
(68,674,252) 52,246,524 122,127,823 49,451,566
Annuity Reserves:
Transfers from accum. units & between accts. 1,776,864 1,701,628 141,714 134,397
- ------------------------------------------------
Annuity payments (1,217,453) (939,220) (36,686) (3,613)
- ------------------------------------------------
Receipt (payment) of mortality guarantee adj. (17,136) 11,258 26,476 --
- ------------------------------------------------ -------------- ------------- ------------ -----------
542,275 773,666 131,504 130,784
-------------- ------------- ------------ -----------
Account Total: (68,131,977) 53,020,190 122,259,327 49,582,350
- ------------------------------------------------
Bond Account
Accumulation Units:
Contract purchases 95,771,458 80,136,740 38,310,391 14,154,820
- ------------------------------------------------
Terminated contracts & transfers to annuity
reserves (55,017,820) (33,142,189) (5,362,264) (424,215)
- ------------------------------------------------ -------------- ------------- ------------ -----------
40,753,638 46,994,551 32,948,127 13,730,605
</TABLE>
H-7
<PAGE>
Lincoln National Variable Annuity Account H
Notes to Financial Statements continued
4. Summary of Changes From Unit Transactions continued
<TABLE>
<CAPTION>
Legacy II Legacy III
Amount Amount Amount Amount
1998 1997 1998 1997
- -------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Bond Account (Continued)
Annuity Reserves:
Transfers from accum.
units & between accts. 651,791 691,290 65,465 132,811
- ------------------------
Annuity payments (267,133) (102,359) (21,305) (3,293)
- ------------------------
Receipt (payment) of
mortality guarantee
adj. (176) (234) 2,007 --
- ------------------------ ------------ ------------ ----------- -----------
384,482 588,697 46,167 129,518
------------ ------------ ----------- -----------
Account Total: 41,138,120 47,583,248 32,994,294 13,860,123
- ------------------------
High-Yield Bond Account
Accumulation Units:
Contract purchases 135,804,932 184,270,318 55,113,767 24,783,776
- ------------------------
Terminated contracts &
transfers to annuity
reserves (200,788,113) (160,961,554) (8,353,986) (581,153)
- ------------------------ ------------ ------------ ----------- -----------
(64,983,181) 23,308,764 46,759,781 24,202,623
Annuity Reserves:
Transfers from accum.
units & between accts. 1,867,393 602,849 74,730 195,211
- ------------------------
Annuity payments (454,376) (269,443) (33,896) (7,401)
- ------------------------
Receipt (payment) of
mortality guarantee
adj. 1,122 (4,844) 14,692 --
- ------------------------ ------------ ------------ ----------- -----------
1,414,139 328,562 55,526 187,810
------------ ------------ ----------- -----------
Account Total: (63,569,042) 23,637,326 46,815,307 24,390,433
- ------------------------
U.S. Government/AAA-
Rated Account
Accumulation Units:
Contract purchases 166,657,873 83,083,299 34,821,390 10,953,372
- ------------------------
Terminated contracts &
transfers to annuity
reserves (136,101,572) (137,391,592) (10,222,891) (2,791,708)
- ------------------------ ------------ ------------ ----------- -----------
30,556,301 (54,308,293) 24,598,499 8,161,664
Annuity Reserves:
Transfers from accum.
units & between accts. 712,721 (2,080) -- 331,202
- ------------------------
Annuity payments (288,555) (193,843) (39,846) (14,806)
- ------------------------
Receipt (payment) of
mortality guarantee
adj. 40,320 (37,097) (1,672) (114)
- ------------------------ ------------ ------------ ----------- -----------
464,486 (233,020) (41,518) 316,282
------------ ------------ ----------- -----------
Account Total: 31,020,787 (54,541,313) 24,556,981 8,477,946
- ------------------------
Cash Management Account
Accumulation Units:
Contract purchases 493,741,514 437,685,502 66,014,956 28,789,775
- ------------------------
Terminated contracts &
transfers to annuity
reserves (473,937,066) (477,381,751) (47,275,290) (14,362,271)
- ------------------------ ------------ ------------ ----------- -----------
19,804,448 (39,696,249) 18,739,666 14,427,504
Annuity Reserves:
Transfers from accum.
units & between accts. 24,415 (238,314) 6,484 --
- ------------------------
Annuity payments (158,324) (192,442) (1,165) --
- ------------------------
Receipt (payment) of
mortality guarantee
adj. 2,044 1,762 (1,812) --
- ------------------------ ------------ ------------ ----------- -----------
(131,865) (428,994) 3,507 --
------------ ------------ ----------- -----------
Account Total: 19,672,583 (40,125,243) 18,743,173 14,427,504
- ------------------------
Global Growth Account
Accumulation Units:
Contract purchases 70,605,753 94,807,473 68,726,468 54,736,214
- ------------------------
Terminated contracts &
transfers to annuity
reserves (41,136,434) (16,701,300) (9,505,490) (1,342,871)
- ------------------------ ------------ ------------ ----------- -----------
29,469,319 78,106,173 59,220,978 53,393,343
Annuity Reserves:
Transfers from accum.
units & between accts. 267,744 129,435 107,634 175,393
- ------------------------
Annuity payments (55,215) (4,669) (31,478) (7,262)
- ------------------------
Receipt (payment) of
mortality guarantee
adj. (969) -- 17,065 (108)
- ------------------------ ------------ ------------ ----------- -----------
211,560 124,766 93,221 168,023
------------ ------------ ----------- -----------
Account Total: 29,680,879 78,230,939 59,314,199 53,561,366
- ------------------------
</TABLE>
H-8
<PAGE>
Lincoln National Variable Annuity Account H
Notes to Financial Statements continued
4. Summary of Changes From Unit Transactions continued
<TABLE>
<CAPTION>
Legacy II Legacy III
Amount Amount Amount Amount
1998 1997 1998 1997
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Global Small Capitalization Account
Accumulation Units:
Contract purchases $ 58,682,748 $ -- $ 19,797,259 --
- ----------------------------------------------------
Terminated contracts & transfers to annuity reserves (10,773,580) -- (892,917) --
- ---------------------------------------------------- --------------- ------------ ------------ ------------
47,909,168 -- 18,904,342 --
Annuity Reserves:
Transfers from accum. units & between accts. 252,165 -- 46,304 --
- ----------------------------------------------------
Annuity payments (11,776) -- (639) --
- ----------------------------------------------------
Receipt (payment) of mortality guarantee adj. -- -- 2,136 --
- ---------------------------------------------------- --------------- ------------ ------------ ------------
240,389 -- 47,801 --
--------------- ------------ ------------ ------------
Account Total: 48,149,557 -- 18,952,143 --
--------------- ------------ ------------ ------------
Product Total $(1,338,251,623) $149,123,090 $941,912,373 $500,699,300
- ---------------------------------------------------- =============== ============ ============ ============
</TABLE>
5. Summary of Units Outstanding at December 31, 1998
<TABLE>
<CAPTION>
Accumulation Reserve Unit Accumulation Reserve
Legacy II Investments Units Units Value Amount Amount Net Asset Total
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Legacy II
Growth Fund 1,219,326,627 4,022,303 $3.934 $ 4,796,899,734 $15,823,966 $ 4,812,723,700
International Fund 1,051,759,276 4,324,749 2.259 2,375,619,380 9,768,356 2,385,387,736
Growth Income Fund 1,824,715,730 5,600,196 3.185 5,811,237,255 17,835,145 5,829,072,400
Asset Allocation Fund 504,099,778 2,157,559 2.668 1,345,004,489 5,756,652 1,350,761,141
Bond Fund 144,667,438 898,539 1.168 169,029,860 1,049,856 170,079,716
High-Yield Bond Fund 264,043,206 1,153,118 2.232 589,425,406 2,574,112 591,999,518
U.S. Government/AAA-
Rated Securities Fund 244,151,450 996,661 1.811 442,244,769 1,805,307 444,050,076
Cash Management Fund 140,499,673 218,164 1.401 196,867,792 305,690 197,173,482
Global Growth Fund 91,373,714 295,563 1.370 125,171,270 404,887 125,576,157
Global Small
Capitalization Fund 47,759,041 265,491 1.015 48,464,181 269,411 48,733,592
------------- ---------- --------------- ----------- ---------------
Subtotal 5,532,395,933 19,932,343 15,899,964,136 55,593,382 15,955,557,518
Legacy II with GMDB
Rider
Growth Fund 70,063,382 -- 3.924 274,941,444 -- 274,941,444
International Fund 52,670,012 -- 2.253 118,658,021 -- 118,658,021
Growth Income Fund 110,722,531 -- 3.177 351,740,356 -- 351,740,356
Asset Allocation Fund 26,935,779 -- 2.661 71,688,521 -- 71,688,521
Bond Fund 6,618,541 -- 1.165 7,713,807 -- 7,713,807
High-Yield Bond Fund 11,991,074 -- 2.227 26,700,710 -- 26,700,710
U.S. Government/AAA-
Rated Securities Fund 12,542,454 -- 1.807 22,662,063 -- 22,662,063
Cash Management Fund 12,070,445 -- 1.398 16,870,667 -- 16,870,667
Global Growth Fund 5,133,366 -- 1.366 7,014,513 -- 7,014,513
Global Small
Capitalization Fund 2,646,656 -- 1.014 2,683,253 -- 2,683,253
------------- ---------- --------------- ----------- ---------------
Subtotal 311,394,240 -- 900,673,355 -- 900,673,355
------------- ---------- --------------- ----------- ---------------
Total Legacy II 5,843,790,173 19,932,343 $16,800,637,491 $55,593,382 $16,856,230,873
============= ========== =============== =========== ===============
</TABLE>
H-9
<PAGE>
Lincoln National Variable Annuity Account H
Notes to Financial Statements continued
5. Summary of Units Outstanding at December 31, 1998 continued
<TABLE>
<CAPTION>
Accumulation Reserve Unit Accumulation Reserve
Legacy III Investments Units Units Value Amount Amount Net Asset Total
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Legacy III
Growth Fund 34,914,566 519,907 $1.677 $ 58,559,744 $ 872,004 $ 59,431,748
International Fund 17,329,908 375,126 1.224 21,211,242 459,142 21,670,384
Growth Income Fund 86,984,617 1,158,754 1.385 120,431,648 1,604,315 122,035,963
Asset Allocation Fund 33,006,940 198,853 1.272 41,988,065 252,960 42,241,025
Bond Fund 8,539,588 159,913 1.111 9,489,729 177,705 9,667,434
High-Yield Bond Fund 11,909,245 212,545 1.085 12,924,910 230,671 13,155,581
U.S. Government/AAA-
Rated Securities Fund 6,310,125 265,127 1.137 7,175,360 301,481 7,476,841
Cash Management Fund 7,947,943 5,143 1.061 8,435,297 5,458 8,440,755
Global Growth Fund 16,793,007 212,331 1.367 22,955,597 290,251 23,245,848
Global Small
Capitalization Fund 2,996,405 51,583 1.014 3,038,492 52,307 3,090,799
------------- --------- -------------- ---------- --------------
Subtotal 226,732,344 3,159,282 306,210,084 4,246,294 310,456,378
Legacy III with GMDB
Rider
Growth Fund 178,720,900 -- 1.673 299,014,827 -- 299,014,827
International Fund 93,698,199 -- 1.221 114,396,027 -- 114,396,027
Growth Income Fund 356,163,991 -- 1.381 491,882,912 -- 491,882,912
Asset Allocation Fund 112,044,789 -- 1.269 142,176,538 -- 142,176,538
Bond Fund 34,412,649 -- 1.108 38,145,549 -- 38,145,549
High-Yield Bond Fund 52,869,138 -- 1.083 57,235,418 -- 57,235,418
U.S. Government/AAA-
Rated Securities Fund 23,721,809 -- 1.134 26,906,997 -- 26,906,997
Cash Management Fund 24,317,669 -- 1.059 25,744,260 -- 25,744,260
Global Growth Fund 81,691,571 -- 1.363 111,310,867 -- 111,310,867
Global Small
Capitalization Fund 18,001,016 -- 1.013 18,236,285 -- 18,236,285
------------- --------- -------------- ---------- --------------
Subtotal 975,641,731 -- 1,325,049,680 -- 1,325,049,680
------------- --------- -------------- ---------- --------------
Total Legacy III 1,202,374,075 3,159,282 $1,631,259,764 $4,246,294 $1,635,506,058
============= ========= ============== ========== ==============
</TABLE>
H-10
<PAGE>
[THIS PAGE INTENTIONALLY LEFT BLANK]
H-11
<PAGE>
Lincoln National Variable Annuity Account H
Notes to Financial Statements continued
6. Net Assets
The following is a summary of net assets owned at December 31, 1998.
<TABLE>
<CAPTION>
Growth- Asset
Growth International Income Allocation Bond
Legacy II Combined Account Account Account Account Account
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Unit Transactions:
Accumulation units: $ 7,009,952,471 $1,573,356,746 $1,270,532,870 $2,302,084,050 $ 673,599,557 $159,750,783
Annuity reserves 35,825,290 9,087,007 7,221,515 10,450,900 3,574,826 1,013,179
- ------------------------ --------------- -------------- -------------- -------------- -------------- ------------
7,045,777,761 1,582,443,753 1,277,754,385 2,312,534,950 677,174,383 160,763,962
Accumulated net
investment income 5,386,279,669 1,626,205,763 529,714,256 2,309,865,315 443,962,461 17,214,953
- ------------------------
Accumulated net realized
gain (loss) on
investments 876,344,659 368,102,128 149,550,639 309,826,872 47,433,716 626,706
- ------------------------
Net unrealized
appreciation
(depreciation) on
investments: 3,547,828,784 1,510,913,500 547,026,477 1,248,585,619 253,879,102 (812,098)
- ------------------------ --------------- -------------- -------------- -------------- -------------- ------------
$16,856,230,873 $5,087,665,144 $2,504,045,757 $6,180,812,756 $1,422,449,662 $177,793,523
=============== ============== ============== ============== ============== ============
<CAPTION>
Growth- Asset
Growth International Income Allocation Bond
Legacy III Combined Account Account Account Account Account
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Unit Transactions:
Accumulation units $ 1,438,700,243 $ 283,767,822 $ 123,792,529 $ 544,473,371 $ 171,579,389 $ 46,678,732
- ------------------------
Annuity reserves 3,911,430 721,167 443,618 1,478,019 262,288 175,685
- ------------------------ --------------- -------------- -------------- -------------- -------------- ------------
1,442,611,673 284,488,989 124,236,147 545,951,390 171,841,677 46,854,417
Accumulated net
investment income 202,532,436 55,529,362 7,979,400 105,597,735 18,422,529 2,332,166
- ------------------------
Accumulated net realized
gain (loss) on
investments (382,973) (16,379) (128,735) (97,330) (7,326) (21,720)
- ------------------------
Net unrealized
appreciation
(depreciation) on
investments (9,255,078) 18,444,603 3,979,599 (37,532,920) (5,839,317) (1,351,880)
- ------------------------ --------------- -------------- -------------- -------------- -------------- ------------
$ 1,635,506,058 $ 358,446,575 $ 136,066,411 $ 613,918,875 $ 184,417,563 $ 47,812,983
=============== ============== ============== ============== ============== ============
</TABLE>
H-12
<PAGE>
<TABLE>
<CAPTION>
U.S. Govt
AAA-Rated Cash Global Global
High-Yield Securities Management Growth Small Capitalization
Bond Account Account Account Account Account
- ---------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$402,721,279 $306,093,773 $166,328,753 $107,575,492 $47,909,168
2,296,478 1,393,133 211,537 336,326 240,389
- ------------ ------------ ------------ ------------ -----------
405,017,757 307,486,906 166,540,290 107,911,818 48,149,557
247,380,286 159,983,474 47,250,486 4,053,240 649,435
2,549,019 (3,330,608) 1,471,865 589,935 (475,613)
(36,246,834) 2,572,367 (1,218,492) 20,035,677 3,093,466
- ------------ ------------ ------------ ------------ -----------
$618,700,228 $466,712,139 $214,044,149 $132,590,670 $51,416,845
============ ============ ============ ============ ===========
<CAPTION>
U.S. Govt
AAA-Rated Cash Global Global
High-Yield Securities Management Growth Small Capitalization
Bond Account Account Account Account Account
- ---------------------------------------------------------------------------
<S> <C> <C> <C> <C>
$ 70,962,404 $ 32,760,163 $ 33,167,170 $112,614,321 $18,904,342
243,336 274,764 3,507 261,244 47,802
- ------------ ------------ ------------ ------------ -----------
71,205,740 33,034,927 33,170,677 112,875,565 18,952,144
6,090,727 1,213,264 1,207,453 3,900,081 259,719
(157,106) 42,345 2,174 8,667 (7,563)
(6,748,362) 93,302 (195,289) 17,772,402 2,122,784
- ------------ ------------ ------------ ------------ -----------
$ 70,390,999 $ 34,383,838 $ 34,185,015 $134,556,715 $21,327,084
============ ============ ============ ============ ===========
</TABLE>
H-13
<PAGE>
Lincoln National Variable Annuity Account H
Notes to Financial Statements continued
7. Investments
The following is a summary of investments owned at December 31, 1998.
<TABLE>
<CAPTION>
Net Unrealized
Percentage Shares Asset Value of Cost of Appreciation/
Legacy II Investments of Net Assets Outstanding Value Shares Shares (Depreciation)
- --------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Growth Fund 30.18% 97,040,849 $52.43 $ 5,087,851,717 $ 3,576,938,217 $1,510,913,500
International Fund 14.85% 147,129,169 17.02 2,504,138,464 1,957,111,987 547,026,477
Growth Income Fund 36.67% 170,323,534 36.29 6,181,041,036 4,932,455,417 1,248,585,619
Asset Allocation Fund 8.44% 91,361,744 15.57 1,422,502,357 1,168,623,255 253,879,102
Bond Fund 1.05% 17,482,806 10.17 177,800,132 178,612,230 (812,098)
High-Yield Bond Fund 3.67% 46,520,538 13.30 618,723,159 654,969,993 (36,246,834)
U.S. Government/AAA-
Rated Securities Fund 2.77% 41,266,980 11.31 466,729,544 464,157,177 2,572,367
Cash Management Fund 1.27% 19,423,969 11.02 214,052,140 215,270,632 (1,218,492)
Global Growth Fund 0.79% 9,954,622 13.32 132,595,569 112,559,892 20,035,677
Global Small
Capitalization Fund 0.31% 5,126,493 10.03 51,418,726 48,325,260 3,093,466
------- --------------- --------------- --------------
Legacy II Total 100.00% $16,856,852,844 $13,309,024,060 $3,547,828,784
======= =============== =============== ==============
Legacy III Investments
Growth Fund (class II
shares) 21.92% 6,838,226 $52.42 $ 358,459,818 $ 340,015,215 $ 18,444,603
International Fund
(class II shares) 8.32% 7,994,801 17.02 136,071,510 132,091,911 3,979,599
Growth Income Fund
(class II shares) 37.54% 16,922,317 36.28 613,941,677 651,474,597 (37,532,920)
Asset Allocation Fund
(class II shares) 11.28% 11,844,857 15.57 184,424,425 190,263,742 (5,839,317)
Bond Fund (class II
shares) 2.92% 4,701,551 10.17 47,814,775 49,166,655 (1,351,880)
High-Yield Bond Fund
(class II shares) 4.30% 5,292,754 13.30 70,393,631 77,141,993 (6,748,362)
U.S. Government/AAA-
Rated Securities Fund
(class II shares) 2.10% 3,040,241 11.31 34,385,124 34,291,822 93,302
Cash Management Fund
(class II shares) 2.09% 3,102,204 11.02 34,186,288 34,381,577 (195,289)
Global Growth Fund
(class II shares) 8.23% 10,109,823 13.31 134,561,751 116,789,349 17,772,402
Global Small
Capitalization Fund
(class II shares) 1.30% 2,126,408 10.03 21,327,874 19,205,090 2,122,784
------- --------------- --------------- --------------
Legacy III Total 100.00% $ 1,635,566,873 $ 1,644,821,951 $ (9,255,078)
======= =============== =============== ==============
Account "H" Total $18,492,419,717 $14,953,846,011 $3,538,573,706
=============== =============== ==============
</TABLE>
8. New Investment Funds
Effective April 25, 1997, the AVIS Global Growth Fund became available as an
investment option for Variable Account contract owners. Effective April 30,
1998, the AVIS Global Small Capitalization Fund became available as an
investment option for Variable Account contract owners.
H-14
<PAGE>
Report of Ernst & Young LLP,
Independent Auditors
Board of Directors of The Lincoln National Life Insurance Company
and
Contract Owners of Lincoln National Variable Annuity Account H
We have audited the accompanying statement of assets and
liability of Lincoln National Variable Annuity Account H
("Variable Account") (comprised of the AVIS Growth, AVIS
International, AVIS Growth-Income, AVIS Asset Allocation,
AVIS Bond, AVIS High-Yield Bond, AVIS U.S. Government/AAA-
Rated Securities, AVIS Cash Management, AVIS Global Growth,
and AVIS Global Small Capitalization subaccounts), as of
December 31, 1998, and the related statement of operations
for the year then ended and the statements of changes in net
assets for each of the two years in the period then ended.
These financial statements are the responsibility of the
Variable Account's management. Our responsibility is to
express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally
accepted auditing standards. Those standards require that we
plan and perform the audit to obtain reasonable assurance
about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the
financial statements. Our procedures included confirmation
of investments owned as of December 31, 1998, by
correspondence with the custodian. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above
present fairly, in all material respects, the financial
position of each of the respective subaccounts constituting
the Lincoln National Variable Annuity Account H at December
31, 1998, the results of their operations for the year then
ended, and the changes in their net assets for each of the
two years in the period then ended in conformity with
generally accepted accounting principles.
Fort Wayne, Indiana
March 11, 1999
H-15
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
BALANCE SHEETS -- STATUTORY BASIS
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
--------- ---------
(IN MILLIONS)
--------------------
<S> <C> <C>
ADMITTED ASSETS
CASH AND INVESTMENTS:
Bonds $23,830.9 $18,560.7
- ------------------------------------------------------------------------------------
Preferred stocks 236.0 257.3
- ------------------------------------------------------------------------------------
Unaffiliated common stocks 259.3 436.0
- ------------------------------------------------------------------------------------
Affiliated common stocks 322.1 412.1
- ------------------------------------------------------------------------------------
Mortgage loans on real estate 3,932.9 3,012.7
- ------------------------------------------------------------------------------------
Real estate 473.8 584.4
- ------------------------------------------------------------------------------------
Policy loans 1,606.0 660.5
- ------------------------------------------------------------------------------------
Other investments 434.4 335.5
- ------------------------------------------------------------------------------------
Cash and short-term investments 1,725.4 2,133.0
- ------------------------------------------------------------------------------------ --------- ---------
Total cash and investments 32,820.8 26,392.2
- ------------------------------------------------------------------------------------
Premiums and fees in course of collection 33.3 42.4
- ------------------------------------------------------------------------------------
Accrued investment income 432.8 343.5
- ------------------------------------------------------------------------------------
Reinsurance recoverable 171.6 71.1
- ------------------------------------------------------------------------------------
Funds withheld by ceding companies 53.7 44.1
- ------------------------------------------------------------------------------------
Federal income taxes recoverable from parent company 64.7 6.9
- ------------------------------------------------------------------------------------
Goodwill 49.5 52.4
- ------------------------------------------------------------------------------------
Other admitted assets 89.3 85.6
- ------------------------------------------------------------------------------------
Separate account assets 36,907.0 31,330.9
- ------------------------------------------------------------------------------------ --------- ---------
Total admitted assets $70,622.7 $58,369.1
- ------------------------------------------------------------------------------------ --------- ---------
--------- ---------
LIABILITIES AND CAPITAL AND SURPLUS
LIABILITIES:
Future policy benefits and claims $12,310.6 $ 5,872.9
- ------------------------------------------------------------------------------------
Other policyholder funds 16,647.5 16,360.1
- ------------------------------------------------------------------------------------
Amounts withheld or retained by Company as agent or trustee 897.6 878.2
- ------------------------------------------------------------------------------------
Funds held under reinsurance treaties 795.8 720.4
- ------------------------------------------------------------------------------------
Asset valuation reserve 484.5 450.0
- ------------------------------------------------------------------------------------
Interest maintenance reserve 159.7 135.4
- ------------------------------------------------------------------------------------
Other liabilities 504.5 294.7
- ------------------------------------------------------------------------------------
Short-term loan payable to parent company 140.0 120.0
- ------------------------------------------------------------------------------------
Net transfers due from separate accounts (789.0) (761.9)
- ------------------------------------------------------------------------------------
Separate account liabilities 36,907.0 31,330.9
- ------------------------------------------------------------------------------------ --------- ---------
Total liabilities 68,058.2 55,400.7
- ------------------------------------------------------------------------------------
CAPITAL AND SURPLUS:
Common stock, $2.50 par value:
Authorized, issued and outstanding shares -- 10 million (owned by Lincoln National
Corporation) 25.0 25.0
- ------------------------------------------------------------------------------------
Surplus notes due to Lincoln National Corporation 1,250.0 --
- ------------------------------------------------------------------------------------
Paid-in surplus 1,930.1 1,821.8
- ------------------------------------------------------------------------------------
Unassigned surplus (deficit) (640.6) 1,121.6
- ------------------------------------------------------------------------------------ --------- ---------
Total capital and surplus 2,564.5 2,968.4
- ------------------------------------------------------------------------------------ --------- ---------
Total liabilities and capital and surplus $70,622.7 $58,369.1
- ------------------------------------------------------------------------------------ --------- ---------
--------- ---------
</TABLE>
See accompanying notes. S-1
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
STATEMENTS OF OPERATIONS -- STATUTORY BASIS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
--------- --------- ---------
(IN MILLIONS)
-------------------------------
<S> <C> <C> <C>
PREMIUMS AND OTHER REVENUES:
Premiums and deposits $12,737.6 $ 5,589.0 $ 7,268.5
- ----------------------------------------------------------------------------
Net investment income 2,107.2 1,847.1 1,756.3
- ----------------------------------------------------------------------------
Amortization of interest maintenance reserve 26.4 41.5 27.2
- ----------------------------------------------------------------------------
Commissions and expense allowances on reinsurance ceded 179.9 99.7 90.9
- ----------------------------------------------------------------------------
Expense charges on deposit funds 134.6 119.3 100.7
- ----------------------------------------------------------------------------
Separate account investment management and administration service fees 396.3 325.5 244.6
- ----------------------------------------------------------------------------
Other income 31.3 21.3 16.8
- ---------------------------------------------------------------------------- --------- --------- ---------
Total revenues 15,613.3 8,043.4 9,505.0
- ----------------------------------------------------------------------------
BENEFITS AND EXPENSES:
Benefits and settlement expenses 13,964.1 4,522.1 5,989.9
- ----------------------------------------------------------------------------
Underwriting, acquisition, insurance and other expenses 2,919.4 3,053.9 3,123.1
- ---------------------------------------------------------------------------- --------- --------- ---------
Total benefits and expenses 16,883.5 7,576.0 9,113.0
- ---------------------------------------------------------------------------- --------- --------- ---------
Gain (loss) from operations before dividends to policyholders, income taxes
and net realized gain on investments (1,270.2) 467.4 392.0
- ----------------------------------------------------------------------------
Dividends to policyholders 67.9 27.5 27.3
- ---------------------------------------------------------------------------- --------- --------- ---------
Gain (loss) from operations before federal income taxes and net realized
gain on investments (1,338.1) 439.9 364.7
- ----------------------------------------------------------------------------
Federal income taxes (credit) (141.0) 78.3 83.6
- ---------------------------------------------------------------------------- --------- --------- ---------
Gain (loss) from operations before net realized gain on investments (1,197.1) 361.6 281.1
- ----------------------------------------------------------------------------
Net realized gain on investments, net of income tax expense and excluding
net transfers to the interest maintenance reserve 46.8 31.3 53.3
- ---------------------------------------------------------------------------- --------- --------- ---------
Net income (loss) $(1,150.3) $ 392.9 $ 334.4
- ---------------------------------------------------------------------------- --------- --------- ---------
--------- --------- ---------
</TABLE>
See accompanying notes.
S-2
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
STATEMENTS OF CHANGES IN CAPITAL AND SURPLUS -- STATUTORY BASIS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
--------- --------- ---------
(IN MILLIONS)
-------------------------------
<S> <C> <C> <C>
Capital and surplus at beginning of year $ 2,968.4 $ 1,962.6 $ 1,732.9
- -----------------------------------------------------------------------------
Correction of prior year's asset valuation reserve -- (37.6) --
- -----------------------------------------------------------------------------
Correction of prior year's admitted assets -- (57.0) --
- ----------------------------------------------------------------------------- --------- --------- ---------
2,968.4 1,868.0 1,732.9
CAPITAL AND SURPLUS INCREASE (DECREASE):
Net income (loss) (1,150.3) 392.9 334.4
- -----------------------------------------------------------------------------
Difference in cost and admitted investment amounts (304.8) (36.2) 38.6
- -----------------------------------------------------------------------------
Nonadmitted assets (17.1) (0.4) (3.0)
- -----------------------------------------------------------------------------
Regulatory liability for reinsurance (35.2) (3.9) 0.6
- -----------------------------------------------------------------------------
Life policy reserve valuation basis (0.4) (0.9) (0.4)
- -----------------------------------------------------------------------------
Asset valuation reserve (34.5) (36.9) (105.5)
- -----------------------------------------------------------------------------
Proceeds from surplus notes from shareholder 1,250.0 -- --
- -----------------------------------------------------------------------------
Paid-in surplus, including contribution of common stock of affiliated
company in 1997 108.4 938.4 100.0
- -----------------------------------------------------------------------------
Separate account receivable due to change in valuation -- (2.6) --
- -----------------------------------------------------------------------------
Dividends to shareholder (220.0) (150.0) (135.0)
- ----------------------------------------------------------------------------- --------- --------- ---------
Capital and surplus at end of year $ 2,564.5 $ 2,968.4 $ 1,962.6
- ----------------------------------------------------------------------------- --------- --------- ---------
--------- --------- ---------
</TABLE>
See accompanying notes. S-3
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
STATEMENTS OF CASH FLOWS -- STATUTORY BASIS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
---------- ---------- ----------
(IN MILLIONS)
----------------------------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Premiums, policy proceeds and other considerations received $ 13,495.2 $ 6,364.3 $ 8,059.4
- -----------------------------------------------------------------------
Allowances and reserve adjustments paid on reinsurance ceded (632.4) (649.2) (767.5)
- -----------------------------------------------------------------------
Investment income received 2,003.9 1,798.8 1,700.6
- -----------------------------------------------------------------------
Separate account investment management and administration service fees 396.3 325.5 244.6
- -----------------------------------------------------------------------
Benefits paid (7,395.8) (5,345.2) (4,050.4)
- -----------------------------------------------------------------------
Insurance expenses paid (2,909.7) (3,193.0) (3,216.8)
- -----------------------------------------------------------------------
Federal income taxes recovered (paid) 84.2 (87.0) (72.3)
- -----------------------------------------------------------------------
Dividends to policyholders (12.9) (28.4) (27.7)
- -----------------------------------------------------------------------
Other income received and expenses paid, net 207.0 (8.7) 117.0
- ----------------------------------------------------------------------- ---------- ---------- ----------
Net cash provided by (used in) operating activities 5,235.8 (822.9) 1,986.9
- -----------------------------------------------------------------------
INVESTING ACTIVITIES
Sale, maturity or repayment of investments 10,926.5 12,142.6 12,542.0
- -----------------------------------------------------------------------
Purchase of investments (16,950.0) (10,345.0) (14,175.4)
- -----------------------------------------------------------------------
Other sources (uses) including reinsured policy loans (778.3) 529.1 (377.2)
- ----------------------------------------------------------------------- ---------- ---------- ----------
Net cash provided by (used in) investing activities (6,801.8) 2,326.7 (2,010.6)
- -----------------------------------------------------------------------
FINANCING ACTIVITIES
Surplus paid-in 108.4 -- 100.0
- -----------------------------------------------------------------------
Proceeds from surplus notes from shareholder 1,250.0 -- --
- -----------------------------------------------------------------------
Proceeds from borrowings from shareholder 140.0 120.0 100.0
- -----------------------------------------------------------------------
Repayment of borrowings from shareholder (120.0) (100.0) (63.0)
- -----------------------------------------------------------------------
Dividends paid to shareholder (220.0) (150.0) (135.0)
- ----------------------------------------------------------------------- ---------- ---------- ----------
Net cash provided by (used in) financing activities 1,158.4 (130.0) 2.0
- ----------------------------------------------------------------------- ---------- ---------- ----------
Net increase (decrease) in cash and short-term investments (407.6) 1,373.8 (21.7)
- -----------------------------------------------------------------------
Cash and short-term investments at beginning of year 2,133.0 759.2 780.9
- ----------------------------------------------------------------------- ---------- ---------- ----------
Cash and short-term investments at end of year $ 1,725.4 $ 2,133.0 $ 759.2
- ----------------------------------------------------------------------- ---------- ---------- ----------
---------- ---------- ----------
</TABLE>
See accompanying notes.
S-4
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
ORGANIZATION AND OPERATIONS
The Lincoln National Life Insurance Company ("Company") is a wholly owned
subsidiary of Lincoln National Corporation ("LNC") and is domiciled in
Indiana. As of December 31, 1998, the Company owns 100% of the outstanding
common stock of four insurance company subsidiaries: First Penn-Pacific Life
Insurance Company ("First Penn"), Lincoln National Health & Casualty
Insurance Company ("LNH&C"), Lincoln National Reassurance Company ("LNRAC")
and Lincoln Life & Annuity Company of New York ("LLANY").
The Company's principal businesses consist of underwriting annuities,
deposit-type contracts and life and health insurance through multiple
distribution channels and the reinsurance of individual and group life and
health business. The Company is licensed and sells its products in 49
states, Canada and several U.S. territories.
USE OF ESTIMATES
The nature of the insurance and investment management businesses requires
management to make estimates and assumptions that affect the amounts
reported in the statutory-basis financial statements and accompanying notes.
Actual results could differ from those estimates.
BASIS OF PRESENTATION
The accompanying financial statements have been prepared in conformity with
accounting practices prescribed or permitted by the Indiana Department of
Insurance ("Insurance Department"), which practices differ from generally
accepted accounting principles ("GAAP"). The more significant variances from
GAAP are as follows:
INVESTMENTS
Bonds are reported at cost or amortized cost or fair value based on their
National Association of Insurance Commissioners ("NAIC") rating. For GAAP,
the Company's bonds are classified as available-for-sale and, accordingly,
are reported at fair value with changes in the fair values reported directly
in shareholder's equity after adjustments for related amortization of
deferred acquisition costs, additional policyholder commitments and deferred
income taxes.
Investments in real estate are reported net of related obligations rather
than on a gross basis. Real estate owned and occupied by the Company is
classified as a real estate investment rather than reported as an operating
asset, and investment income and operating expenses include rent for the
Company's occupancy of those properties. Changes between cost and admitted
asset investment amounts are credited or charged directly to unassigned
surplus rather than to a separate surplus account.
Under a formula prescribed by the NAIC, the Company defers the portion of
realized capital gains and losses on sales of fixed income investments,
principally bonds and mortgage loans, attributable to changes in the general
level of interest rates and amortizes those deferrals over the remaining
period to maturity of the individual security sold. The net deferral is
reported as the Interest Maintenance Reserve ("IMR") in the accompanying
balance sheets. Realized capital gains and losses are reported in income net
of federal income tax and transfers to the IMR. The asset valuation reserve
("AVR") is determined by an NAIC prescribed formula and is reported as a
liability rather than unassigned surplus. Under GAAP, realized capital gains
and losses are reported in the income statement on a pre-tax basis in the
period in which the asset giving rise to the gain or loss is sold and
valuation allowances are provided when there has been a decline in value
deemed other than temporary, in which case, the provision for such declines
are charged to income.
SUBSIDIARIES
The accounts and operations of the Company's subsidiaries are not
consolidated with the accounts and operations of the Company as would be
required by GAAP. Under statutory accounting principles, the Company's
subsidiaries are carried at their statutory-basis net equity and presented
in the balance sheet as affiliated common stocks.
POLICY ACQUISITION COSTS
The costs of acquiring and renewing business are expensed when incurred.
Under GAAP, acquisition costs related to traditional life insurance, to the
extent recoverable from future policy revenues, are deferred and amortized
over the premium-paying
S-5
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
period of the related policies using assumptions consistent with those used
in computing policy benefit reserves. For universal life insurance, annuity
and other investment-type products, deferred policy acquisition costs, to
the extent recoverable from future gross profits, are amortized generally in
proportion to the present value of expected gross profits from surrender
charges and investment, mortality and expense margins.
NONADMITTED ASSETS
Certain assets designated as "nonadmitted," principally furniture and
equipment and certain receivables, are excluded from the accompanying
balance sheets and are charged directly to unassigned surplus.
PREMIUMS
Revenues for universal life policies consist of the entire premium received.
Under GAAP, premiums received in excess of policy charges are not recognized
as premium revenue.
Premiums and deposits with respect to annuity and other investment-type
contracts are reported as premium revenues; whereas, under GAAP, such
premiums and deposits are treated as liabilities and policy charges
represent revenues.
BENEFIT RESERVES
Certain policy reserves are calculated based on statutorily required
interest and mortality assumptions rather than on estimated expected
experience or actual account balances as would be required under GAAP.
Death benefits paid, policy and contract withdrawals, and the change in
policy reserves on universal life policies, annuity and other
investment-type contracts are reported as benefits and settlement expenses
in the accompanying statements of income; whereas, under GAAP, withdrawals
are treated as a reduction of the policy or contract liabilities and
benefits would represent the excess of benefits paid over the policy account
value and interest credited to the account values.
REINSURANCE
Premiums, claims and policy benefits and contract liabilities are reported
in the accompanying financial statements net of reinsurance amounts. For
GAAP, all assets and liabilities related to reinsurance ceded contracts are
reported on a gross basis.
A liability for reinsurance balances has been provided for unsecured policy
and contract liabilities and unearned premiums ceded to reinsurers not
authorized by the Insurance Department to assume such business. Changes to
those amounts are credited or charged directly to unassigned surplus. Under
GAAP, an allowance for amounts deemed uncollectible is established through a
charge to income.
Commissions on business ceded are reported as income when received rather
than deferred and amortized with deferred policy acquisition costs. Business
assumed under 100% indemnity and assumption reinsurance agreements is
accounted for as a purchase for GAAP reporting purposes and the ceding
commission represents the purchase price. Under purchase accounting, assets
acquired and liabilities assumed are reported at fair value at the date of
the transaction and the excess of the purchase price over the sum of the
amounts assigned to assets acquired less liabilities assumed is recorded as
goodwill. On a statutory-basis, the ceding commission is expensed when paid
and reinsurance premiums and benefits are accounted for on bases consistent
with those used in accounting for the original policies issued and the terms
of the reinsurance contracts.
Certain reinsurance contracts meeting risk transfer requirements under
statutory-basis accounting practices have been accounted for using
traditional reinsurance accounting whereas such contracts would be accounted
for using deposit accounting under GAAP.
INCOME TAXES
Deferred income taxes are not provided for differences between financial
statement amounts and tax bases of assets and liabilities.
POLICYHOLDER DIVIDENDS
Policyholder dividends are recognized when declared rather than over the
term of the related policies.
S-6
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
SURPLUS NOTES DUE TO LNC
Surplus notes due to LNC are reported as surplus rather than as liabilities.
On a statutory-basis, interest on surplus notes is not accrued until
approval is received from the Indiana Insurance Commissioner whereas under
GAAP, interest would be accrued periodically based on the outstanding
principal and the interest rate.
STATEMENTS OF CASH FLOWS
Cash and short-term investments in the statements of cash flows represent
cash balances and investments with initial maturities of one year or less.
Under GAAP, the corresponding captions of cash and cash equivalents include
cash balances and investments with initial maturities of three months or
less.
A reconciliation of the Company's net income (loss) and capital and surplus
determined on a statutory-basis with amounts determined in accordance with
GAAP is as follows:
<TABLE>
<CAPTION>
CAPITAL AND SURPLUS NET INCOME (LOSS)
-----------------------------------------------------
DECEMBER 31 YEAR ENDED DECEMBER 31
1998 1997 1998 1997 1996
-----------------------------------------------------
(IN MILLIONS)
-----------------------------------------------------
<S> <C> <C> <C> <C> <C>
Amounts reported on a statutory-basis $ 2,564.5 $ 2,968.4 $(1,150.3) $ 392.9 $ 334.4
- -------------------------------------------
GAAP adjustments:
Deferred policy acquisition costs,
present value of future profits and
goodwill 3,085.2 958.3 48.5 (98.9) 66.7
----------------------------------------
Policy and contract reserves (2,299.9) (1,672.9) 1,743.4 (48.6) (57.1)
----------------------------------------
Interest maintenance reserve 159.7 135.4 24.4 58.7 (39.7)
----------------------------------------
Deferred income taxes 181.6 (13.0) (218.6) 70.3 1.8
----------------------------------------
Policyholders' share of earnings and
surplus on participating business (132.8) (79.8) 3.2 5.3 (.3)
----------------------------------------
Asset valuation reserve 484.5 450.0 -- -- --
----------------------------------------
Net realized gain (loss) on investments (174.1) (91.5) (116.7) (20.4) 78.7
----------------------------------------
Unrealized gain on investments 1,335.1 1,245.5 -- -- --
----------------------------------------
Nonadmitted assets, including nonadmitted
investments 119.1 61.0 -- -- --
----------------------------------------
Investments in subsidiary companies 490.4 188.8 41.3 (80.5) 29.9
----------------------------------------
Surplus notes and related interest (1,251.5) -- (1.5) -- --
----------------------------------------
Other, net (120.1) (162.5) 103.6 (35.0) (82.6)
---------------------------------------- --------- --------- --------- --------- ---------
Net increase (decrease) 1,877.2 1,019.3 1,627.6 (149.1) (2.6)
- ------------------------------------------- --------- --------- --------- --------- ---------
Amounts on a GAAP basis $ 4,441.7 $ 3,987.7 $ 477.3 $ 243.8 $ 331.8
- ------------------------------------------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
S-7
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
Other significant accounting practices are as follows:
INVESTMENTS
Bonds not backed by loans are principally stated at amortized cost and the
discount or premium is amortized using the interest method.
Mortgage-backed bonds are valued at amortized cost and income is recognized
using a constant effective yield based on anticipated prepayments and the
estimated economic life of the securities. When actual prepayments differ
significantly from anticipated prepayments, the effective yield is
recalculated to reflect actual payments to date and anticipated future
payments. The net investment in the securities is adjusted to the amount
that would have existed had the new effective yield been applied since the
acquisition of the securities.
Short-term investments include investments with maturities of less than one
year at the date of acquisition. The carrying amounts for these investments
approximate their fair values.
Preferred stocks are reported at cost or amortized cost.
Unaffiliated common stocks are reported at fair value as determined by the
Securities Valuation Office of the NAIC and the related unrealized gains
(losses) are reported in unassigned surplus without adjustment for federal
income taxes.
Policy loans are reported at unpaid balances.
The Company uses various derivative instruments as part of its overall
liability-asset management program for certain investments and life
insurance and annuity products. The Company values all derivative
instruments on a basis consistent with that of the hedged item. Upon
termination, gains and losses on those instruments are included in the
carrying values of the underlying hedged items and are amortized over the
remaining lives of the hedged items as adjustments to investment income or
benefits from the hedged items through the IMR. Any unamortized gains or
losses are recognized when the underlying hedged items are sold. The
premiums paid for interest rate caps and swaptions are deferred and
amoritized to net investment income on a straight-line basis over the term
of the respective derivative.
Hedge accounting is applied as indicated above after the Company determines
that the items to be hedged expose the Company to interest rate
fluctuations, the widening of bond yield spreads over comparable maturity
U.S. government obligations, increased liabilities associated with certain
reinsurance agreements and foreign exchange risk. Moreover, the derivatives
used are designated as a hedge and reduce the indicated risk by having a
high correlation between changes in the value of the derivatives and the
items being hedged at both the inception of the hedge and throughout the
hedge period. Should such criteria not be met or if the hedged items have
been sold, terminated or matured, the change in value of the derivatives is
included in net income.
Mortgage loans on real estate are reported at unpaid balances, less
allowances for impairments. Real estate is reported at depreciated cost.
Realized investment gains and losses on investments sold are determined
using the specific identification method. Changes in admitted asset carrying
amounts of bonds, mortgage loans and common and preferred stocks are
credited or charged directly in unassigned surplus.
LOANED SECURITIES
Securities loaned are treated as collateralized financing transactions and a
liability is recorded equal to the repurchase price. It is the Company's
policy to take possession of securities with a market value at least equal
to the securities loaned. Securities loaned are recorded at amortized cost
as long as the value of the related collateral is sufficient. The Company's
agreements with third parties generally contain contractual provisions to
allow for additional collateral to be obtained when necessary. The Company
values collateral daily and obtains additional collateral when deemed
appropriate.
GOODWILL
Goodwill, which represents the excess, subject to certain limitations, of
the ceding commission over statutory-basis net assets of business purchased
S-8
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
under an assumption reinsurance agreement, is amortized on a straight-line
basis over ten years.
PREMIUMS
Life insurance and annuity premiums are recognized as revenue when due.
Accident and health premiums are earned pro rata over the contract term of
the policies.
BENEFITS
Life, annuity and accident and health benefit reserves are developed by
actuarial methods and are determined based on published tables using
statutorily specified interest rates and valuation methods that will
provide, in the aggregate, reserves that are greater than or equal to the
minimum or guaranteed policy cash values or the amounts required by the
Insurance Department. The Company waives deduction of deferred fractional
premiums on the death of life and annuity policy insureds and returns any
premium beyond the date of death, except for policies issued prior to March
1977. Surrender values on policies do not exceed the corresponding benefit
reserves. Additional reserves are established when the results of cash flow
testing under various interest rate scenerios indicate the need for such
reserves. If net premiums exceed the gross premiums on any insurance
in-force, additional reserves are established. Benefit reserves for policies
underwritten on a substandard basis are determined using the multiple table
reserve method.
The tabular interest, tabular less actual reserve released and the tabular
cost have been determined by formula or from the basic data for such items.
Tabular interest funds not involving life contingencies were determined
using the actual interest credited to the funds plus the change in accrued
interest.
Liabilities related to guaranteed investment contracts and policyholder
funds left on deposit with the Company generally are equal to fund balances
less applicable surrender charges.
CLAIMS AND CLAIM ADJUSTMENT EXPENSES
Unpaid claims and claim adjustment expenses on accident and health policies
represent the estimated ultimate net cost of all reported and
unreported claims incurred during the year. The Company does not discount
claims and claim adjustment expense reserves. The reserves for unpaid claims
and claim adjustment expenses are estimated using individual case-basis
valuations and statistical analyses. Those estimates are subject to the
effects of trends in claim severity and frequency. Although considerable
variability is inherent in such estimates, management believes that the
reserves for claims and claim adjustment expenses are adequate. The
estimates are continually reviewed and adjusted as necessary as experience
develops or new information becomes known; such adjustments are included in
current operations.
REINSURANCE CEDED AND ASSUMED
Reinsurance premiums, benefits and claims and claim adjustment expenses are
accounted for on bases consistent with those used in accounting for the
original policies issued and the terms of the reinsurance contracts. Certain
business is transacted on a funds withheld basis and investment income on
investments managed by the Company are reported in net investment income.
PENSION BENEFITS
Costs associated with the Company's defined benefit pension plans are
systematically accrued during the expected period of active service of the
covered employees.
INCOME TAXES
The Company and eligible subsidiaries have elected to file consolidated
federal and state income tax returns with LNC and certain LNC subsidiaries.
Pursuant to an intercompany tax sharing agreement with LNC, the Company
provides for income taxes on a separate return filing basis. The tax sharing
agreement also provides that the Company will receive benefit for net
operating losses, capital losses and tax credits which are not usable on a
separate return basis to the extent such items may be utilized in the
consolidated income tax returns of LNC.
STOCK OPTIONS
The Company recognizes compensation expense for its stock option incentive
plans using the intrinsic value method of accounting. Under the terms of
S-9
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES (CONTINUED)
the intrinsic value method, compensation cost is the excess, if any, of the
quoted market price of LNC's common stock at the grant date, or other
measurement date, over the amount an employee must pay to acquire the stock.
ASSETS HELD IN SEPARATE ACCOUNTS AND LIABILITIES RELATED TO SEPARATE
ACCOUNTS
Separate account assets and liabilities reported in the accompanying balance
sheets represent funds that are separately administered for variable life
and variable annuity contracts and for which the contractholder, rather than
the Company, bears the investment risk. Separate account assets are reported
at fair value. The operations of the separate accounts are not included in
the accompanying financial statements. Policy administration and investment
management fees charged on separate account policyholder deposits are
included in income from separate account investment management and
administration service fees. Mortality charges on variable universal life
contracts are included in income from expense charges on deposit funds. Fees
charged relative to variable annuity and variable universal life
administration agreements for separate account products sold by other
insurance companies and not recorded on the Company's financial statements
are included in income from separate account investment management and
administration service fees.
RECLASSIFICATION
Certain amounts in the 1997 financial statements have been reclassified to
conform with the 1998 presentation. These reclassifications had no effect on
unassigned surplus or net income previously reported.
2. PERMITTED STATUTORY ACCOUNTING PRACTICES
The Company's statutory-basis financial statements are prepared in
accordance with accounting practices prescribed or permitted by the
Insurance Department. "Prescribed" statutory accounting practices are
interspersed throughout state insurance laws and regulations, the NAIC's
ACCOUNTING PRACTICES AND PROCEDURES MANUAL and a variety of other NAIC
publications. "Permitted" statutory accounting practices encompass all
accounting practices that are not prescribed; such practices may differ from
state to state, may differ from company to company within a state and may
change in the future.
In 1998, the NAIC adopted codified statutory accounting principles
("Codification"). Codification will likely change, to some extent,
prescribed statutory accounting practices and may result in changes to the
accounting practices that the Company uses to prepare its statutory-basis
financial statements. Codification will require adoption by the various
states before it becomes the prescribed statutory-basis of accounting for
insurance companies domesticated within those states. Accordingly, before
Codification becomes effective for the Company, the state of Indiana must
adopt Codification as the prescribed basis of accounting on which domestic
insurers must report their statutory-basis results to the Insurance
Department. At this time, it is anticipated that Indiana will adopt
Codification, however, based on current guidance, management believes that
the impact of Codification will not be material to the Company's
statutory-basis financial statements.
The Company has received written approval from the Insurance Department to
record surrender charges applicable to separate account liabilities for
variable life and annuity products as a liability in the separate account
financial statements payable to the Company's general account. In the
accompanying financial statements, a corresponding receivable is recorded
with the related income impact recorded in the accompanying Statement of
Operations as a change in reserves or change in premium and other deposit
funds.
S-10
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS
The major categories of net investment income are as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
-------------------------------
(IN MILLIONS)
-------------------------------
<S> <C> <C> <C>
Income:
Bonds $ 1,714.3 $ 1,524.4 $ 1,442.2
----------------------------------------------------------------
Preferred stocks 19.7 23.5 9.6
----------------------------------------------------------------
Unaffiliated common stocks 10.6 8.3 6.5
----------------------------------------------------------------
Affiliated common stocks 5.2 15.0 9.5
----------------------------------------------------------------
Mortgage loans on real estate 323.6 257.2 269.3
----------------------------------------------------------------
Real estate 81.4 92.2 114.4
----------------------------------------------------------------
Policy loans 86.5 37.5 35.0
----------------------------------------------------------------
Other investments 26.5 28.2 22.4
----------------------------------------------------------------
Cash and short-term investments 104.7 70.3 48.9
---------------------------------------------------------------- --------- --------- ---------
Total investment income 2,372.5 2,056.6 1,957.8
- -------------------------------------------------------------------
Expenses:
Depreciation 19.3 21.0 25.0
----------------------------------------------------------------
Other 246.0 188.5 176.5
---------------------------------------------------------------- --------- --------- ---------
Total investment expenses 265.3 209.5 201.5
- ------------------------------------------------------------------- --------- --------- ---------
Net investment income $ 2,107.2 $ 1,847.1 $ 1,756.3
- ------------------------------------------------------------------- --------- --------- ---------
--------- --------- ---------
</TABLE>
Nonadmitted accrued investment income at December 31, 1997
amounted to $2,600,000, consisting principally of interest
on bonds in default and mortgage loans. No accrued
investment income was nonadmitted at December 31, 1998.
S-11
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS (CONTINUED)
The cost or amortized cost, gross unrealized gains and
losses and the fair value of investments in bonds are
summarized as follows:
<TABLE>
<CAPTION>
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
----------------------------------------------
(IN MILLIONS)
----------------------------------------------
<S> <C> <C> <C> <C>
At December 31, 1998:
Corporate $17,658.4 $ 1,159.8 $ 148.2 $18,670.0
------------------------------------------------
U.S. government 900.7 88.8 3.4 986.1
------------------------------------------------
Foreign government 947.8 59.9 61.2 946.5
------------------------------------------------
Mortgage-backed 4,312.1 171.6 33.4 4,450.3
------------------------------------------------
State and municipal 11.9 .7 -- 12.6
------------------------------------------------ --------- ----------- ----------- ---------
$23,830.9 $ 1,480.8 $ 246.2 $25,065.5
--------- ----------- ----------- ---------
--------- ----------- ----------- ---------
At December 31, 1997:
Corporate $13,003.8 $ 942.2 $ 60.1 $13,885.9
------------------------------------------------
U.S. government 436.3 67.9 -- 504.2
------------------------------------------------
Foreign government 1,202.1 104.9 5.4 1,301.6
------------------------------------------------
Mortgage-backed 3,874.3 215.2 27.1 4,062.4
------------------------------------------------
State and municipal 44.2 .3 -- 44.5
------------------------------------------------ --------- ----------- ----------- ---------
$18,560.7 $ 1,330.5 $ 92.6 $19,798.6
--------- ----------- ----------- ---------
--------- ----------- ----------- ---------
</TABLE>
The carrying amount of bonds in the balance sheets at
December 31, 1998 and 1997 reflects adjustments of
$11,800,000 and $5,500,000, respectively, to decrease
amortized cost as a result of the Securities Valuation
Office of the NAIC ("SVO") designating certain investments
as low or lower quality.
A summary of the cost or amortized cost and fair value of
investments in bonds at December 31, 1998, by contractual
maturity, is as follows:
<TABLE>
<CAPTION>
COST OR
AMORTIZED FAIR
COST VALUE
--------------------
(IN MILLIONS)
--------------------
<S> <C> <C>
Maturity:
In 1999 $ 705.6 $ 712.6
--------------------------------------------------------------------------
In 2000-2003 4,041.9 4,142.8
--------------------------------------------------------------------------
In 2004-2008 6,652.0 6,860.1
--------------------------------------------------------------------------
After 2008 8,119.3 8,899.7
--------------------------------------------------------------------------
Mortgage-backed securities 4,312.1 4,450.3
-------------------------------------------------------------------------- --------- ---------
Total $23,830.9 $25,065.5
- ----------------------------------------------------------------------------- --------- ---------
--------- ---------
</TABLE>
S-12
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS (CONTINUED)
The expected maturities may differ from the contractual
maturities in the foregoing table because certain borrowers
may have the right to call or prepay obligations with or
without call or prepayment penalties.
Proceeds from sales of investments in bonds during 1998,
1997 and 1996 were $9,395,000,000, $9,715,000,000 and
$10,996,900,000, respectively. Gross gains during 1998, 1997
and 1996 of $186,300,000, $218,100,000 and $169,700,000,
respectively, and gross losses of $138,000,000, $78,000,000
and $177,000,000, respectively, were realized on those
sales.
At December 31, 1998 and 1997, investments in bonds, with an
admitted asset value of $97,800,000 and $76,200,000,
respectively, were on deposit with state insurance
departments to satisfy regulatory requirements.
Unrealized gains and losses on investments in unaffiliated
common stocks and preferred stocks are reported directly in
unassigned surplus and do not affect operations. The cost or
amortized cost, gross unrealized gains and losses and the
fair value of investments in unaffiliated common stocks and
preferred stocks are as follows:
<TABLE>
<CAPTION>
COST OR GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------------------------------------------
(IN MILLIONS)
--------------------------------------------
<S> <C> <C> <C> <C>
At December 31, 1998:
Preferred stocks $236.0 $ 8.9 $ 2.4 $242.5
- ----------------------------------------
Unaffiliated common stocks 223.3 62.0 26.0 259.3
- ----------------------------------------
At December 31, 1997:
Preferred stocks $257.3 $12.1 $ .7 $268.7
- ----------------------------------------
Unaffiliated common stocks 357.0 98.5 19.5 436.0
- ----------------------------------------
</TABLE>
The carrying amount of preferred stocks in the balance
sheets at December 31, 1998 and 1997 reflects adjustments of
$5,800,000 and $4,000,000, respectively, to decrease
amortized cost as a result of the SVO designating certain
investments as low or lower quality.
During 1998, the minimum and maximum lending rates for
mortgage loans were 6.41% and 8.08%, respectively. At the
issuance of a loan, the percentage of loan to value on any
one loan does not exceed 75%. At December 31, 1998, the
Company did not hold any mortgages with interest overdue
beyond one year. All properties covered by mortgage loans
have fire insurance at least equal to the excess of the loan
over the maximum loan that would be allowed on the land
without the building.
S-13
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS (CONTINUED)
The components of the Company's real estate are summarized
as follows:
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
--------------------
(IN MILLIONS)
--------------------
<S> <C> <C>
Occupied by the Company:
Land $ 2.5 $ 2.5
--------------------------------------------------------------------------------
Buildings 9.0 8.4
--------------------------------------------------------------------------------
Less accumulated depreciation (1.7) (1.2)
-------------------------------------------------------------------------------- --------- ---------
Net real estate occupied by the Company 9.8 9.7
- -----------------------------------------------------------------------------------
Other:
Land 93.2 124.1
--------------------------------------------------------------------------------
Buildings 413.0 491.6
--------------------------------------------------------------------------------
Other 7.9 8.1
--------------------------------------------------------------------------------
Less accumulated depreciation (50.1) (49.1)
-------------------------------------------------------------------------------- --------- ---------
Net other real estate 464.0 574.7
- ----------------------------------------------------------------------------------- --------- ---------
Net real estate $ 473.8 $ 584.4
- ----------------------------------------------------------------------------------- --------- ---------
--------- ---------
</TABLE>
Realized capital gains are reported net of federal income
taxes and amounts transferred to the IMR as follows:
<TABLE>
<CAPTION>
1998 1997 1996
-------------------------------
(IN MILLIONS)
-------------------------------
<S> <C> <C> <C>
Realized capital gains $ 179.7 $ 209.3 $ 69.3
- ------------------------------------------------------------------------
Less amount transferred to IMR (net of related taxes (credit) of $27.3,
$54.0 and $(6.7) in 1998, 1997 and 1996, respectively) 50.8 100.2 (12.4)
- ------------------------------------------------------------------------ --------- --------- ---------
128.9 109.1 81.7
Less federal income taxes on realized gains 82.1 77.8 28.4
- ------------------------------------------------------------------------ --------- --------- ---------
Net realized capital gains $ 46.8 $ 31.3 $ 53.3
- ------------------------------------------------------------------------ --------- --------- ---------
--------- --------- ---------
</TABLE>
S-14
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
4. SUBSIDIARIES
Statutory-basis financial information related to the
Company's four wholly owned insurance subsidiaries is
summarized as follows (in millions):
<TABLE>
<CAPTION>
DECEMBER 31, 1998
--------------------------------------------
FIRST
PENN LNH&C LNRAC LLANY
--------------------------------------------
<S> <C> <C> <C> <C>
Cash and invested assets $ 1,221.1 $ 333.9 $ 403.6 $ 1,938.0
- ---------------------------------------------------------
Other assets 40.3 31.3 490.0 270.2
- --------------------------------------------------------- --------- ----------- --------- ---------
Total admitted assets $ 1,261.4 $ 365.2 $ 893.6 $ 2,208.2
- --------------------------------------------------------- --------- ----------- --------- ---------
--------- ----------- --------- ---------
Insurance reserves $ 1,149.8 $ 266.3 $ 281.8 $ 1,814.5
- ---------------------------------------------------------
Other liabilities 42.0 24.0 553.7 45.1
- ---------------------------------------------------------
Liabilities related to separate accounts -- -- -- 236.9
- ---------------------------------------------------------
Capital and surplus 69.6 74.9 58.1 111.7
- --------------------------------------------------------- --------- ----------- --------- ---------
Total liabilities and capital and surplus $ 1,261.4 $ 365.2 $ 893.6 $ 2,208.2
- --------------------------------------------------------- --------- ----------- --------- ---------
--------- ----------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1998
--------------------------------------------
FIRST
PENN LNH&C LNRAC LLANY
--------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 310.4 $ 165.0 $ 150.3 $ 1,402.6
- -----------------------------------------------------------
Expenses 310.6 164.4 139.5 1,656.1
- -----------------------------------------------------------
Net realized gains (losses) (0.3) 0.9 (0.1) (0.7)
- ----------------------------------------------------------- --------- ----------- --------- ---------
Net income (loss) $ (0.5) $ 1.5 $ 10.7 $ (254.2)
- ----------------------------------------------------------- --------- ----------- --------- ---------
--------- ----------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
------------------------------------------------
FIRST
PENN LNH&C LNRAC LLANY
------------------------------------------------
<S> <C> <C> <C> <C>
Cash and invested assets $ 1,154.4 $ 284.8 $ 399.0 $ 796.3
- -----------------------------------------------------------
Other assets 36.9 77.3 481.6 130.8
- ----------------------------------------------------------- --------- ----------- ----------- -----------
Total admitted assets $ 1,191.3 $ 362.1 $ 880.6 $ 972.1
- ----------------------------------------------------------- --------- ----------- ----------- -----------
--------- ----------- ----------- -----------
Insurance reserves $ 1,072.2 $ 266.7 $ 279.3 $ 588.7
- -----------------------------------------------------------
Other liabilities 48.4 21.7 546.4 5.8
- -----------------------------------------------------------
Liabilities related to separate accounts -- -- -- 164.7
- -----------------------------------------------------------
Capital and surplus 70.7 73.7 54.9 212.9
- ----------------------------------------------------------- --------- ----------- ----------- -----------
Total liabilities and capital and surplus $ 1,191.3 $ 362.1 $ 880.6 $ 972.1
- ----------------------------------------------------------- --------- ----------- ----------- -----------
--------- ----------- ----------- -----------
</TABLE>
S-15
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
4. SUBSIDIARIES (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31, 1997
----------------------------------------------
FIRST
PENN LNH&C LNRAC LLANY
----------------------------------------------
<S> <C> <C> <C> <C>
Revenues $ 267.6 $ 135.4 $ 125.3 $ 230.0
- -------------------------------------------------------------
Expenses 262.6 244.2 114.6 224.4
- -------------------------------------------------------------
Net realized gains (losses) .1 .6 (.1) (.1)
- ------------------------------------------------------------- --------- --------- ----------- -----------
Net income (loss) $ 5.1 $ (108.2) $ 10.6 $ 5.5
- ------------------------------------------------------------- --------- --------- ----------- -----------
--------- --------- ----------- -----------
</TABLE>
The Company also owns three non-insurance subsidiaries, all
of which were formed or acquired in 1998. AnnuityNet, Inc.
was formed for the distribution of variable annuities over
the internet and is valued on the equity method with an
admitted asset value of $1,500,000 at December 31, 1998.
Lincoln National Insurance Associates was purchased for
$600,000 and is valued on the equity method with an admitted
asset value of $600,000 at December 31, 1998. Sagemark
Consulting, Inc. ("Sagemark") was purchased in 1998 and is a
broker dealer acquired in connection with a reinsurance
transaction completed in 1998. Sagemark is valued on the
equity method with an admitted asset value of $5,700,000 at
December 31, 1998.
The carrying value of all affiliated common stocks, was
$322,100,000 and $412,100,000 at December 31, 1998 and 1997,
respectively. The insurance affiliates are carried at
statutory-basis net equity while other affiliates are
recorded at GAAP basis net equity, adjusted for certain
items which would be non-admitted under statutory accounting
principles. The cost basis of investments in subsidiaries as
of December 31, 1998 and 1997 was $631,100,000 and
$466,200,000, respectively.
During 1998, 1997 and 1996 the Company's insurance
subsidiaries paid dividends of $5,200,000, $15,000,000 and
$10,500,000, respectively.
5. FEDERAL INCOME TAXES
The effective federal income tax rate in the accompanying
statements of operations differs from the prevailing
statutory tax rate principally due to tax-exempt investment
income, dividends received tax deductions and differences
between statutory accounting and tax return recognition
relative to policy acquisition costs, policy and contract
liabilities and reinsurance ceding commissions.
In 1997 and 1996, federal income taxes incurred totaled
$78,300,000 and $83,600,000, respectively. In 1998, a
federal income tax net operating loss of $103,800,000 and
tax credits of $19,300,000 were incurred and carried back to
recover taxes paid in prior years.
The Company paid $2,300,000, $164,500,000 and $100,400,000
to LNC in 1998, 1997 and 1996, respectively, for federal
income taxes.
Under prior income tax law, one-half of the excess of a life
insurance company's income from operations over its taxable
investment income was not taxed, but was set aside in a
special tax account designated as "Policyholders' Surplus."
The Company has approximately $187,000,000 of untaxed
"Policyholders' Surplus" on which no payment of federal
income taxes will be required unless it is distributed as a
dividend, or under other specified conditions. Barring the
passage of unfavorable legislation, the Company does not
believe that any significant portion of the account will be
taxed in the foreseeable future and no related tax liability
has been recognized. If the entire balance of the account
S-16
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
5. FEDERAL INCOME TAXES (CONTINUED)
became taxable under the current federal income tax rate,
the tax would be approximately $65,500,000.
6. SUPPLEMENTAL FINANCIAL DATA
The balance sheet caption, "Other admitted assets", includes
amounts recoverable from other insurers for claims paid by
the Company, and the balance sheet caption, "Future policy
benefits and claims," has been reduced for insurance ceded
as follows:
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
--------------------
(IN MILLIONS)
--------------------
<S> <C> <C>
Insurance ceded $ 4,081.8 $ 1,431.0
- -------------------------------------------------------------------------------
Amounts recoverable from other insurers 79.9 35.9
- -------------------------------------------------------------------------------
</TABLE>
Reinsurance transactions, excluding assumption reinsurance,
included in the income statement caption, "Premiums and
deposits," are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
-------------------------------
(IN MILLIONS)
-------------------------------
<S> <C> <C> <C>
Insurance assumed $ 9,018.9 $ 727.2 $ 241.3
- ----------------------------------------------------------------------
Insurance ceded 877.1 302.9 193.3
- ---------------------------------------------------------------------- --------- --------- ---------
Net amount included in premiums $ 8,141.8 $ 424.3 $ 48.0
- ---------------------------------------------------------------------- --------- --------- ---------
--------- --------- ---------
</TABLE>
The income statement caption, "Benefits and settlement
expenses," is net of reinsurance recoveries of
$2,098,800,000, $1,240,500,000 and $787,900,000 for 1998,
1997 and 1996, respectively.
Details underlying the balance sheet caption "Other
policyholder funds" are as follows:
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
--------------------
(IN MILLIONS)
--------------------
<S> <C> <C>
Premium deposit funds $16,285.2 $16,201.8
- -----------------------------------------------------------------------------
Undistributed earnings on participating business 348.4 142.0
- -----------------------------------------------------------------------------
Other 13.9 16.3
- ----------------------------------------------------------------------------- --------- ---------
$16,647.5 $16,360.1
--------- ---------
--------- ---------
</TABLE>
S-17
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
6. SUPPLEMENTAL FINANCIAL DATA (CONTINUED)
Deferred and uncollected life insurance premiums and annuity
considerations included in the balance sheet caption,
"Premiums and fees in course of collection," are as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1998
-----------------------------------
NET OF
GROSS LOADING LOADING
-----------------------------------
(IN MILLIONS)
-----------------------------------
<S> <C> <C> <C>
Ordinary new business $ 9.5 $ 3.4 $ 6.1
- -----------------------------------------------------------------------
Ordinary renewal (13.7) 11.3 (25.0)
- -----------------------------------------------------------------------
Group life 14.2 .2 14.0
- ----------------------------------------------------------------------- --------- ----- -----------
$ 10.0 $ 14.9 $ (4.9)
--------- ----- -----------
--------- ----- -----------
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997
-----------------------------------
NET OF
GROSS LOADING LOADING
-----------------------------------
(IN MILLIONS)
-----------------------------------
<S> <C> <C> <C>
Ordinary new business $ 3.2 $ 2.4 $ .8
- ------------------------------------------------------------------------
Ordinary renewal 17.8 3.2 14.6
- ------------------------------------------------------------------------
Group life 10.6 .2 10.4
- ------------------------------------------------------------------------ --------- --- -----
$ 31.6 $ 5.8 $ 25.8
--------- --- -----
--------- --- -----
</TABLE>
The Company has entered into non-exclusive managing general
agent agreements with International Benefit Services Corp.,
HRM Claim Management, Inc. and Pediatrics Insurance
Consultants, Inc. to write group life and health business.
Direct premiums written related to the agreements amounted
to $11,900,000 and $13,400,000 in 1998 and 1997,
respectively. During 1996, LNC Administrative Services
Corporation, an affiliate, entered into a similar agreement
with the Company with direct premiums written amounting to
$7,000,000 and $7,200,000 in 1998 and 1997, respectively.
Authority granted by the managing general agents agreements
include underwriting, claims adjustment and claims payment
services.
S-18
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
7. ANNUITY RESERVES
At December 31, 1998, the Company's annuity reserves and
deposit fund liabilities, including separate accounts, that
are subject to discretionary withdrawal with adjustment,
subject to discretionary withdrawal without adjustment and
not subject to discretionary withdrawal provisions are
summarized as follows:
<TABLE>
<CAPTION>
AMOUNT PERCENT
----------------------
(IN MILLIONS)
----------------------
<S> <C> <C>
Subject to discretionary withdrawal with adjustment:
With market value adjustment $ 2,659.5 5%
-----------------------------------------------------------------------------
At book value, less surrender charge 2,959.2 5
-----------------------------------------------------------------------------
At market value 35,472.0 63
----------------------------------------------------------------------------- --------- ---
41,090.7 73
Subject to discretionary withdrawal without adjustment at book value with
minimal or no charge or adjustment 12,747.3 22
- --------------------------------------------------------------------------------
Not subject to discretionary withdrawal 2,625.1 5
- -------------------------------------------------------------------------------- --------- ---
Total annuity reserves and deposit fund liabilities -- before reinsurance 56,463.1 100%
- -------------------------------------------------------------------------------- ---
---
Less reinsurance 1,683.8
- -------------------------------------------------------------------------------- ---------
Net annuity reserves and deposit fund liabilities, including separate accounts $54,779.3
- -------------------------------------------------------------------------------- ---------
---------
</TABLE>
A reconciliation of the total net annuity reserves and
deposit fund liabilities to the amounts reported in the
Company's 1998 Annual Statement and the Company's Separate
Accounts Annual Statement is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1998
-------------
(IN MILLIONS)
-------------
<S> <C>
Per 1998 Annual Statement:
Exhibit 8, Section B -- Total (net) $ 2,554.6
- ----------------------------------------------------------------
Exhibit 8, Section C -- Total (net) 26.0
- ----------------------------------------------------------------
Exhibit 10, Column 1, Line 19 16,579.6
- ---------------------------------------------------------------- -------------
19,160.2
- ---------------------------------------------------------------- -------------
Per Separate Accounts Annual Statement
Exhibit 6, Column 2, Line 0299999 146.4
- ----------------------------------------------------------------
Page 3, Line 3 35,472.7
- ---------------------------------------------------------------- -------------
35,619.1
- ---------------------------------------------------------------- -------------
Total net annuity reserves and deposit fund liabilities $54,779.3
- ---------------------------------------------------------------- -------------
-------------
</TABLE>
8. CAPITAL AND SURPLUS
In 1998, the Company issued two surplus notes to LNC in return for cash of
$1,250,000,000. The first note for $500,000,000 was issued to LNC in
connection with the CIGNA indemnity reinsurance transaction on January 5,
1998. This note calls for the Company to pay the principal amount of the
notes on or before March 31, 2028 and interest to be paid quarterly at an
annual rate of 6.56%. Subject to approval by the Indiana Insurance
Commissioner, LNC also has a right to redeem the note for immediate
repayment in total or in part once per year on the anniversary date of the
note, but not before January 5, 2003. Any payment of interest or
S-19
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
8. CAPITAL AND SURPLUS (CONTINUED)
repayment of principal may be paid only out of the Company's earnings, only
if the Company's surplus exceeds specified levels ($2,315,700,000 at
December 31, 1998), and subject to approval by the Indiana Insurance
Commissioner. No interest payments were approved by the Indiana Insurance
Commissioner as of December 31, 1998 and, thus, no amounts were accrued at
that date.
The second note for $750,000,000 was issued on December 18, 1998 to LNC in
connection with the Aetna indemnity reinsurance transaction. This note calls
for the Company to pay the principal amount of the notes on or before
December 31, 2028 and interest to be paid quarterly at an annual rate of
6.03%. Subject to approval by the Indiana Insurance Commissioner, LNC also
has a right to redeem the note for immediate repayment in total or in part
once per year on the anniversary date of the note, but not before December
18, 2003. Any payment of interest or repayment of principal may be paid only
out of the Company's earnings, only if the Company's surplus exceeds
specified levels ($2,379,600,000 at December 31, 1998), and subject to
approval by the Indiana Insurance Commissioner. No interest payments were
approved by the Indiana Insurance Commissioner as of December 31, 1998 and,
thus, no amounts were accrued at that date.
A summary of the terms of these surplus notes follows:
<TABLE>
<CAPTION>
CURRENT YEAR
PRINCIPAL PRINCIPAL INTEREST
DATE ISSUED AMOUNT OF NOTE OUTSTANDING PAID
------------------------------- -------------- ------------- ------------
<S> <C> <C> <C>
January 5, 1998 $500,000,000 $ 500,000,000 $ 32,300,000
-------------------------------
December 18, 1998 750,000,000 750,000,000 --
-------------------------------
</TABLE>
Life insurance companies are subject to certain Risk-Based Capital ("RBC")
requirements as specified by the NAIC. Under those requirements, the amount
of capital and surplus maintained by a life insurance company is to be
determined based on the various risk factors related to it. At December 31,
1998, the Company exceeds the RBC requirements.
The payment of dividends by the Company is limited and cannot be made except
from earned profits. The maximum amount of dividends that may be paid by
life insurance companies without prior approval of the Indiana Insurance
Commissioner is subject to restrictions relating to statutory surplus and
net gain from operations. In January 1998, the Company assumed a block of
individual life insurance and annuity business from CIGNA and in October
1998, the Company assumed a block of individual life insurance business from
Aetna (SEE NOTE 10). The statutory accounting regulations do not allow
goodwill to be recognized on indemnity reinsurance transactions and
therefore, the related ceding commission was expensed in the accompanying
Statement of Operations and resulted in the reduction of unassigned surplus.
As a result of these transactions, the Company's statutory-basis unassigned
surplus is negative as of December 31, 1998 and it will be necessary for the
Company to obtain prior approval of the Indiana Insurance Commissioner
before paying any dividends to LNC until such time as statutory-basis
unassigned surplus is positive. It is expected that statutory-basis
unassigned surplus will return to a positive position within two to three
years from the closing of the Aetna transaction assuming a level of
statutory-basis earnings coinciding with recent earnings patterns. If
statutory-basis earnings are less then recent patterns due to adverse
operating conditions or further indemnity reinsurance transactions of this
nature or other factors, or if dividends are approved and paid at amounts
higher than recent history, the statutory-basis unassigned surplus may not
return to a positive position as soon as expected. Although no assurance can
be given, management believes that the approvals for the payment of such
dividends in amounts consistent with those paid in the past can be obtained.
S-20
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
9. EMPLOYEE BENEFIT PLANS
LNC maintains defined benefit pension plans for its employees (including
Company employees) and a defined contribution plan for the Company's agents.
LNC also maintains 401(k) plans, deferred compensation plans and
postretirement medical and life insurance plans for its employees and agents
(including the Company's employees and agents). The aggregate expenses and
accumulated obligations for the Company's portion of these plans are not
material to the Company's statutory-basis financial statements of income or
financial position for any of the periods shown.
LNC has various incentive plans for key employees, agents and directors of
LNC and its subsidiaries that provide for the issuance of stock options,
stock appreciation rights, restricted stock awards and stock incentive
awards. These plans are comprised primarily of stock option incentive plans.
Stock options granted under the stock option incentive plans are at the
market value at the date of grants and, subject to termination of
employment, expire ten years from the date of grant. Such options are
transferable only upon death and are exercisable one year from the date of
grant for options issued prior to 1992. Option issued subsequent to 1991 are
exercisable in 25% increments on the option issuance anniversary in the four
years following issuance.
As of December 31, 1998, 885,252 and 504,369 shares of LNC common stock were
subject to options granted to Company employees and agents, respectively,
under the stock option incentive plans of which 430,053 and 87,160,
respectively, were exercisable on that date. The exercise prices of the
outstanding options range from $23.50 to $96.41. During 1998, 1997 and 1996,
136,469, 170,789 and 72,405 options were exercised, respectively, and
18,288, 1,846 and 10,950 options were forfeited, respectively.
10. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES
DISABILITY INCOME CLAIMS
The liability for disability income claims net of the related asset for
amounts recoverable from reinsurers at December 31, 1998 and 1997 is a net
liability of $670,100,000 and $516,900,000, respectively. This liability is
based on the assumption that the recent experience will continue in the
future. If incidence levels and/or claim termination rates fluctuate
significantly from the assumptions underlying reserves, adjustments to
reserves could be required in the future. Accordingly, this liability may
prove to be deficient or excessive. The Company reviews reserve levels on an
ongoing basis. However, it is management's opinion that such future
development will not materially affect the financial position of the
Company.
During 1997, the Company conducted an in-depth review of loss experience on
its disability income business. As a result of this study, the reserve level
was deemed to be inadequate to meet future obligations if current incident
levels were to continue in the future. In order to address this situation,
the Company strengthened its disability income reserves by $80,000,000 in
1997.
MARKETING AND COMPLIANCE ISSUES
Regulators continue to focus on market conduct and compliance issues. Under
certain circumstances companies operating in the insurance and financial
services markets have been held responsible for providing incomplete or
misleading sales materials and for replacing existing policies with policies
that were less advantageous to the policyholder. The Company's management
continues to monitor the Company's sales materials and compliance procedures
and is making an extensive effort to minimize any potential liability. Due
to the uncertainty surrounding such matters, it is not possible to provide a
meaningful estimate of the range of potential outcomes at this time;
however, it is management's opinion that such future development will not
materially affect the financial position of the Company.
GROUP PENSION ANNUITIES
The liabilities for guaranteed interest and group pension annuity contracts,
which are no longer being sold by the Company, are supported by a single
portfolio of assets that attempts to match the duration of these
liabilities. Due to the long-term nature of group pension annuities and the
resulting inability to exactly match cash flows, a risk exists that future
cash flows from investments will not be reinvested at rates as high as
currently earned by the portfolio. Accordingly, these liabilities may prove
to be deficient or excessive. However, it is management's opinion that such
future
S-21
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
10. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES (CONTINUED)
development will not materially affect the financial position of the
Company.
LEASES
The Company leases its home office properties through sale-leaseback
agreements. The agreements provide for a 25 year lease period with options
to renew for six additional terms of five years each. The agreements also
provide the Company with the right of first refusal to purchase the
properties during the term of the lease, including renewal periods, at a
price as defined in the agreements. The Company also has the option to
purchase the leased properties at fair market value as defined in the
agreements on the last day of the initial 25-year lease ending in 2009 or on
the last day of any of the renewal periods.
Total rental expense on operating leases in 1998, 1997 and 1996 was
$34,000,000, $29,300,000 and $26,400,000, respectively. Future minimum
rental commitments are as follows (in millions):
<TABLE>
<S> <C>
1999 $ 18.9
- --------------------------------------
2000 18.4
- --------------------------------------
2001 18.7
- --------------------------------------
2002 18.7
- --------------------------------------
2003 18.6
- --------------------------------------
Thereafter 116.6
- -------------------------------------- ---------
$ 209.9
---------
---------
</TABLE>
INFORMATION TECHNOLOGY COMMITMENT
In February 1998, the Company signed a seven-year contract with IBM Global
Services for information technology services for the Fort Wayne operations.
Total costs incurred in 1998 were $54,800,000. Future minimum annual costs
range from $33,600,000 to $56,800,000, however future costs are dependent on
usage and could exceed these amounts.
INSURANCE CEDED AND ASSUMED
The Company cedes insurance to other companies, including certain
affiliates. The portion of risks exceeding the Company's retention limit is
reinsured with other insurers. Prior to December 31, 1997, the Company
limited its maximum coverage that it retained on an individual to
$3,000,000. Based on a review of the capital and business in-force effective
in January 1998, the Company changed the amount it will retain on an
individual to $10,000,000. Portions of the Company's deferred annuity
business have also been reinsured with other companies to limit its exposure
to interest rate risks. At December 31, 1998, the reserves associated with
these reinsurance arrangements totaled $1,608,500,000. To cover products
other than life insurance, the Company acquires other insurance coverages
with retentions and limits that management believes are appropriate for the
circumstances. The accompanying statutory-basis financial statements reflect
premiums, benefits and policy acquisition expenses net of reinsurance ceded.
The Company remains liable if its reinsurers are unable to meet their
contractual obligations under the applicable reinsurance agreements.
Proceeds from the sale of common stock of American Statements Financial
Corporation ("American States") and proceeds from the January 5, 1998
surplus note, were used to finance an indemnity reinsurance transaction
whereby the Company and LLANY reinsured 100% of a block of individual life
insurance and annuity business from CIGNA Corporation ("CIGNA"). The Company
paid $1,264,400,000 to CIGNA on January 2, 1998 under the terms of the
reinsurance agreement and recognized a ceding commission expense of
$1,127,700,000 in 1998, which is included in the Statement of Operations
line item "Underwriting, acquisition, insurance and other expenses." At the
time of closing, this block of business had statutory liabilities of
$4,658,200,000 that became the Company's obligation. The Company also
received assets, measured on a historical statutory basis, equal to the
liabilities.
Pursuant to the terms of the reinsurance agreement, the Company, LLANY and
CIGNA are in the final stages of agreeing to the statutory-basis values of
these assets and liabilities. Any changes to these values that may occur in
future periods will not be material to the Company's financial position.
Subsequent to this transaction, the Company and LLANY announced that they
had reached an agreement to sell the administration rights to a variable
S-22
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
10. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES (CONTINUED)
annuity portfolio that had been acquired as part of the block of business
assumed on January 2, 1998. This sale closed on October 12, 1998 with an
effective date of August 1, 1998.
In connection with the completion of the CIGNA reinsurance transaction, the
Company recorded a charge of $31,000,000 to cover certain costs of
integrating the existing operations with the new block of business.
On October 1, 1998, the Company and LLANY entered into an indemnity
reinsurance transaction whereby the Company and LLANY reinsured 100% of a
block of individual life insurance business from Aetna, Inc. The Company
paid $856,300,000 to Aetna on October 1, 1998 under the terms of the
reinsurance agreement and recognized a ceding commission expense of
$815,300,000 in 1998, which is included in the Statement of Operations line
item "Underwriting, acquisition, insurance and other expenses." At the time
of closing, this block of business had statutory liabilities of
$2,813,300,000 that became the Company's obligation. The Company also
received assets, measured on a historical statutory basis, equal to the
liabilities. The Company financed this reinsurance transaction with proceeds
from short-term debt borrowings from LNC until the December 18, 1998 surplus
note was approved by the Insurance Department. Subsequent to the Aetna
transaction, the Company and LLANY announced that they had reached an
agreement to retrocede the sponsored life business assumed for $87,600,000.
The retrocession agreement closed on October 14, 1998 with an effective date
of October 1, 1998.
The Company assumes insurance from other companies, including certain
affiliates. At December 31, 1998, the Company has provided $44,900,000 of
statutory-basis surplus relief to other insurance companies under
reinsurance transactions. The Company has retroceded 100% of this accepted
surplus relief to its off-shore reinsurance affiliates. Generally, such
amounts are offset by corresponding receivables from the ceding company,
which are secured by future profits on the reinsured business. However, the
Company is subject to the risk that the ceding company may become insolvent
and the right of offset would not be permitted.
The regulatory required liability for unsecured reserves ceded to
unauthorized reinsurers was $43,400,000 and $8,200,000 at December 31, 1998
and 1997, respectively.
VULNERABILITY FROM CONCENTRATIONS
At December 31, 1998, the Company did not have a material concentration of
financial instruments in a single investee or industry. The Company's
investments in mortgage loans principally involve commercial real estate. At
December 31, 1998, 25% of such mortgages ($980,500,000) involved properties
located in Texas and California. Such investments consist of first mortgage
liens on completed income-producing properties and the mortgage outstanding
on any individual property does not exceed $58,200,000.
At December 31, 1998, the Company did not have a concentration of: 1)
business transactions with a particular customer, lender or distributor; 2)
revenues from a particular product or service; 3) sources of supply of labor
or services used in the business; or 4) a market or geographic area in which
business is conducted that makes it vulnerable to an event that is at least
reasonably possible to occur in the near term and which could cause a severe
impact to the Company's financial condition.
OTHER CONTINGENCY MATTERS
The Company is involved in various pending or threatened legal proceedings
arising from the conduct of business. Most of these proceedings are routine
in the ordinary course of business. The Company maintains professional
liability insurance coverage for claims in excess of $5,000,000. The degree
of applicability of this coverage will depend on the specific facts of each
proceeding. In some instances, these proceedings include claims for
compensatory and punitive damages and similar types of relief in addition to
amounts for alleged contractual liability or requests for equitable relief.
After consultation with legal counsel and a review of available facts, it is
management's opinion that the ultimate liability, if any, under these suits
will not have a material adverse affect on the financial position of the
Company.
S-23
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
10. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES (CONTINUED)
Four lawsuits involving alleged fraud in the sale of interest sensitive
universal life and whole life insurance have been filed as class actions
against the Company, although the court has not certified a class in any of
these cases. Plaintiffs seek unspecified damages and penalties for
themselves and on behalf of the putative class. While the relief sought in
these cases is substantial, it is premature to make assessments about the
potential loss, if any, because the status of the cases ranges from the
early states of litigation to the dismissal and appeals stage. Management
intends to defend these suits vigorously. The amount of liability, if any,
which may arise as a result of these suits cannot be reasonably estimated at
this time.
The number of insurance companies that are under regulatory supervision has
resulted, and is expected to continue to result, in assessments by state
guaranty funds to cover losses to policyholders of insolvent or
rehabilitated companies. Mandatory assessments may be partially recovered
through a reduction in future premium taxes in some states. The Company has
accrued for expected assessments net of estimated future premium tax
deductions.
GUARANTEES
The Company has guarantees with off-balance-sheet risks whose contractual
amounts represent credit exposure. Outstanding guarantees with off-
balance-sheet risks at December 31, 1998 relate to mortgage loan
pass-through certificates. The Company has sold commercial mortgage loans
through grantor trusts which issued pass-through certificates. The Company
has agreed to repurchase any mortgage loans which remain delinquent for 90
days at a repurchase price substantially equal to the outstanding principal
balance plus accrued interest thereon to the date of repurchase. The
outstanding guarantees as of December 31, 1998 and 1997 were $30,900,000 and
$41,600,000, respectively. It is management's opinion that the value of the
properties underlying these commitments is sufficient that in the event of
default the impact would not be material to the Company. Accordingly, both
the carrying value and fair value of these guarantees is zero at December
31, 1998 and 1997.
The Company's wholly owned subsidiary, LNH&C, accepts personal accident
reinsurance programs from other insurance companies. Most of these programs
are presented to LNH&C by independent brokers who represent the ceding
companies. Certain excess of loss personal accident reinsurance programs
created in the London market during 1993 through 1996 have produced and have
potential to produce significant losses. At December 31, 1998 and 1997,
liabilities of $177,400,000 and $186,300,000, respectively, have been
established for such programs. These reserves are based on various estimates
that are subject to considerable uncertainty. Accordingly, this reserve may
prove to be deficient or excessive. However, it is management's opinion that
such future development will not materially affect the financial position of
the Company.
The Company and LNH&C continue to investigate the personal accident
reinsurance programs to determine if there are additional programs including
certain workers compensation programs, which may produce losses. At this
time, the Company and LNH&C do not have sufficient information to determine
whether or not it is probable that additional losses have been incurred nor
can the Company and LNH&C accurately estimate the ultimate cost or timing of
the outcome on these programs.
DERIVATIVES
The Company has derivatives with off-balance-sheet risks whose notional or
contract amounts exceed the credit exposure. The Company has entered into
derivative transactions to reduce its exposure to fluctuations in interest
rates, the widening of bond yield spreads over comparable maturity U.S.
government obligations, commodity risk, credit risk, increased liabilities
associated with reinsurance agreements and foreign exchange risks. In
addition, the Company is subject to the risks associated with changes in the
value of its derivatives; however, such changes in value generally are
offset by changes in the value of the items
S-24
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
10. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES (CONTINUED)
being hedged by such contracts. Outstanding derivatives with
off-balance-sheet risks, shown in notional or contract amounts along with
their carrying value and estimated fair values, are as follows:
<TABLE>
<CAPTION>
NOTIONAL OR ASSETS (LIABILITIES)
CONTRACT AMOUNTS -----------------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
-------------------------------------------------------
DECEMBER 31 DECEMBER 31 DECEMBER 31
1998 1997 1998 1998 1997 1997
-------------------------------------------------------
(IN MILLIONS)
-------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Interest rate derivatives:
Interest rate cap agreements $4,108.8 $4,900.0 $ 9.3 $ .9 $13.9 $ .9
---------------------------------
Swaptions 1,899.5 1,752.0 16.2 2.5 6.9 6.9
---------------------------------
Interest rate swaps 258.3 10.0 -- 9.9 -- (1.8)
---------------------------------
Put options 21.3 -- -- 2.2 -- --
--------------------------------- -------- -------- -------- ----- -------- ------
6,287.9 6,662.0 25.5 15.5 20.8 6.0
Foreign currency derivatives:
Forward contracts 1.5 163.1 -- -- 5.4 5.4
---------------------------------
Foreign currency swaps 47.2 15.0 -- .3 -- (2.1)
--------------------------------- -------- -------- -------- ----- -------- ------
48.7 178.1 -- .3 5.4 3.3
Commodity derivatives:
Commodity swaps 8.1 -- -- 2.4 -- --
--------------------------------- -------- -------- -------- ----- -------- ------
$6,344.7 $6,840.1 $25.5 $18.2 $26.2 $ 9.3
-------- -------- -------- ----- -------- ------
-------- -------- -------- ----- -------- ------
</TABLE>
A reconciliation of the notional or contract amounts for the significant
programs using derivative agreements and contracts at December 31 is as
follows:
<TABLE>
<CAPTION>
------------------------------------------------------------------
INTEREST RATE CAPS SPREAD LOCKS SWAPTIONS
1998 1997 1998 1997 1998 1997
------------------------------------------------------------------
(IN MILLIONS)
------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at beginning of year $ 4,900.0 $ 5,500.0 $ -- $ -- $ 1,752.0 $ 672.0
- ------------------------------------
New contracts 708.8 -- -- 50.0 218.3 1,080.0
- ------------------------------------
Terminations and maturities (1,500.0) (600.0) -- (50.0) (70.8) --
- ------------------------------------ --------- --------- --- --------- --------- ---------
Balance at end of year $ 4,108.8 $ 4,900.0 $ -- $ -- $ 1,899.5 $ 1,752.0
- ------------------------------------ --------- --------- --- --------- --------- ---------
--------- --------- --- --------- --------- ---------
</TABLE>
<TABLE>
<CAPTION>
FINANCIAL FUTURES
CONTRACTS INTEREST RATE SWAPS
--------------------------------------------
1998 1997 1998 1997
--------------------------------------------
<S> <C> <C> <C> <C>
Balance at beginning of year $ -- $ 147.7 $ 10.0 $ --
- -------------------------------------------------------------
New contracts -- 88.3 2,226.6 10.0
- -------------------------------------------------------------
Terminations and maturities -- (236.0) (1,978.3) --
- ------------------------------------------------------------- --- --------- --------- ---------
Balance at end of year $ -- $ -- $ 258.3 $ 10.0
- ------------------------------------------------------------- --- --------- --------- ---------
--- --------- --------- ---------
</TABLE>
S-25
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
10. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES (CONTINUED)
<TABLE>
<CAPTION>
PUT OPTIONS COMMODITY SWAPS
------------------------------------------------
1998 1997 1998 1997
------------------------------------------------
<S> <C> <C> <C> <C>
Balance at beginning of year $ -- $ -- $ -- $ --
- --------------------------------------------------------------------
New contracts 21.3 -- 8.1 --
- --------------------------------------------------------------------
Terminations and maturities -- -- -- --
- -------------------------------------------------------------------- --------- --- --- ---
Balance at end of year $ 21.3 $ -- $ 8.1 $ --
- -------------------------------------------------------------------- --------- --- --- ---
--------- --- --- ---
</TABLE>
<TABLE>
<CAPTION>
FOREIGN CURRENCY DERIVATIVES (FOREIGN INVESTMENTS)
------------------------------------------------------------------
FOREIGN EXCHANGE FOREIGN CURRENCY FOREIGN CURRENCY
FORWARD CONTRACTS OPTIONS SWAPS
1998 1997 1998 1997 1998 1997
------------------------------------------------------------------
(IN MILLIONS)
------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at beginning of year $ 163.1 $ 251.5 $ -- $ 43.9 $ 15.0 $ 15.0
- -------------------------------------------
New contracts 419.8 833.1 -- -- 39.2 --
- -------------------------------------------
Terminations and maturities (581.4) (921.6) -- (43.9) (7.0) --
- ------------------------------------------- --------- --------- --- --------- --------- ---------
Balance at end of year $ 1.5 $ 163.0 $ -- $ -- $ 47.2 $ 15.0
- ------------------------------------------- --------- --------- --- --------- --------- ---------
--------- --------- --- --------- --------- ---------
</TABLE>
INTEREST RATE CAP AGREEMENTS
The interest rate cap agreements, which expire in 1999 through 2006, entitle
the Company to receive quarterly payments from the counterparties on
specified future reset dates, contingent on future interest rates. For each
cap, the amount of such payments, if any, is determined by the excess of a
market interest rate over a specified cap rate multiplied by the notional
amount divided by four. The purpose of the Company's interest rate cap
agreement program is to protect its annuity line of business from the effect
of rising interest rates. The premium paid for the interest rate caps is
included in other assets ($9,300,000 as of December 31, 1998) and is being
amortized over the terms of the agreements. This amortization is included in
net investment income.
SWAPTIONS
Swaptions, which expire in 1999 through 2003, entitle the Company to receive
settlement payments from the counterparties on specified expiration dates,
contingent on future interest rates. For each swaption, the amount of such
settlement payments, if any, is determined by the present value of the
difference between the fixed rate on a market rate swap and the strike rate
multiplied by the notional amount. The purpose of the Company's swaption
program is to protect its annuity line of business from the effect of rising
interest rates. The premium paid for the swaptions is included in other
assets ($16,200,000 as of December 31, 1998) and is being amortized over the
terms of the agreements. This amortization is included in net investment
income.
SPREAD LOCK AGREEMENTS
Spread-lock agreements provide for a lump sum payment to or by the Company,
depending on whether the spread between the swap rate and a specified
government note is larger or smaller than a contractually specified spread.
Cash payments are based on the product of the notional amount, the spread
between the swap rate and the yield of an equivalent maturity government
security and the price sensitivity of the swap at that time. The purpose of
the Company's spread-lock program is to protect a portion of its fixed
maturity securities against widening of spreads.
FINANCIAL FUTURE CONTRACTS
The Company uses exchange-traded financial futures contracts to hedge
against interest rate risks and to manage duration of a portion of its
S-26
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
10. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES (CONTINUED)
fixed maturity securities. Financial futures contracts obligate the Company
to buy or sell a financial instrument at a specified future date for a
specified price. They may be settled in cash or through delivery of the
financial instrument. Cash settlements on the change in market values of
financial futures contracts are made daily.
INTEREST RATE SWAP AGREEMENTS
The Company uses interest rate swap agreements to hedge its exposure to
floating rate bond coupon payments, replicating a fixed rate bond. An
interest rate swap is a contractual agreement to exchange payments at one or
more times based on the actual or expected price, level, performance or
value of one or more underlying interest rates. The Company is required to
pay the counterparty to the agreements the stream of variable coupon
payments generated from the bonds, and in turn, receives a fixed payment
from the counterparty at a predetermined interest rate. The net
receipts/payments from interest rate swaps are recorded in net investment
income.
The Company also uses interest rate swap agreements to hedge its exposure to
interest rate fluctuations related to the anticipated purchase of assets to
support newly acquired or assumed blocks of business. Once the assets are
purchased, the gains resulting from the termination of the swap agreements
are applied to the basis of the assets purchased. The gains are recognized
in earnings over the life of the assets.
PUT OPTION
The Company uses put options, combined with various perpetual fixed income
securities, and interest rate swaps to replicate a fixed income, fixed
maturity investment. The put options give the Company the right, but not the
obligation, to sell to the counterparty of the agreement the specified
securities on a specified date at a fixed price.
FOREIGN CURRENCY DERIVATIVES (FOREIGN INVESTMENTS)
The Company uses a combination of foreign exchange forward contracts,
foreign currency options and foreign currency swaps, all of which are traded
over-the-counter, to hedge some of the foreign exchange risk of investments
in fixed maturity securities denominated in foreign currencies. The foreign
currency forward contracts obligate the Company to deliver a specified
amount of currency at a future date at a specified exchange rate. Foreign
currency options give the Company the right, but not the obligation, to buy
or sell a foreign currency at a specific exchange rate during a specified
time period. A foreign currency swap is a contractual agreement to exchange
the currencies of two different countries pursuant to an agreement to
re-exchange the two currencies at the same rate of exchange at a specified
future date.
COMMODITY SWAP
The Company uses a commodity swap to hedge its exposure to fluctuations in
the price of gold, which is the underlying variable in determining the
periodic interest payments associated with a fixed income security. A
commodity swap is a contractual agreement to exchange a certain amount of a
particular commodity for a fixed amount of cash. The Company owns a fixed
income security that meets its coupon payment obligations in gold bullion.
The Company is obligated to pay to the counterparty the gold bullion, and in
return, receives from the counterparty a stream of fixed income payments.
The fixed income payments are the product of the swap notional multiplied by
the fixed rate stated in the swap agreement. The net receipts/payments from
commodity swaps are recorded in net investment income.
ADDITIONAL DERIVATIVE INFORMATION
Expenses for the agreements and contracts described above amounted to
$10,000,000, $7,000,000 and $6,900,000 in 1998, 1997 and 1996, respectively.
Deferred losses of $48,200,000 as of December 31, 1998, were the result of:
1) terminated and expired spread-lock agreements and; 2) terminated interest
rate swaps. These losses are included with the related fixed maturity
securities to which the hedge applied and are being amortized over the life
of such securities.
The Company is exposed to credit loss in the event of nonperformance by
counterparties on interest rate cap agreements, swaptions, spread-lock
agreements, financial futures, interest rate swaps, put options and foreign
currency derivatives. However, the Company does not anticipate
nonperformance
S-27
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
10. RESTRICTIONS, COMMITMENTS AND CONTINGENCIES (CONTINUED)
by any of the counterparties. The credit risk associated with such
agreements is minimized by purchasing such agreements from financial
institutions with long-standing, superior performance records. The amount of
such exposure is essentially the net replacement cost or market value for
such agreements with each counterparty if the net market value is in the
Company's favor. At December 31, 1998, the exposure was $21,100,000.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following discussion outlines the methodologies and assumptions used to
determine the estimated fair values of the Company's financial instruments.
Considerable judgment is required to develop these fair values. Accordingly,
the estimates shown are not necessarily indicative of the amounts that would
be realized in a one-time, current market exchange of all of the Company's
financial instruments.
BONDS AND UNAFFILIATED COMMON STOCK
Fair values of bonds are based on quoted market prices, where available. For
bonds not actively traded, fair values are estimated using values obtained
from independent pricing services. In the case of private placements, fair
values are estimated by discounting expected future cash flows using a
current market rate applicable to the coupon rate, credit quality and
maturity of the investments. The fair values of unaffiliated common stocks
are based on quoted market prices.
PREFERRED STOCK
Fair values of preferred stock are based on quoted market prices, where
available. For preferred stock not actively traded, fair values are based on
values of issues of comparable yield and quality.
MORTGAGE LOANS ON REAL ESTATE
The estimated fair value of mortgage loans on real estate was established
using a discounted cash flow method based on credit rating, maturity and
future income. The ratings for mortgages in good standing are based on
property type, location, market conditions, occupancy, debt service
coverage, loan to value, caliber of tenancy, borrower and payment record.
Fair values for impaired mortgage loans are based on: 1) the present value
of expected future cash flows discounted at the loan's effective interest
rate; 2) the loan's market price; or 3) the fair value of the collateral if
the loan is collateral dependent.
POLICY LOANS
The estimated fair values of investments in policy loans are calculated on a
composite discounted cash flow basis using Treasury interest rates
consistent with the maturity durations assumed. These durations are based on
historical experience.
OTHER INVESTMENTS AND CASH AND SHORT-TERM INVESTMENTS
The carrying values for assets classified as other investments and cash and
short-term investments in the accompanying statutory-basis balance sheets
approximate their fair value.
INVESTMENT-TYPE INSURANCE CONTRACTS
The balance sheet captions, "Future policy benefits and claims" and "Other
policyholder funds," include investment type insurance contracts (i.e.,
deposit contracts and guaranteed interest contracts). The fair values for
the deposit contracts and certain guaranteed interest contracts are based on
their approximate surrender values. The fair values for the remaining
guaranteed interest and similar contracts are estimated using discounted
cash flow calculations. These calculations are based on interest rates
currently offered on similar contracts with maturities that are consistent
with those remaining for the contracts being valued.
The remainder of the balance sheet captions "Future policy benefits and
claims" and "Other policyholder funds," that do not fit the definition of
"investment-type insurance contracts" are considered insurance contracts.
Fair value disclosures are not required for these insurance contracts and
have not been determined by the Company. It is the Company's position that
the disclosure of the fair value of these insurance contracts is important
because readers of these financial statements could draw inappropriate
conclusions about the Company's capital and surplus determined on a fair
value basis. It could be misleading if only the fair value of assets and
liabilities defined as financial instruments are disclosed. The Company and
other
S-28
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
11. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
companies in the insurance industry are monitoring the related actions of
the various rule-making bodies and attempting to determine an appropriate
methodology for estimating and disclosing the "fair value" of their
insurance contract liabilities.
SHORT-TERM DEBT
For short-term debt, the carrying value approximates fair value.
SURPLUS NOTES DUE TO LNC
Fair values for surplus notes are estimated using discounted cash flow
analysis based on the Company's current incremental borrowing rate for
similar types of borrowing arrangements.
GUARANTEES
The Company's guarantees include guarantees related to mortgage loan
pass-through certificates. Based on historical performance where repurchases
have been negligible and the current status, which indicates none of the
loans are delinquent, the fair value liability for the guarantees related to
the mortgage loan pass-through certificates is zero.
DERIVATIVES
The Company employs several different methods for determining the fair value
of its derivative instruments. Fair values for these contracts are based on
current settlement values. These values are based on quoted market prices
for the foreign currency exchange contracts and financial future contracts
and; 2) industry standard models that are commercially available for
interest rate cap agreements, swaptions, spread lock agreements, interest
rate swaps, commodity swaps and put options.
INVESTMENT COMMITMENTS
Fair values for commitments to make investment in fixed maturity securities
(primarily private placements), mortgage loans on real estate and real
estate are based on the difference between the value of the committed
investments as of the date of the accompanying balance sheets and the
commitment date. These estimates would take into account changes in interest
rates, the counterparties' credit standing and the remaining terms of the
commitments.
SEPARATE ACCOUNTS
Assets held in separate accounts are reported in the accompanying
statutory-basis balance sheets at fair value. The related liabilities are
also reported at fair value in amounts equal to the separate account assets.
S-29
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
11. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The carrying values and estimated fair values of the Company's financial
instruments are as follows:
<TABLE>
<CAPTION>
DECEMBER 31
----------------------------------------------
1998 1997
----------------------------------------------
CARRYING CARRYING
ASSETS (LIABILITIES) VALUE FAIR VALUE VALUE FAIR VALUE
- -----------------------------------------------------------------------------------------------
(IN MILLIONS)
----------------------------------------------
<S> <C> <C> <C> <C>
Bonds $ 23,830.9 $ 25,065.5 $ 18,560.7 $ 19,798.6
- -----------------------------------------------
Preferred stocks 236.0 242.5 257.3 268.7
- -----------------------------------------------
Unaffiliated common stocks 259.3 259.3 436.0 436.0
- -----------------------------------------------
Mortgage loans on real estate 3,932.9 4,100.1 3,012.7 3,179.2
- -----------------------------------------------
Policy loans 1,606.0 1,685.9 660.5 648.3
- -----------------------------------------------
Other investments 434.4 434.4 335.5 335.5
- -----------------------------------------------
Cash and short-term investments 1,725.4 1,725.4 2,133.0 2,133.0
- -----------------------------------------------
Investment-type insurance contracts:
Deposit contracts and certain guaranteed
interest contracts (17,845.8) (17,486.4) (17,324.2) (16,887.6)
--------------------------------------------
Remaining guaranteed interest and similar
contracts (714.4) (738.2) (1,267.0) (1,294.6)
--------------------------------------------
Short-term debt (140.0) (140.0) (120.0) (120.0)
- -----------------------------------------------
Surplus notes due to LNC (1,250.0) (1,335.1) -- --
- -----------------------------------------------
Derivatives 25.5 18.2 26.2 9.3
- -----------------------------------------------
Investment commitments -- (0.6) -- (0.5)
- -----------------------------------------------
Separate account assets 36,907.0 36,907.0 31,330.9 31,330.9
- -----------------------------------------------
Separate account liabilities (36,907.0) (36,907.0) (31,330.9) (31,330.9)
- -----------------------------------------------
</TABLE>
12. ACQUISITIONS AND SALES OF SUBSIDIARIES
In October 1996, the Company and LLANY purchased a block of group
tax-qualified annuity business from UNUM Corporation affiliates. The bulk of
the transaction was completed in the form of an assumption reinsurance
transaction, which resulted in a ceding commission of $71,800,000. The
ceding commission resulted in admissible goodwill of $62,300,000, which is
being amortized on a straight-line basis over 10 years. LLANY was required
by the New York Department of Insurance to expense its portion of the ceding
commission in 1996. Policy liabilities and related accruals of the Company
and its wholly owned subsidiary increased by $3,200,000,000 as a result of
this transaction.
In 1997, LNC contributed 25,000,000 shares of common stock of American
States to the Company. American States is a property casualty insurance
holding company of which LNC owned 83.3%. The contributed common stock was
accounted for as a capital contribution equal to the fair value of the
common stock received by the Company. Subsequently, the American States
common stock owned by the Company, along with all other American States
common stock owned by LNC and its affiliates, was sold. The Company received
proceeds from the sale in the amount of $1,175,000,000. The Company
recognized no gain or loss on the sale of its portion of the common stock
due to the receipt of the stock at fair value. The proceeds from this sale
of stock were used to partially finance the CIGNA indemnity reinsurance
transaction.
S-30
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
13. TRANSACTIONS WITH AFFILIATES
A wholly owned subsidiary of LNC, Lincoln Life and Annuity Distributors,
Inc. ("LLAD"), has a nearly exclusive general agent's contract with the
Company under which it sells the Company's products and provides the service
that otherwise would be provided by a home office marketing department and
regional offices. For providing these selling and marketing services, the
Company paid LLAD override commissions of $76,700,000 in 1998 and override
commissions and operating expense allowances of $61,600,000 and $56,300,000
in 1997 and 1996, respectively. LLAD incurred expenses of $102,400,000,
$5,500,000 and $15,700,000 in 1998, 1997 and 1996, respectively, in excess
of the override commissions and operating expense allowances received from
the Company, which the Company is not required to reimburse. Effective in
January 1998, the Company and LLAD agreed to increase the override
commission expense and eliminate the operating expense allowance.
Cash and short-term investments at December 31, 1998 and 1997 include the
Company's participation in a short-term investment pool with LNC of
$383,600,000 and $325,600,000, respectively. Related investment income
amounted to $16,800,000, $15,500,000 and $15,300,000 in 1998, 1997 and 1996,
respectively. Short-term loan payable to parent company at December 31, 1998
and 1997 represent notes payable to LNC.
The Company provides services to and receives services from affiliated
companies which resulted in a net payment of $92,100,000, $48,500,000 and
$34,100,000 in 1998, 1997 and 1996, respectively.
The Company cedes and accepts reinsurance from affiliated companies.
Premiums in the accompanying statements of income include premiums on
insurance business accepted under reinsurance contracts and exclude premiums
ceded to other affiliated companies, as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997 1996
-------------------------------
(IN MILLIONS)
-------------------------------
<S> <C> <C> <C>
Insurance assumed $ 13.7 $ 11.9 $ 17.9
- ----------------------
Insurance ceded 290.1 100.3 302.8
- ----------------------
</TABLE>
The balance sheets include reinsurance balances with affiliated companies as
follows:
<TABLE>
<CAPTION>
DECEMBER 31
1998 1997
--------------------
(IN MILLIONS)
--------------------
<S> <C> <C>
Future policy benefits
and claims assumed $ 197.3 $ 245.5
- ------------------------
Future policy benefits
and claims ceded 1,125.0 997.2
- ------------------------
Amounts recoverable on
paid and unpaid losses 84.2 30.4
- ------------------------
Reinsurance payable on
paid losses 6.0 5.3
- ------------------------
Funds held under
reinsurance treaties --
net liability 1,375.4 1,115.4
- ------------------------
</TABLE>
Substantially all reinsurance ceded to affiliated companies is with
unauthorized companies. To take a reserve credit for such reinsurance, the
Company holds assets from the reinsurer, including funds held under
reinsurance treaties, and is the beneficiary on letters of credit
aggregating $318,300,000 and $280,900,000 at December 31, 1998 and 1997,
respectively. The letters of credit are issued by banks and represent
guarantees of performance under the reinsurance agreement. At December 31,
1998 and 1997, LNC had guaranteed $237,000,000 and $229,100,000,
respectively, of these letters of credit. At December 31, 1998, the Company
has a receivable (included in the foregoing amounts) from affiliated
insurance companies in the amount of $122,400,000 for statutory surplus
relief received under financial reinsurance ceded agreements.
14. SEPARATE ACCOUNTS
Separate account assets held by the Company consist primarily of long-term
bonds, common stocks, short-term investments and mutual funds and are
carried at market value. Substantially all of the separate accounts do not
have any minimum guarantees and the investment risks associated with market
value changes are borne entirely by the policyholder.
Separate account premiums, deposits and other considerations amounted to
$3,953,300,000, $4,821,800,000 and $4,148,700,000 in 1998, 1997
S-31
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
14. SEPARATE ACCOUNTS (CONTINUED)
and 1996, respectively. Reserves for separate accounts with assets at fair
value were $36,145,900,000 and $30,560,700,000 at
December 31, 1998 and 1997, respectively. All reserves are subject to
discretionary withdrawal at market value.
A reconciliation of transfers to (from) separate accounts is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31
1998 1997
------------------------
(IN MILLIONS)
------------------------
<S> <C> <C>
Transfers as reported in the Summary of Operations of the
various separate accounts:
Transfers to separate accounts $ 3,954.9 $ 4,824.0
- ------------------------------------------------------------
Transfers from separate accounts (4,069.8) (2,943.8)
- ------------------------------------------------------------ --------- ---------
Net transfers to (from) separate accounts as reported in the
Summary of Operations $ (114.9) $ 1,880.2
- ------------------------------------------------------------ --------- ---------
--------- ---------
</TABLE>
15. RECONCILIATION OF ANNUAL STATEMENT TO AUDITED FINANCIAL STATEMENTS
In 1997, certain errors were identified by the Illinois
Insurance Department in the calculation of the AVR as of
December 31, 1996 and 1995. The effects of the AVR errors
also resulted in the need for revisions in the calculation
of certain investment limitation thresholds, the results of
which indicated that additional assets should have been
nonadmitted as of December 31, 1996. As discussed by the
Company with the Indiana and Illinois Insurance Departments,
corrections were made to affected pages of the Company's
NAIC Annual Statement which were refiled with various state
insurance departments. However, due to immateriality of the
corrections in relation to the financial statements taken as
a whole, the audited 1996 and 1995 statutory-basis financial
statements were not corrected and re-issued.
The Company's 1997 NAIC Annual Statement, as filed with
various state insurance departments, also includes the
corrected balances for 1996 and 1995. The following is a
reconciliation of total admitted assets, total liabilities
and capital and surplus as of December 31, 1996 as presented
in the 1997 NAIC Annual Statement (as corrected) to the
accompanying audited financial statements.
<TABLE>
<CAPTION>
TOTAL CAPITAL
ADMITTED TOTAL AND
ASSETS LIABILITIES SURPLUS
---------------------------------
<S> <C> <C> <C>
Balance as of December 31, 1996 as
reported in the accompanying audited
financial statements $50,016.6 $ 48,054.0 $1,962.6
- ----------------------------------------
Effect of AVR errors -- 37.6 (37.6)
- ----------------------------------------
Effect of change in investment
limitations (57.0) -- (57.0)
- ---------------------------------------- --------- ----------- --------
Balance as of December 31, 1996 as
reported in the 1997 NAIC Annual
Statement $49,959.6 $ 48,091.6 $1,868.0
- ---------------------------------------- --------- ----------- --------
--------- ----------- --------
</TABLE>
S-32
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
16. CENTURY COMPLIANCE (UNAUDITED)
The Year 2000 issue is pervasive and complex and affects virtually every
aspect of the Company's business. The Company's computer systems and
interfaces with the computer systems of vendors, suppliers, customers and
business partners are particularly vulnerable. The Company has been
redirecting a large portion of internal Information Technology efforts and
contracting with outside consultants to update systems to address Year 2000
issues. Experts have been engaged to assist in developing work plans and
cost estimates and to complete remediation activities.
For the year ended December 31, 1998, the Company identified expenditures of
$26,300,000 to address this issue. This brings the expenditures for 1996
through 1998 to $34,200,000 million. The Company's financial plans for 1999
and 2000 include expected expenditures of an additional $38,300,000 bringing
estimated overall Year 2000 expenditures to $72,500,000. Because updating
systems and procedures is an integral part of the Company's on-going
operations, approximately 50% of expenditures shown above are expected to
continue after all Year 2000 issues have been resolved. Actual Year 2000
expenditures through December 31, 1998 and future Year 2000 expenditures are
expected to be funded from operating cash flows. The anticipated cost of
addressing Year 2000 issues is based on management's current best estimates
which were derived utilizing numerous assumptions of future events,
including the continued availability of certain resources, third party
modification plans and other factors. Such costs will be closely monitored
by management. Nevertheless, there can be no guarantee that actual costs
will not be higher than these estimated costs. Specific factors that might
cause such differences include, but are not limited to, the availability and
cost of personnel trained in this area, the ability to locate and correct
all relevant computer problems and other uncertainties. The total
expenditures identified represent only the Company's portion of LNC's larger
expenditures to address the Year 2000 issue.
The current scope of the overall Year 2000 program includes the following
four major project areas: 1) addressing the readiness of business
applications, operating systems and hardware on mainframe, personal computer
and Local Area Network platforms (IT); 2) addressing the readiness of non-IT
embedded software and equipment (non-IT); 3) addressing the readiness of key
business partners and 4) establishing Year 2000 contingency plans.
The projects to address IT and non-IT readiness have four major phases.
Phase one involves raising awareness and creating an inventory of all IT and
non-IT assets. The second phase consists of assessing all items inventoried
to initially determine whether they are affected by the Year 2000 issue and
preparing general plans and strategies. The third phase entails the detailed
planning and remediation of affected systems and equipment. The last phase
consists of testing to verify Year 2000 readiness.
The Company has completed those four phases for over two-thirds of its high
priority IT systems, including those provided by software vendors. While the
Company's year 2000 program for nearly all high priority IT systems is
expected to be completed in the first quarter 1999, phase four, for a small
but important subset of these systems, will continue through the end of the
second quarter 1999. As of December 31, 1998, the status of projects
addressing readiness of IT assets is: 100% of IT assets have been
inventoried (Phase 1) and assessed (Phase 2); 94% of IT projects have been
through the remediation phase (Phase 3) with the last project scheduled for
completion by the end of March 1999; and 69% of IT projects have completed
the testing phase (Phase 4) with the last project scheduled to finish
testing by the end of June 1999. A portion of the effort that extends into
1999 is dependent on outside third parties and is behind the original
schedule. The Company is working with these parties to modify the completion
schedule.
As of December 31, 1998, the status of projects that address readiness of
high priority non-IT assets is: 100% of non-IT assets have been inventoried
(Phase 1) and assessed (Phase 2); 79% of non-IT projects addressing
remediation (Phase 3) have been completed and 21% of non-IT projects have
completed the testing phase (Phase 4). The Company expects to have all
phases related to high priority non-IT completed by the end of October 1999.
S-33
<PAGE>
THE LINCOLN NATIONAL LIFE INSURANCE COMPANY
NOTES TO STATUTORY-BASIS FINANCIAL STATEMENTS (CONTINUED)
16. CENTURY COMPLIANCE (UNAUDITED) (CONTINUED)
Concurrent with the IT and non-IT projects, the readiness of key business
partners is being reviewed and Year 2000 contingency plans are being
developed. The most significant categories of key business partners are
financial institutions, software vendors and utility providers (gas,
electric and telecommunications). Surveys have been mailed to these key
business partners. Based on responses received, current levels of readiness
are being assessed, follow-up contacts are underway, alternative strategies
are being developed and testing is being scheduled where feasible. This
effort is expected to continue well into 1999. As noted above, software
vendor assessments are considered part of the IT projects and, therefore,
would follow the schedule shown above for such projects.
While the Company is working to meet the schedules outlined above, some
uncertainty remains. Specific factors that give rise to this uncertainty
include a possible loss of technical resources to perform the work, failure
to identify all susceptible systems, non-compliance by third parties whose
systems and operations impact the Company and other similar uncertainties.
A worst case scenario might include the Company's inability to achieve Year
2000 readiness with respect to one or more of the Company's significant
policyholder systems resulting in a material disruption to the Company's
operations. Specifically, the Company could experience an interruption in
its ability to collect and process premiums or deposits, process claim
payments, accurately maintain policyholder information, accurately maintain
accounting records and/or perform adequate customer service. Should the
worst case scenario occur, it could, depending on its duration, have a
material impact on the Company's results of operations and financial
position. Simple failures can be repaired and returned to production within
a matter of hours with no material impact. Unanticipated failures with a
longer service disruption period would have a more serious impact. For this
reason, the Company is placing significant emphasis on risk management and
Year 2000 contingency planning. The Company is in the process of modifying
its contingency plans to address potential Year 2000 issues. Where these
efforts identify high risks due either to unacceptable work around
procedures or significant readiness risks, appropriate risk management
techniques are being developed. These techniques, such as resource shifting
or use of alternate providers, will be employed to provide stronger
assurances of readiness. The Company has gone through exercises to identify
worst case scenario failures. At this time, the Company believes its plans
are sufficient to mitigate identified worst case scenarios.
S-34
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors
The Lincoln National Life Insurance Company
We have audited the accompanying statutory-basis balance sheets
of The Lincoln National Life Insurance Company (a wholly owned
subsidiary of Lincoln National Corporation) as of December 31,
1998 and 1997, and the related statutory-basis statements of
operations, changes in capital and surplus and cash flows for
each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of the
Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted
auditing standards. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating
the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
As described in Note 1 to the financial statements, the Company
presents its financial statements in conformity with accounting
practices prescribed or permitted by the Indiana Department of
Insurance, which practices differ from generally accepted
accounting principles. The variances between such practices and
generally accepted accounting principles and the effects on the
accompanying financial statements are also described in Note 1.
In our opinion, because of the effects of the matter described
in the preceding paragraph, the financial statements referred to
above do not present fairly, in conformity with generally
accepted accounting principles, the financial position of The
Lincoln National Life Insurance Company at December 31, 1998 and
1997, or the results of its operations or its cash flows for
each of the three years in the period ended December 31, 1998.
However, in our opinion, the financial statements referred to
above present fairly, in all material respects, the financial
position of The Lincoln National Life Insurance Company at
December 31, 1998 and 1997, and the results of its operations
and its cash flows for each of the three years in the period
ended December 31, 1998, in conformity with accounting practices
prescribed or permitted by the Indiana Department of Insurance.
/s/ Ernst & Young LLP
February 1, 1999
S-35
