Annual Report


*	Issued by Lincoln National Capital III, Lincoln National Capital IV and Lincoln National Capital V, respectively. Payments of distributions and payments on liquidation or redemption are guaranteed by Lincoln National Corporation.

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes þ No o

As of February 28, 2003, 177,362,916 shares of common stock were outstanding. The aggregate market value of such shares (based upon the closing price of these shares on the New York Stock Exchange) held by non-affiliates was approximately $5,024,691,000.

Select materials from the Proxy Statement for the Annual Meeting of Shareholders, scheduled for May 8, 2003 have been incorporated by reference into Part III of this Form 10-K.

Lincoln National Corporation (“LNC”) is a holding company. Through subsidiary companies, LNC operates multiple insurance and investment management businesses. The collective group of companies uses “Lincoln Financial Group” as its marketing identity. Based on assets, LNC is the 39th largest U.S. Corporation (2002 Fortune 500, Largest U.S. Corporations, April 2002). Based on revenues, LNC is the 8th largest U.S. stockholder-owned company within the Fortune 500 Life/ Health Insurance Industry Ranking (2002 Fortune 500 by Industry Rankings, April 2002). Operations are divided into four business segments: 1) Lincoln Retirement (formerly known as the Annuities segment), 2) Life Insurance, 3) Investment Management and 4) Lincoln UK. Over the past five years, segments have been redefined as follows. During the first quarter of 2000, changes to the structure of LNC’s internal organization resulted in the creation of a separate Annuities segment (now known as the Lincoln Retirement segment) and a separate Life Insurance segment. At the end of 2000, LNC established a new wholesaling distribution organization, Lincoln Financial Distributors (“LFD”), to focus on the changing business needs of financial intermediaries. Beginning with the first quarter of 2001, LFD’s results were reported within Other Operations. Previously, LNC’s wholesaling efforts were conducted separately within the Lincoln Retirement, Life Insurance and Investment Management segments. Prior to the fourth quarter of 2001, LNC had a Reinsurance segment. LNC’s reinsurance operations were acquired by Swiss Re on December 7, 2001 and the related segment information prior to the close of this transaction was moved to Other Operations.

Revenues, pre-tax income and assets for LNC’s major business segments and other operations are shown in this Form 10-K report as part of the consolidated financial statements (see Note 9 to the consolidated financial statements). The LNC “Other Operations” category includes the financial data for operations that are not directly related to the business segments, unallocated corporate items (such as, corporate investment income and interest expense on short-term and long-term borrowings), the operations of Lincoln Financial Advisors (“LFA”) and LFD, and the historical results of the former Reinsurance segment along with the ongoing amortization of deferred gain on the indemnity reinsurance portion of the transaction with Swiss Re (for further discussion of the transaction with Swiss Re, refer to Acquisitions, Divestitures and Discontinued Lines of Business below).

Although one of the subsidiaries held by LNC was formed in 1905, LNC itself was formed in 1968. LNC is an Indiana corporation that maintains its principal offices at 1500 Market Street, Suite 3900, Philadelphia, Pennsylvania 19102-2112. As of December 31, 2002, there were 60 persons engaged in the governance of the LNC holding company. Total employment of Lincoln National Corporation at December 31, 2002 on a consolidated basis was 5,830. Of this total, approximately 2,140 employees are included in “Other Operations” related primarily to the operations of LFA and LFD.

The primary operating subsidiaries that comprise LNC are Lincoln National Life Insurance Company (“LNL”); First Penn-Pacific Life Insurance Company (“First Penn”); Lincoln Life & Annuity Company of New York (“Lincoln Life New York”), Delaware Management Holdings, Inc. (“Delaware”), Lincoln National (UK) plc, LFA and LFD.

LNL is an Indiana corporation with its annuities operations headquartered in Fort Wayne, Indiana and its life insurance operations headquartered in Hartford, Connecticut. The primary operations of LNL are reported in the Lincoln Retirement and Life Insurance segments. LNL also has operations that are reported in the Investment Management segment and the results of LNL’s reinsurance operations acquired by Swiss Re via an indemnity reinsurance transaction are reported in Other Operations.

First Penn is an Indiana corporation headquartered in Schaumburg, Illinois. First Penn offers universal life, term life and deferred fixed annuity products for distribution in most states of the United States. Through the end of 2000, all of the operations of First Penn were reported in the Life Insurance segment. Beginning in

Lincoln Life New York is a New York company headquartered in Syracuse, New York. Lincoln Life New York offers fixed annuities, variable annuities, universal life, variable universal life, term life and other individual life insurance products within the state of New York utilizing the distribution networks described below under Distribution. The operations of Lincoln Life New York are primarily reported in the Lincoln Retirement and Life Insurance segments.

Over the last several years, LNC has undertaken a variety of acquisitions and divestitures, and has exited certain businesses. These actions have been conducted with the goal of strengthening shareholder value by providing more consistent sources of earnings and by focusing on financial products that have the potential for significantly growing earnings. To this end, the following transactions have occurred during the three years covered by this Form 10-K:

On August 30, 2002, LNC acquired The Administrative Management Group, Inc. (“AMG”), an employee benefits record keeping firm for $21.6 million in cash. Contingent payments up to an additional $14 million will be paid over a period of 4 years (2003-2006) if certain criteria are met. Any such contingent payments will be expensed as incurred. AMG, a strategic partner of LNC’s Retirement segment for several years, provides record keeping services for the Lincoln Alliance Program along with approximately 400 other clients nationwide. As of December 31, 2002, the application of purchase accounting to this acquisition resulted in goodwill of $20.2 million.

On December 7, 2001, Swiss Re acquired LNC’s reinsurance operation for $2.0 billion. In addition, LNC retained the capital supporting the reinsurance operation. After giving effect to the increased levels of capital needed within the Life Insurance and Lincoln Retirement segments that result from the change in the ongoing mix of business under LNC’s internal capital allocation models, the disposition of LNC’s reinsurance operation freed-up approximately $100 million of retained capital.

The transaction structure involved a series of indemnity reinsurance transactions combined with the sale of certain stock companies that comprised LNC’s reinsurance operation. At the time of closing, an immediate gain of $15.0 million after-tax was recognized on the sale of the stock companies. A gain of $723.1 million after-tax ($1.1 billion pre-tax) relating to the indemnity reinsurance agreements was reported at the time of closing. This gain was recorded as a deferred gain on LNC’s consolidated balance sheet, in accordance with the requirements of FAS 113, and is being amortized into earnings at the rate that earnings on the reinsured business are expected to emerge, over a period of 15 years.

On October 29, 2002 LNC and Swiss Re settled disputed matters totaling about $770 million that had arisen in connection with the final closing balance sheets associated with Swiss Re’s acquisition of LNC’s reinsurance operations. The settlement provided for a payment by LNC of $195 million to Swiss Re, which was recorded by LNC as a reduction in deferred gain. As a result of additional information made available to LNC following the settlement with Swiss Re in the fourth quarter of 2002, LNC recorded a further reduction in the deferred gain of $51.6 million after-tax ($79.4 million pre-tax), as well as a $9.4 million after-tax ($8.3 million pre-tax) reduction in the gain on the sale of subsidiaries.

As part of the dispute settlement, LNC also paid $100 million to Swiss Re in satisfaction of LNC’s $100 million indemnification obligation with respect to personal accident business. As a result of this payment, LNC has no further underwriting risk with respect to the reinsurance business sold. However, because LNC has not been relieved of it legal liabilities to the underlying ceding companies with respect to the portion of the business indemnity reinsured by Swiss Re, under FAS 113 the reserves for the underlying reinsurance contracts as well as a corresponding reinsurance recoverable from Swiss Re will continue to be carried on LNC’s balance sheet during the run-off period of the underlying reinsurance business. This is particularly relevant in the case of the exited personal accident and disability income reinsurance lines of business where the underlying reserves are based upon various estimates that are subject to considerable uncertainty.

Also during 2002, LNC exercised a contractual right to “put” its interest in a subsidiary company containing LNC’s disability income reinsurance business to Swiss Re for $10 million. The $10 million sale price was approximately equal to LNC’s book basis in the subsidiary.

During 2000, LNC transferred Lincoln UK’s sales force to Inter-Alliance Group PLC. Concurrent with the announcement of this transfer, LNC also ceased writing new business in the United Kingdom (“UK”) through direct distribution. These actions followed a strategic review of the Lincoln UK segment in late 1999, where LNC concluded that trends in the UK insurance market including the unfavorable regulatory environment raised significant concerns regarding the ongoing fit of the Lincoln UK segment within LNC’s overall strategic plans. While these actions have changed the focus of Lincoln UK’s business to maintaining the in-force policies, it is not closed to new business and continues to sell some new products.

LNC has an extensive distribution network for the sale of fixed annuities, variable annuities, universal life insurance, variable universal life insurance, term life insurance, other individual insurance coverages, retail mutual funds, “529” college savings plans, 401(k) products and managed account products. LNC’s distribution strategy reflects a marketplace where consumers increasingly want to do business on their own terms. LNC’s network consists of internally owned wholesaling and retailing business units: LFD and LFA, respectively, as well as distribution for annuities through a third party alliance with American Funds Distributors (“AFD”). In 2003, LNC and AFD agreed to transition the wholesaling of the American Legacy Variable Annuity product line to LFD. For further discussion, see the Lincoln Retirement Distribution section. LFD, headquartered in Philadelphia, Pennsylvania, consists of approximately 250 internal and external wholesalers organized to penetrate multiple channels including the Wirehouse/ Regional channel, the Independent Financial Planner channel, the Marketing General Agent channel and the Financial Institutions channel. Through its relationships with a large number of financial intermediaries, LFD has access to approximately 200,000 financial consultants, intermediaries and advisors.

LFA is a retail broker/dealer and financial planning firm that offers a full range of financial and estate planning services. LFA and its consolidated affiliate, Sagemark, offer access to annuities, 401(k) plans, pensions, universal and variable universal life insurance and other wealth accumulation and protection products and services, and is a preferred distributor of LNC retail products. LFA and Sagemark are headquartered in Hartford, Connecticut and consist of nearly 2,100 planners in 39 offices across the United States.

Institutional investment products managed in the Investment Management segment including large case 401(k) plans which are marketed by a separate sales force in conjunction with pension consultants. These products are offered primarily to defined benefit and defined contribution plan sponsors, endowments, foundations and insurance companies.

During 2002, Lincoln Financial Group (“LFG”), the marketing name for LNC and its affiliates, continued building its brand on a national basis through an integrated package of national magazine, television and Internet advertising, sponsorships of major sporting events, educational partnerships, public relations and promotional events. In 2002, much of the advertising effort was focused on an advertising plan designed to secure brand awareness and familiarity with financial intermediaries, the No. 1 target audience. Since introducing trade advertising with the LFD’s “Hero” campaign in March 2001, LFG’s aided awareness has grown to 91% among intermediaries. Familiarity also is climbing and reached a high of 72% in 2002.

A new consumer advertising campaign was launched in July 2002 depicting Abraham Lincoln guiding customers through dangerous waters and on challenging putting greens. These ads continue the brand promise of providing Clear solutions in a complex world™. This new campaign was tested in independent research and was viewed as significantly more likeable and unique than a base of 818 financial competitor ads.

In June 2002, Lincoln Financial Group announced a major new partnership with the Philadelphia Eagles football team to name its new state-of-the-art stadium Lincoln Financial Field. The new facility is nearing completion and is scheduled to open its gates to the public in August 2003. Based on evidence from other

The Lincoln Retirement segment (formerly the Annuities segment), headquartered in Fort Wayne, Indiana, with additional operations in Portland, Maine and the Chicago, Illinois metro area, provides tax-deferred investment growth and lifetime income opportunities for its clients through the manufacture and sale of fixed and variable annuities. There are two lines of business within this segment, individual annuities and employer-sponsored markets. Both lines of business offer fixed annuity and variable annuity products.

The individual annuities line of business markets non-qualified and qualified fixed and variable annuities to individuals. Annuities are attractive, because they provide tax-deferred growth in the underlying principal, thereby deferring the tax consequences of the growth in value until withdrawals are made from the accumulation values, often at lower tax rates occurring during retirement. In addition to favorable tax treatment, annuities are unique in that retirees can select a variety of payout alternatives to help provide an income flow during life. The individual annuities market is a growth market that has seen an increase in competition along with new product types and promotion.

The employer-sponsored retirement line of business markets fixed and variable annuities along with a turnkey retirement program (investments, record-keeping, employee education and compliance) to targeted markets. The key segments of the employer-sponsored retirement markets are: healthcare, public/governmental, education, corporate and not-for-profit. Within these segments, LNC targets those markets that offer the most favorable demographics, distribution synergies and current and potential market share.

In general, an annuity is a contract between an insurance company and an individual or group in which the insurance company, after receipt of one or more contributions, agrees to pay an amount of money either in one lump sum or on a periodic basis (i.e., annually, semi-annually, quarterly or monthly), beginning on a certain date and continuing for a period of time as specified in the contract. Such payments can begin the month after the deposit is received (referred to as an immediate annuity) or at a future date in time (referred to as a deferred annuity). This retirement vehicle helps protect an individual from outliving his money and can be either a fixed annuity or a variable annuity.

Fixed Annuity: A fixed deferred annuity preserves the principal value of the contract while guaranteeing a minimum interest rate to be credited to the accumulation value. LNC offers both single and flexible premium fixed deferred annuities to the individual annuities market. Single premium fixed deferred annuities are contracts that allow only a single contribution to be made. Flexible premium fixed deferred annuities are contracts that allow multiple contributions on either a scheduled or non-scheduled basis. With fixed deferred annuities, the contractholder has the right to surrender the contract and receive the current accumulation value less any applicable surrender charge and, if applicable, market value adjustment. Also, certain fixed annuity products, such as the popular Step Five Fixed Annuity, allow for a window period between the end of the fixed guarantee period and the start of the subsequent guarantee period during which the account holder can withdraw their funds without incurring a surrender charge. Fixed annuity contributions are invested in LNC’s general account. LNC bears the investment risk for fixed annuity contracts. To protect itself from premature withdrawals, LNC imposes surrender charges. Surrender charges are typically applicable during the early years of the annuity contract, with a declining level of surrender charges over time. LNC expects to earn a spread between what it earns on the underlying general account investments supporting the fixed annuity product line and what it credits to its fixed annuity contractholders’ accounts.

Throughout 2001 and 2002, even with the historically low interest rate environment, fixed annuities have taken on increased importance due to the sustained volatility of the equity markets that began in the second quarter of 2000. LNC primarily distributes fixed annuities through the Financial Institutions channel and to a lesser extent in the Independent Financial Planner and Wirehouse/ Regional channels. LNC’s fixed annuity sales in 2001 through 2002 were bolstered by product offerings that were introduced in 2001 including the Lincoln Select and ChoicePlus Fixed Annuities and the StepFive® Fixed Annuity.

The guarantees of the StepFive Fixed Annuity have been especially well-received in the Financial Institutions channel. New product offerings launched in 2002 in the Financial Institutions channel included the AccelaRate and ChoiceGuarantee® Fixed Annuities. The market value adjusted (“MVA”) feature of the Lincoln Select and ChoicePlus Fixed Annuities is expected to be more attractive in the Wirehouse/ Regional channel during a volatile interest rate environment. This feature increases or decreases the cash surrender value of the annuity based on a decrease or increase in interest rates. Contractholders participate in gains when the contract is surrendered in a falling interest rate market, and LNC is protected from losses up to a cap when the contract is surrendered in a rising interest rate market. A new version of Lincoln Select that provides the individual with a higher interest rate but a larger potential penalty for early withdrawal or surrender is being considered.

Variable Annuity: A variable annuity provides the contractholder the ability to direct the investment of deposits into one or more sub-accounts offered by the product. The value of the contractholder’s account varies with the performance of the underlying sub-accounts chosen by the contractholder. The underlying assets of the sub-accounts are managed within a special insurance series of mutual funds. Because the contractholder’s return is tied to the performance of the segregated assets underlying the variable annuity, the contractholder bears the investment risk associated with these investments. LNC charges the contractholder insurance and administrative fees based upon the value of the variable contract.

The separate account choices for LNC’s variable annuities cover diverse asset classes with varying levels of risk and include both equity funds and fixed income funds. The Individual and Group Multi-Fund® Variable Annuity product line offers 36 fund choices from 13 well known advisors: AIM®, Alliance Capital®, American Fund Insurance Series^sm, Baron Capital Funds, Delaware Investments^sm, Deutsche Asset Management, Fidelity Investments®, Janus, MFS Investment Management®, Neuberger Berman Management Inc., Putnam Investments, Inc., Scudder Investments and Wells Fargo. LNC’s Lincoln Choice Plus^sm Variable Annuity, an individual multi-manager product line, has 44 fund offerings from AIM®, Alliance Capital®, American Funds Insurance Series^sm, Delaware Investments^sm, Fidelity Investments®, Franklin®, Janus, MFS Investment Management®, Neuberger Berman Management, Inc., Putnam Investments, Inc., and Scudder Investments. LNC’s American Legacy Variable Annuity, a premier single manager individual and group variable annuity product line, offers 13 mutual fund choices from American Funds Insurance Series^sm. American Funds is the 3rd largest mutual fund company for 2002 based on assets under management. LNC’s Alliance Program, which is for the employer-sponsored market, has over 2000 mutual fund choices plus a fixed account. This product is customized for each employer.

Most of LNC’s variable annuity products also offer the choice of a fixed option that provides for guaranteed interest credited to the account value. In addition, many of LNC’s individual variable annuities feature minimum guaranteed death benefits. These minimum guaranteed death benefits include either guaranteed return of premium, the highest account value attained on any policy anniversary through attained age 80 (i.e., high water mark), or a 5% annual step up (i.e., roll-up) of the account value depending on the specific terms of the contract.

LNC earns mortality assessments and expense assessments on variable annuity accounts to cover insurance and administrative charges. These expenses are built into accumulation unit values, which when multiplied by the number of units owned for any sub-account equals the contractholder’s account value for that sub-account. Some products feature decreasing fee schedules based on account value break points. The fees that LNC earns from these policies are classified as insurance fees on the income statement. In addition, for some contracts, LNC collects surrender charges when contractholders surrender their contracts during the early years of a contract. For other contracts, LNC collects surrender charges when contractholders surrender

their contracts during a number of years subsequent to each deposit. LNC’s individual variable annuity products have a maximum surrender period of ten years. The assets that support variable annuities are included in the assets held in separate accounts balance and the related liabilities for the current account values are included in the liabilities related to separate accounts balance.

In 2002, LNC continued to grow variable annuity incremental deposits (i.e., gross deposits reduced by transfers from other Lincoln Retirement products). These sales were the result of the product momentum which started in the year 2000 when LNC introduced more new variable annuity products than it did in the preceding five years and continued through 2002. In 2002, a new low cost variable annuity product, Multi-Fund 5 was launched. In addition, the ChoicePlus and American Legacy product offerings in New York were expanded to include bonus, L-share and A-share (American Legacy only) contracts. LNC now offers through most of its variable annuity product lines, A-share, B-share, C-share, L-share and bonus variable annuities. The differences in A, B, C and L-shares relate to the sales charge and fee structure associated with the contract. An A-share has a front-end sales charge. A B-share has a contingent deferred sales charge that is only paid if the account is surrendered or withdrawals are in excess of contractual free withdrawals within the contract’s specified surrender charge period. A C-share has no front-end sales charge or back-end surrender charge. Like a B-share, an L-share has a contingent deferred sales charge that is only paid if the account is surrendered or withdrawals are in excess of contractual free withdrawals within the contract’s specified surrender charge period. The differences between the L-share and B-share are the length of the surrender charge period and the fee structure. L-shares have a shorter surrender charge period, so for the added liquidity, mortality and expense assessments are higher.

A bonus annuity is a variable annuity contract, which offers a bonus credit to a contract based on a specified percentage (typically ranging from 2% to 5%) of each deposit. Bonus products, in general have come under increased scrutiny due to concerns with whether they have been properly designed and sold with the contractholders’ interests in mind. The concern is that the higher expenses and extended surrender charge periods that are often associated with bonus annuities may not be adequately understood by contractholders. In developing bonus annuity products for its Lincoln ChoicePlus and American Legacy variable annuities, LNC has attempted to address these concerns, while at the same time designing products that are competitive in the marketplace. A key competitive feature of LNC’s bonus annuity that is attractive to long-term contractholders is the persistency credit. This feature rewards a contractholder with a bonus credit of 20 basis points per annum after maintaining an account for 14 years. In addition, a 30 basis point per annum persistency credit is offered on LNC’s L-share products after a contractholder maintains an account for eight years.

LNC offers other innovative product features including the Income4Life® Solution, Income4Life Advantage and when sold in conjunction with Income4Life, the Accumulated Benefit Enhancement (“ABE”) rider. The Income4Life Solution and Income4Life Advantage features allow variable annuity contractholders access and control during the income distribution phase of their contract. This added flexibility allows the contractholder to access the account value for transfers, additional withdrawals and other service features like portfolio rebalancing. The ABE rider which was first introduced in 2002 lets clients transfer their balances to LNC variable annuity products and retain the death benefit of their prior variable annuity. Unlike bonus products, which require longer surrender penalties and increased mortality and expense assessments, this rider is available only in conjunction with Income4Life on all share classes of most LNC variable annuity product lines with no additional charge.

According to Variable Annuity Research and Data Services (“VARDS”), LNC’s American Legacy III Variable Annuity ranked number 3 out of 122 variable annuities for asset-weighted performance for the five-year period ended December 31, 2002. The American Legacy I Variable Annuity ranked number 1 on this basis. Challenging equity markets like those experienced in 2001 and 2002 may prompt contactholders of competitors’ variable annuities to consider better-performing LNC variable annuities.

Looking forward, so-called living benefits that provide equity market performance guarantees, are becoming more prevalent in the industry. LNC is looking at various product approaches and designs in this

Fixed annuity products as well as most individual variable annuity product lines are distributed by LFD. Recently, LNC and American Funds Distributors (“AFD”) have agreed to transition the wholesaling of the American Legacy Variable Annuity product line to LFD. Currently, AFD uses wholesalers who focus on both American Funds mutual funds, as well as the American Legacy Variable Annuity products. Segment management believes that the change to a dedicated team focused on key broker/dealer relationships developed in conjunction with AFD, should lead to renewed growth in American Legacy Variable Annuity sales. Lincoln Financial Advisors (“LFA”), LNC’s retail broker/dealer and financial planning firm, as a client of AFD and LFD, sells the American Legacy Variable Annuity and the ChoicePlus Variable Annuity. LFA also sells LNC’s MultiFund Variable Annuity product line in both the individual and employer-sponsored retirement markets and the Alliance Program in the employer-sponsored retirement market. Group fixed and variable annuity products are also distributed through the Lincoln Retirement Fringe Benefit Division’s dedicated sales force to the employer-sponsored retirement market.

Capitalizing on a broad product portfolio and a strong and diverse distribution network, LNC is a leader in both the individual and employer-sponsored annuity markets. According to VARDS, LNC ranks 4th in assets as of December 31, 2002 and 10th in variable annuity sales for the year ended December 31, 2002 in the United States. LNC ranked 10th in fixed annuity sales through financial institutions for 2002 (Kenneth Kehrer Associates Fixed Annuity Sales Through Financial Institutions Rankings for 2002).

LNC was an early entrant into the fixed and variable annuity business and as such has a mature book of business with many contracts that are out of the surrender charge period. As a result, LNC, as well as other seasoned industry participants, have been vulnerable to what are referred to as Section 1035 exchanges, named after the Internal Revenue Code Section that governs these exchanges. In 1035 exchanges, contractholders surrender their annuity and make a non-taxable transfer to another insurance company’s non-qualified annuity. Over the last three years LNC’s lapse rate went from approximately 12% in 2000 to 9.7% in 2001 and back up to 10.5% in 2002, which was better than pricing in all three years. LNC’s strong persistency and new sales growth have contributed to the maintenance of overall positive net flows throughout 2002. LNC first achieved overall positive net flows in the third quarter of 2001 after over three years of net outflows. Over the last few years, a contributing factor to the strong persistency experienced by LNC’s variable annuities has been the weak equity markets. Contractholders whose variable annuity contracts have guaranteed minimum death benefits that are in the money due to equity market declines are less likely to transfer from these contracts. In the future, however, given the ongoing volatility of the equity markets, living benefit guarantees offered by some competitors may provide contractholders with an inducement to do a 1035 exchange.

The Life Insurance segment, headquartered in Hartford, Connecticut, focuses on the creation and protection of wealth for its clients through the manufacture and sale of life insurance products. The Life Insurance segment offers both single and survivorship versions of universal life (“UL”), variable universal life (“VUL”), and interest-sensitive whole life (“ISWL”), as well as corporate owned life insurance (“COLI”) and term insurance. The segment also offers a linked-benefit product which is a universal life insurance policy linked with an accelerated benefits rider that provides a benefit for long-term care needs. This operation targets the affluent market, defined as households with at least $500,000 of investable net worth. Two key measures of the effectiveness of meeting the needs of this market include average face amount of policies sold, which was $1.2 million for the year ended December 31, 2002, and average premiums paid per policy sold, which were approximately $28,000 for the same period.

The Life Insurance segment’s book of business includes interest/market-sensitive products (UL, VUL, ISWL, COLI) and traditional life products (term and guaranteed cost whole life). Profitability is driven by mortality margins (defined below), investment margins (spreads/fees), expenses and surrender fees.

Mortality margins represent the difference between amounts charged the customer to cover the mortality risk and the cost of reinsurance and death benefits paid. Mortality charges are either specifically deducted from the contractholder’s fund (i.e. cost of insurance assessments or “COIs”) or embedded in the premiums charged to the customer. In either case, these amounts are a function of the rates priced into the product and level of insurance in-force (less reserves previously set aside to fund benefits). Insurance in-force, in turn, is driven by sales, persistency and mortality experience.

Similar to the annuity product classifications described above, life products can be classified as “fixed” and “variable” contracts. This classification describes whether the policyholder or LNC bears the investment risk of the assets supporting the policy. This also determines the manner in which LNC earns investment margin profits from these products, either as investment spreads for fixed products or as fees charged for variable products.

Fixed Life Insurance (primarily UL and ISWL): Premiums net of expense loads and charges received on fixed products are invested in LNC’s general account investment portfolio, so LNC bears the risk on investment performance. LNC manages investment margins, (i.e. the difference between the rate the portfolio earns compared to the rate that is credited to the customer) by seeking to maximize current yields, in line with asset/liability and risk management targets, while crediting a competitive rate to the customer. Crediting rates are typically subject to guaranteed minimums specified in the underlying life insurance contract.

Variable Universal Life Insurance (VUL): Premiums net of expense loads and charges received on VUL products are invested in separate accounts which offer several investment options for the customer’s selection. The investment choices are the same, in most cases, as the investment choices offered in LNC’s variable annuity contracts. In addition, VUL products offer a fixed account option which is managed by LNC. Investment risk is borne by the customer on all but the fixed account option. LNC charges fees for mortality costs and administrative expenses, as well as investment management fees.

Corporate Owned Life Insurance (“COLI”): COLI is typically purchased by corporations funding non-qualified benefit plans. These include 401(k) excess — voluntary deferrals of executive salary and/or bonus in excess of 401(k) limits and Supplemental Executive Retirement Plans (SERP’s) in a variety of forms, paid for with corporate funds. LNC offers a portfolio of both fixed UL and variable UL COLI products sold primarily through specialty brokers.

Term Life Insurance: Term life insurance provides a death benefit without a cash accumulation balance. Policy premiums are generally paid annually.

Distribution of the Life Insurance segment’s products occurs primarily through LNC’s internally owned wholesaling arm, LFD, and its retail sales arm, LFA. Both channels have an industry-wide reputation of being highly skilled in the development of financial and estate planning solutions for the affluent market. During August of 2002, the Life Insurance segment entered into a marketing agreement with M Group Financial (“M Group”) to sell LNC’s life insurance products. LNC became one of five core carriers providing life insurance and annuity products to the member firms of M Group. M Group is the largest Independent Producer Group in the nation. It is represented by over 100 firms. M Group firm members provide an opportunity to further broaden the distribution of LNC’s products to the affluent market.

LNC is a leading provider of life insurance products designed specifically for the high net-worth and affluent markets. Product breadth, design innovation, competitiveness and speed to market all contribute to the strength of LNC’s life insurance operations. Averaging close to 10 major product upgrades and/or new features per year since 1998, including 14 significant VUL, UL, Term and COLI product enhancements and new riders in 2002, the Life Insurance segment is successful at meeting changing needs when market trends shift.

LNC’s current market leadership position is a result of the breadth and quality of its product portfolio along with its commitment to exceptional customer service, its extensive distribution network and the growth opportunity offered by its target market, the affluent.

The Investment Management segment, which is headquartered in Philadelphia, Pennsylvania with offices in Fort Wayne, London, and Denver, provides investment products and services to both individual and institutional investors. The primary companies within this business segment include Lincoln National Investments, Inc. (“LNI”), Lincoln National Investment Companies, Inc. (“LNIC”), and Delaware Management Holdings, Inc. (“Delaware”). LNI and LNIC are intermediate level holding companies that own the operating companies within this segment. The Investment Management segment also includes the 401(k) operations of LNL. The operating subsidiaries within Delaware offer a broad line of mutual funds, retirement plan services and other investment products including managed accounts, and “529” college savings plans to retail investors and also offer investment advisory services and products to institutional clients, which primarily include pension funds, foundations, endowment funds and trusts. Delaware currently serves as investment advisor to approximately 275 institutional accounts; acts as investment manager and/or shareholder services agent for approximately 100 open-end funds; and serves as investment manager for 10 closed-end funds. The Investment Management segment also provides investment advisory services for LNC’s corporate portfolios.

The Investment Management segment provides an array of products for a range of investors. Products include domestic and international equity and fixed-income retail mutual funds, separate accounts, institutional mutual funds, managed accounts, “529” college savings plans, and retirement plans and services as well as administration services for these products.

For the individual investor, Delaware offers various products including mutual funds and managed accounts. Delaware also provides investment management and account administration services for variable annuity products. Delaware offers alternative pricing schemes for mutual funds including traditional front-end load funds, back-end load funds, and level-load funds. Variable annuity products provide the contractholder the ability to direct the investment of deposits into one or more funds offered by the product. The Institutional Class shares of the mutual funds are also available to institutional clients and retirement plan participants (such as defined contribution plans). Delaware also provides investment services to high net worth and small institutional investor markets through managed accounts. A managed account is provided to individual investors through relationships with broker-dealer sponsored programs.

Delaware offers various retirement plans and services, including 401(k) plans. A 401(k) plan allows employees to divert a portion of their salary to a company-sponsored tax-sheltered account, thus deferring taxes until retirement. These plans generally offer several investment options such as equity and fixed income products. In 2002, Delaware entered the “529” college savings plan market with the roll out of “529” programs for the state of Hawaii and the Commonwealth of Pennsylvania. The persistence of poor equity markets, combined with a more crowded “529” marketplace, resulted in lower than anticipated sales in 2002.

Delaware provides a broad range of institutional investment advisory services to corporate and public retirement plans, endowments and foundations, nuclear decommissioning trusts, socially responsible investors, sub-advisory clients and Taft-Hartley plans, among others. Most clients utilize individually managed separate accounts, which means clients have the opportunity to customize the management of their portfolio by including or excluding certain types of securities, sectors or segments within a given asset class. Because of their individually managed nature, these separate accounts are best suited for larger investment mandates. Currently, Delaware’s minimum account size is typically $10 million for U.S. investments and $100 million for non-U.S. investments.

The funds included in the Delaware Pooled Trust product offering are no-load mutual funds designed for the institutional investor and high net worth individual. Delaware Pooled Trust is a series of SEC registered mutual funds managed in styles that are similar to institutional separate account offerings and best suited for smaller to medium-sized institutional investment mandates. Delaware’s minimum account size for these vehicles is typically $1 million.

Diversity of investment styles, as well as diversity of clients served are prudent ways to diversify risk in varying market environments. Delaware, historically known primarily for a conservative, “value” equity investment style, has evolved over the last few years into an investment manager with strong and diversified offerings across multiple asset classes including value and growth equity investment styles; high-grade, high-yield and municipal fixed-income investment styles; balanced and quantitative investment styles; and international and global equity and fixed income investment styles. Delaware’s investment performance, which began to improve in 2000 with the implementation of various targeted initiatives, has been strong over the last two years. Positive investment performance has been the key driver of the overall positive net flows that have been achieved throughout 2002. The segment experienced positive net flows of $2.9 billion in 2002, an improvement of $3.5 billion from the prior year. The key contributors to this improvement were higher retail and institutional sales and improved retention of institutional assets, primarily in response to the improved investment performance relative to peers. Overall retail sales increased $2.0 billion and institutional inflows increased $1.4 billion. In addition, retail equity sales increased $1.7 billion in what was a difficult sales environment given the further weakening of the equity markets in 2002. The retail sales growth was primarily attributable to increased sales of managed accounts. A portion of these sales was bolstered by external events affecting key competitors. While the Investment Management segment has made measurable progress on the initiatives of investment performance, sales growth and institutional asset retention, its focus in 2003 is not only to sustain and improve upon those results, but also to improve overall profitability.

The businesses in the Investment Management segment deliver their broad range of products through multiple distribution channels, enabling them to reach an expanding community of retail and institutional investors. Delaware distributes retail mutual funds, managed accounts, “529” college savings plans and retirement products through the LFD distribution network, LFA, and Delaware’s direct retirement sales force. Institutional products are marketed primarily by Delaware’s institutional marketing group working closely with manager selection consultants. These products are also offered primarily to defined benefit and defined contribution plan sponsors, endowments, foundations and insurance companies.

Lincoln UK is headquartered in Barnwood, Gloucester, England, and is licensed to do business throughout the United Kingdom (“UK”). Although Lincoln UK transferred its sales force to Inter-Alliance Group PLC in the third quarter of 2000, it continues to manage, administer and accept new deposits on its

In the third quarter of 2002, Lincoln UK agreed to outsource its customer service and policy administration function to the Capita Group, plc (“Capita”). The agreement involved the transfer of approximately 500 employees to Capita. The number of employees noted below reflects the actual level of staffing for the current business structure.

LNC’s Retirement, Life Insurance and Lincoln UK business segments, in common with those of other insurance companies, are subject to regulation and supervision by the states, territories and countries in which they are licensed to do business. The laws of these jurisdictions generally establish supervisory agencies with broad administrative powers relative to granting and revoking licenses to transact business, regulating trade practices, licensing agents, prescribing and approving policy forms, regulating premium rates for some lines of business, establishing reserve requirements, regulating competitive matters, prescribing the form and content of financial statements and reports, regulating the type and amount of investments permitted and prescribing minimum levels of capital. The ability to continue an insurance business is dependent upon the maintenance of the licenses in the various jurisdictions. In addition, variable annuities and variable life insurance businesses and products are subject to regulation and supervision by the Securities and Exchange Commission (“SEC”) and the National Association of Securities Dealers (“NASD”).

LNC’s Investment Management segment, in common with other investment management groups, is subject to regulation and supervision by the SEC, NASD, Municipal Securities Rulemaking Board (“MSRB”), Financial Services Authority (“FSA”) in London, the Pennsylvania Department of Banking and jurisdictions of the states, territories and foreign countries in which they are licensed to do business.

LFA is subject to regulation and supervision by the SEC and NASD on broker dealer and registered investment advisor issues.

LNC’s insurance subsidiaries protect themselves against losses greater than the amount they are willing to retain on any one risk or event by purchasing reinsurance from unaffiliated insurance companies (see Note 7 to the consolidated financial statements).

All businesses LNC is involved in are highly competitive due to the market structure and the large number of competitors. At the end of 2001, the latest year for which data is available, there were approximately 1,225 life insurance companies in the United States. As noted previously, based on revenues, LNC is the 8th largest U.S. stockholder-owned company within the Fortune 500 Life/ Health Insurance industry ranking (2002 Fortune 500 by Industry Rankings, April 2002). LNC’s investment management companies were the 51st largest U.S. investment management group at the end of 2001 (2001 Institutional Investor 300 Money Managers, July 2002). Also, many of the products offered by LNC’s operating companies are similar to products offered by non-insurance financial services companies, such as banks. The Financial Services Modernization Act was passed in November 1999 and repealed the Glass-Steagall Act of 1933 and expands the Bank Holding Company Act of 1956. This act allows, among other things, cross-ownership by banks, securities firms and insurance companies. In 2002, there were some cross-ownership activities in the financial services industry; however, there was minimal impact on LNC’s operations.

Because of the nature of the insurance and investment management businesses, there is no single customer or group of customers upon whom the business is dependent. Although LNC does not have any significant concentration of customers, LNC’s Retirement segment has a long-standing distribution relation-

ship with American Funds Distributors (“AFD”) that is significant to this segment. In 2002, the American Legacy Variable Annuity product line sold through AFD accounted for about 15% of LNC’s total gross annuity deposits. In addition, the American Legacy Variable Annuity product line represents approximately 31% of LNC’s total gross annuity account values at December 31, 2002. Recently, LNC and AFD have agreed to transition the wholesaling of American Legacy to LFD. Currently, AFD uses wholesalers who focus on both American Funds mutual funds as well as the American Legacy Variable Annuity products. Segment management believes that this change to a dedicated team focused on key broker/dealer relationships developed in conjunction with AFD should renew growth in American Legacy Variable Annuity sales.

LNC does not have a separate unit that conducts market research. Research activities related to new products or services, or the improvement of existing products or services, are conducted within the business segments. Expenses related to such activities are not material. Also, sales are not dependent upon select geographic areas. LNC has foreign operations that are significant in relationship to the consolidated group (see Note 9 to the consolidated financial statements).

LNC files annual, quarterly and current reports, proxy statements and other documents with the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934 (the “Exchange Act”). The public may read and copy any materials that LNC files with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an Internet website that contains reports, proxy and information statements, and other information regarding issuers, including LNC, that file electronically with the SEC. The public can obtain any documents that LNC files with the SEC at http://www.sec.gov.

LNC also makes available free of charge on or through its Internet website (http://www.lfg.com) LNC’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after LNC electronically files such material with, or furnishes it to, the SEC.

LNC and the various operating businesses own or lease approximately 2.9 million square feet of office space. The governance group for LNC and the Investment Management segment lease 0.4 million square feet of office space in Philadelphia, Pennsylvania. The operating units in the Fort Wayne, Indiana area own or lease 1.0 million square feet. Also, businesses operating in the Chicago, Illinois metro area; Hartford, Connecticut and the United Kingdom own or lease another 0.6 million square feet of office space. An additional 0.9 million square feet of office space is owned or leased in other U.S. cities and foreign countries for branch offices and other operations. As shown in the notes to the consolidated financial statements (see Note 7 to the consolidated financial statements), the rental expense on operating leases for office space and equipment totaled $67.0 million for 2002. Office space rent expense accounts for $56.6 million of this total. This discussion regarding properties does not include information on investment properties.

LNC and its subsidiaries are involved in various pending or threatened legal proceedings, including purported class actions, arising from the conduct of business. In some instances, these proceedings include claims for unspecified or substantial 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 these proceedings ultimately will be resolved without materially affecting the consolidated financial position of LNC. (See Note 7 to the consolidated financial statements).

During the fourth quarter of 2002, no matters were submitted to security holders for a vote.

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

The dividend on LNC’s common stock is declared each quarter by LNC’s Board of Directors. In determining dividends, the Board takes into consideration items such as LNC’s financial condition, including current and expected earnings, projected cash flows and anticipated financing needs. The range of market prices and cash dividends declared by calendar quarter for the past two years are as follows:

Note: At December 31, 2002, the number of shareholders of record of LNC’s common stock was 10,381.


(1)	Per share amounts were affected by the retirement of 12,088,100; 11,278,022; 6,222,581; 7,675,000 and 1,246,562 shares of common stock in 2002, 2001, 2000, 1999 and 1998, respectively. In addition, 4,630,318 shares of common stock were issued in 2001 related to the settlement of purchase contracts issued in conjunction with FELINE PRIDES financing.

Item 7. Management’s Discussion and Analysis of Results and Financial Condition

The pages that follow review results of operations of LNC Consolidated, LNC’s four business segments and “Other Operations”; LNC’s consolidated investments; and consolidated financial condition including liquidity, cash flows and capital resources. Historical financial information is presented and analyzed. Where appropriate, factors that may affect future financial performance are identified and discussed. Certain statements made in this report are “forward-looking statements” within the meaning of the Securities Litigation Reform Act of 1995 (the “Act”). Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain words like: “believe”, “anticipate”, “expect”, “estimate”, “project”, “will”, “shall” and other words or phrases with similar meaning.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the results contained in the forward-looking statements. These risks and uncertainties include, among others, subsequent significant changes in: the Company (e.g., acquisitions and divestitures of legal

entities and blocks of business — directly or by means of reinsurance transactions); financial markets (e.g., interest rates and securities markets); competitors and competing products and services; LNC’s ability to operate its businesses in a relatively normal manner; legislation (e.g., corporate, individual, estate and product taxation); the price of LNC’s stock; accounting principles generally accepted in the United States; regulations (e.g., insurance and securities regulations); and debt and claims-paying ratings issued by nationally recognized statistical rating organizations.

Other risks and uncertainties include: the risk that significant accounting, fraud or corporate governance issues may adversely affect the value of certain investments; whether necessary regulatory approvals are obtained (e.g., insurance department, Hart-Scott-Rodino, etc.) and, if obtained, whether they are obtained on a timely basis; whether proceeds from divestitures of legal entities and blocks of business can be used as planned; litigation, arbitration and other actions (e.g., (a) adverse decisions in significant actions including, but not limited to extra contractual and class action damage cases, (b) new decisions which change the law, (c) unexpected trial court rulings, (d) unavailability of witnesses and (e) newly discovered evidence); acts of God (e.g., hurricanes, earthquakes and storms); whether there will be any significant charges or benefits resulting from the contingencies described in the footnotes to LNC’s consolidated financial statements; acts of terrorism or war; the stability of governments in countries in which LNC’s subsidiaries do business; and other insurance risks (e.g., policyholder mortality and morbidity).

The risks included here are not exhaustive. Other sections of this report, and LNC’s quarterly reports on Form 10-Q, current reports on Form 8-K and other documents filed with the Securities and Exchange Commission include additional factors which could impact LNC’s business and financial performance. Moreover, LNC operates in a rapidly changing and competitive environment. New risk factors emerge from time to time and it is not possible for management to predict all such risk factors. Further, it is not possible to assess the impact of all risk factors on LNC’s business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undo reliance on forward-looking statements as a prediction of actual results. In addition, LNC disclaims any obligation to update any forward-looking statements to reflect events or circumstances that occur after the date of this report.

Given the nature of LNC’s business, the Company’s accounting policies require the use of judgments relating to a variety of assumptions and estimates. Because of the inherent uncertainty in the assumptions and estimates underlying these accounting policies, under different conditions or assumptions the amounts reported in LNC’s financial statements could be materially different. Throughout Management’s Discussion and Analysis, the application of these various critical accounting policies is addressed along with the effect of changes in estimates and assumptions.

To provide an overall perspective on these critical accounting policies, and guidance as to the specific areas within Management’s Discussion and Analysis where these critical accounting policies are discussed in detail, a summary of critical accounting policies and the disclosure location is presented below.

Accounting for intangible assets requires numerous assumptions, such as estimates of expected future profitability for various LNC operations and LNC’s ability to retain its existing blocks of life and annuity business in force. LNC’s accounting policies for the intangible assets of deferred acquisition costs (“DAC”) and the present value of acquired blocks of in-force policies (“PVIF”) are discussed within the Lincoln Retirement, Life Insurance and Lincoln UK segments. LNC’s overall accounting policy for other identified intangibles and goodwill is discussed within Results of Consolidated Operations. A key assumption affecting the accounting for DAC and PVIF is the performance of equity markets. Sensitivity to changes in equity market performance upon LNC’s net income is discussed under the heading “First Quarter 2003 Guidance for the Effects of Equity Market Volatility on Fee Income, DAC and GMDB” found within LNC’s discussion of Consolidated Operating results. Additionally, LNC has goodwill resulting from various acquisitions. Refer to the “Accounting for Business Combinations and Goodwill and Other Intangible Assets” section for discussion of the evaluation of goodwill for impairment. Within the Investment Management segment, LNC has an

Determining whether a decline in current fair values for invested assets is other than a temporary decline in value can frequently involve a variety of assumptions and estimates, particularly for investments that are not actively traded on established markets. For instance, assessing the value of some investments requires an analysis of expected future cash flows. Some investment structures, such as collateralized debt obligations, often represent selected levels, or tranches of underlying investments in a wide variety of underlying issuers. LNC’s accounting policies for its invested assets are discussed within Results of Consolidated Operations and Consolidated Investments. Specific discussion of LNC’s accounting policy for write-downs for securities that were determined to have declines in fair value that were other than temporary along with analysis of securities available-for-sale in an unrealized loss position can be found within Consolidated Investments.

To protect itself from a variety of equity market and interest rate risks that are inherent in many of LNC’s life insurance and annuity products, LNC uses various derivative instruments. Assessing the effectiveness of these hedging programs and evaluating the carrying values of the related derivatives often involves a variety of assumptions and estimates. LNC’s accounting policies for derivatives are discussed within Results of Consolidated Operations, Consolidated Investments and within the discussion of Quantitative and Qualitative Disclosures About Market Risk. In addition, discussion of the potential impact on interest rate risk in a falling rate environment is included in the “Interest Rate Risk — Falling Rates” section within LNC’s discussion of Quantitative and Qualitative Disclosures About Market Risk.

Establishing adequate liabilities for LNC’s obligations to its policyholders requires assumptions to be made regarding mortality and morbidity. The effect of variances in these assumptions is discussed within the Lincoln Retirement and Life Insurance segments. In addition, refer to the discussion of personal accident and disability income reserves included within the Acquisition and Divestiture discussion of the disposition of LNC’s former Reinsurance segment within Other Operations. As discussed within the Lincoln Retirement segment, one of the liabilities is the reserve for Guaranteed Minimum Death Benefits (“GMDB”). A key assumption affecting the accounting for GMDB is the performance of equity markets. Sensitivity to changes in equity market performance upon GMDB and LNC’s net income is discussed under the heading “First Quarter 2003 Guidance for the Effects of Equity Market Volatility” found within LNC’s discussion of Quantitative and Qualitative Disclosures About Market Risk.

Pursuant to the accounting rules for LNC’s obligations to employees under its various retirement and welfare benefit plans, LNC is required to make a large number of assumptions, such as the future performance of financial markets and the composition of LNC’s employee workforce in the future. LNC’s accounting for its employee plans is discussed in detail within Note 6 Employee Benefit Plans, which is included in the notes to consolidated financial statements.

Establishing reserves for litigation and compliance-related regulatory actions inherently involve a variety of estimates of potential future outcomes. These matters are discussed within Results of Consolidated Operations and in the Lincoln UK segment, with additional detail provided within Note 7 Restrictions, Commitments and Contingencies, which is included in the notes to consolidated financial statements.

As LNC responds to an ever-changing business environment and continues to adapt its organizational and operational structures, the frequency of necessary restructuring activities increases. Establishing reserves for the expected costs of these restructurings requires a variety of estimates and assumptions. The accounting for LNC’s restructurings is discussed within Results of Consolidated Operations and within Results of Operations for each affected business segment, as well as within Note 12 Restructuring Charges included in the notes to consolidated financial statements.

Continued access to capital markets and maintenance of favorable debt and claims paying ratings are critical to LNC’s future success. LNC’s accounting, in a wide variety of areas, is inherently dependant upon continued access to capital and maintaining adequate ratings. Detailed discussion of LNC’s access to capital markets, liquidity status and ratings are contained within Review of Consolidated Financial Condition.

Finally, it is LNC’s policy to provide disclosure of commitments or guarantees so that its financial statements present as complete a picture of LNC’s financial condition as possible. The vast majority of these commitments or guarantees relate to LNC’s life insurance and retirement businesses and, as such, are reflected on LNC’s balance sheet. Any off-balance sheet commitments or guarantees that LNC is subject to are disclosed within Review of Consolidated Financial Condition and Note 7 Restrictions, Commitments and Contingencies which is included in the notes to consolidated financial statements.

On pages 19 through 56, the results of operations of LNC consolidated, LNC’s four business segments and “Other Operations” are presented and discussed. Pages 56 through 68 discuss LNC’s consolidated investments. Pages 68 through 73 discuss LNC’s consolidated financial condition including liquidity and cash flow, and capital resources. Pages 73 through 81 provide LNC’s quantitative and qualitative disclosures about market risk. Please note that all amounts stated in this “Management’s Discussion and Analysis” are on an after-tax basis except where specifically identified as pre-tax.

This “Management’s Discussion and Analysis” should be read in conjunction with the audited consolidated financial statements and accompanying notes presented on pages 83 through 147.

Net income decreased $498.6 million or 84%. The decrease in net income included an increase in realized losses on investments and derivatives of $102.8 million and expenses totaling $199.1 million recorded in 2002 related to increases in reserves for the business sold through indemnity reinsurance to Swiss Re. The realized losses on investments resulted from declines in value and the sale and write-downs of fixed maturity securities. See the Consolidated Investment section for further discussion of this matter.

A significant contributor to the decrease in net income was the poor performance of the equity markets impact on fee income, DAC and PVIF amortization and GMDB reserves and benefits. The equity market impact is discussed in more detail within the discussion of results of operations by segment.

Consolidated revenue decreased primarily due to the reduction of revenue of $1,699.4 million (pre-tax), excluding realized losses on investments, from the former Reinsurance segment in 2001. Another contributor to the decline in revenue was the increase in realized losses on investments noted above. Included in 2002 revenue was $74.4 million (pre-tax) for the amortization of the deferred gain on indemnity reinsurance compared to $20.4 million in 2001. The Lincoln Retirement and Lincoln UK segments experienced decreased fee income due to the negative impact that 2001 and 2002 equity market declines had on average variable annuity (Retirement) and unit-linked (Lincoln UK) account values. The Investment Management segment had decreased investment advisory fees and other revenue and fees as a result of lower retail and institutional assets under management during 2002. The decrease in assets under management was primarily a result of the declining equity markets.

Consolidated expenses (excluding goodwill amortization, restructuring charges, reserve increases on business sold through reinsurance and federal income taxes) decreased by $1,202.0 million or 22% largely due to the sale of LNC’s reinsurance business to Swiss Re in the fourth quarter of 2001. Expenses for the operations of the former Reinsurance segment, excluding goodwill amortization, were $1,503.7 million in 2001. Expenses were negatively affected by the decline in the equity markets which resulted in negative unlocking of DAC and PVIF in the Lincoln Retirement, Life Insurance and Lincoln UK business segments, and increased reserves and payments for GMDB in the Lincoln Retirement segment.

For 2002, LNC reported a tax benefit of $90.0 million on $1.6 million of pre-tax earnings. This unusual relationship between tax benefit and pre-tax earnings results from the fact that LNC has tax-preferred investment income that does not change proportionately with the change in consolidated pre-tax earnings. LNC’s tax-preferred investment income is primarily the result of dividend received deductions attributable to LNC’s allocable share of dividend income generated by equity securities held within the Lincoln Retirement segments’ separate accounts. See note 4, Federal Income Taxes, to the consolidated financial statements for more details.

Net income for 2001 was $590.2 million compared to $621.4 million for 2000, a $31.2 million or 5% decrease. Restructuring charges, net of the release of liabilities, included in net income in 2001 and 2000 were $24.7 million and $80.2 million, respectively. Contributing to the decrease in 2001 were realized losses on investments and derivative instruments of $73.6 million in 2001 compared to $17.5 million in 2000. These investment losses were due primarily to losses of $41.8 million (pre-tax) taken on Enron and Argentina securities in the fourth quarter of 2001 in addition to increased write-downs of other securities throughout 2001 due to credit deterioration. Partially offsetting the additional losses in 2001 was the gain on sale of certain reinsurance stock companies to Swiss Re of $15.0 million. The remaining $30.1 million decrease in Net Income between years was primarily the result of decreased earnings from the Lincoln Retirement and Investment Management segments, as well as LNC’s distributors, LFA and LFD, which are reported in Other Operations. These negative variances were partially offset by improved earnings from the Life Insurance segment and the former Reinsurance segment, included within Other Operations. In addition, included in net income for 2001 was one month’s amortization of the deferred gain on the business transferred to Swiss Re via indemnity reinsurance. There was also a decrease in the net loss from LNC Financing and Other Corporate within Other Operations.

Total revenue, excluding realized gains and losses on investments and derivative instruments and gain on sale of subsidiaries, decreased by $395.7 million or 6% in 2001 due primarily to lower fee income in the Lincoln Retirement segment and lower investment advisory fees in the Investment Management segment resulting from the depressed equity markets in 2001 and to a lesser extent to net outflows in annuities and investment products. In addition, Lincoln UK had a decrease in operating revenue due to lower business volume along with lower fee income resulting from a downturn in the United Kingdom equity markets over

the last half of 2001. The former Reinsurance segment’s operating revenue was down in 2001 as its results only included eleven months of activity. Finally, LFA and LFD included in Other Operations had lower sales revenue largely attributable to the volatile equity markets. Partially offsetting these negative variances, the Life Insurance segment had increased operating revenue due to growth in life insurance in-force.

Total expenses, exclusive of restructuring charges and Federal income taxes, decreased by $329.9 million or 6% in 2001 due primarily to decreased expenses in the Lincoln UK segment as a result of the decrease in business volume along with effective expense management. The former Reinsurance segment had a decrease due to only eleven months of expenses being reported for its operations. However, included in 2001 expenses for the former Reinsurance segment were losses recorded for the events of September 11. The Lincoln Retirement segment had a decrease in expenses due primarily to less amortization of deferred acquisition costs and other intangible assets partially offset by increased operating and administrative expenses and benefits expenses. The Investment Management segment also experienced decreased expenses due to effective expense management and lower amortization of other intangibles assets. Partially offsetting these positive variances were increases in expenses in the Life Insurance segment, as well as LFD and LFA. Expenses increased in the Life Insurance segment primarily as a result of the growth in in-force, which drove interest credited to policyholders higher. LFD had higher expenses primarily as a result of its investment in new wholesalers during 2001 and LFA experienced an increase in general and administrative expenses partially offset by a decrease in commissions and other volume-related expenses. These expenses fell as a direct result of lower sales volume in 2001. For further discussion of the results of operations, see the discussion of the results of operations by segment.


(1)	For additional detail of deposit and net flow information see the discussion of the Results of Operations by Segment.

(2)	Consolidating adjustments represent the elimination of deposits and net flows on products affecting more than one segment.

First Quarter 2003 Guidance for the Estimated Effect of Equity Market Volatility

In prior periods, Lincoln National Corporation (“LNC”) provided guidance on the estimated effect of equity market volatility on its 2002 results. The following guidance is being provided for purposes of modeling the expected effects of equity market volatility for the first quarter of 2003. As will be explained in greater

detail below, the effects on LNC’s results of significant volatility in equity markets are complex and are not expected to be proportional for market increases and market decreases. The first quarter 2003 information provided below is based upon market conditions and LNC’s mix of business as of the beginning of the year. This guidance can be expected to change as actual circumstances change. Although LNC believes this guidance provides reasonable estimates based upon conditions as of January 1, 2003, LNC claims no responsibility for updating this forward-looking information.

This guidance is intended to provide a general indication of the expected effect of equity market volatility on LNC’s fee income; deferred acquisition costs (“DAC”) and present value of in-force (“PVIF”) intangible assets; and guaranteed minimum death benefit (“GMDB”) reserves. Excluded from this guidance is the effect that equity market changes may have upon LNC’s realized and unrealized gains and losses on investments and intangible assets, other than DAC and PVIF. For example, write-downs for impairment of goodwill and deferred dealer commission assets may be necessary under certain market conditions. These matters are not included within the guidance provided in this document.

In measuring the estimated effects of changes in equity markets on its Retirement segment, LNC uses the S&P 500 index. LNC has generally found that the S&P 500 index is reasonably correlated to the effect of overall equity markets performance on this segment’s account values. Because LNC’s fee income earned on its variable annuity business is determined daily, the change in the S&P 500 on a daily average basis relative to the level of the S&P 500 at the beginning of each quarter provides a reasonable indication of the impact quarterly changes in equity markets have on the Retirement segment’s fee income. Because end of period account values are used for computing DAC unlocking and for incurred GMDB costs, the end of period change in the S&P 500 is used in measuring the estimated market impact of DAC unlocking and for the impact associated with incurred GMDB costs. In addition, because DAC and GMDB calculations have an assumed 9% positive annual equity market return, or a 2.25% quarterly assumption, variances in actual market performance relative to these calculation assumptions will generate positive or negative DAC unlocking and GMDB adjustments.

It is important to understand that the actual effect on fee income of market changes in the current quarter of an equity market change and the effect in the immediately following quarter will not be equal to a pro-rata 25% of the estimated annualized effect of the market change. This is due to the fact that the actual change in fee income in the immediate quarter during which the market changes is measured by the change in actual variable account values from the beginning of the quarter compared to the average balance of variable account values for the quarter. The change in fee income due to the change from average account values to ending account values does not occur in the immediate quarter of the market change; rather, that change in fee income will occur in the quarter following the market change. LNC estimates that this lagging effect for the fourth quarter 2002 equity markets change will create a decrease of $0.5 million in fee income in the first quarter of 2003, because average account values for the fourth quarter of 2002 exceeded the level of ending account values at December 31, 2002.

LNC also uses the S&P 500 index when describing the general effects of changes in equity markets for the Life Insurance segment. For the Lincoln UK segment, the FTSE 100 index provides a reasonable measure for approximating the effect of equity markets performance on earnings. LNC estimates that the lagging effect for the fourth quarter 2002 equity markets change will create a decrease of $0.1 million in fee income for Lincoln UK in the first quarter of 2003, because average account values for the fourth quarter of 2002 exceeded the level of ending account values at December 31, 2002.

Additional market indices are used in measuring the effects of the market on the results of LNC’s Investment Management segment. All of the relevant equity market indices (S&P, NASDAQ and MSCI EAFE) declined during the third quarter, ranging from a 19.9% NASDAQ decline to a 19.7% decline in the MSCI EAFE index. The fourth quarter increases were a 13.9% increase in the NASDAQ and a 6.5% increase in the MSCI EAFE index. The ongoing effect of the fourth quarter equity markets increase is expected to be a $0.1 million increase in the first quarter of 2003.

The following discussion concerning the estimated effects of ongoing equity market volatility on LNC’s earnings is intended to be illustrative. Actual effects may vary depending on a variety of factors, many of which

are outside of LNC’s control, such as changing customer behaviors that might result in changes in the mix of LNC’s business between variable or fixed annuity contracts, switching between investment alternatives available within variable products, or changes in policy lapsation rates. The relative effects shown in the illustrative scenarios presented below should not be considered to be indicative of the proportional effects on earnings that more significant changes in equity markets may generate. Such non-proportional effects include those discussed earlier, such as incurred GMDB costs and DAC unlocking.

Since the effect of continued equity market volatility is complex and subject to a variety of estimates and assumptions, such as assumed rates of long-term equity market performance, it is difficult to provide information that can be reliably applied to predict earnings effects over a broad range of equity markets performance alternatives. But in an effort to provide some insight into these matters, LNC has provided below illustrative examples of the effects that equity market volatility might be expected to have on LNC’s earnings. The underlying assumptions regarding these illustrations are as follows:


	1)	The first scenario assumes that equity markets remain unchanged from their respective levels at December 31, 2002 through the first quarter of 2003.

	2)	The second scenario assumes that from December 31, 2002 through the end of the first quarter of 2003 equity markets increase smoothly by 2.5%.

	3)	The third scenario assumes that from December 31, 2002 through the end of the first quarter of 2003 equity markets decline smoothly by 2.5%.

As the above assumptions indicate, actual equity market changes that may have occurred since December 31, 2002 up to the date of issuance of this guidance are not being considered; rather, the examples that follow are provided to illustrate the effects of a hypothetical change in equity markets from December 31, 2002. The following tables are examples of the estimated effects on earnings that might be expected for each of these scenarios.

Differences exist in the market change effect on fee income for the current quarter, as compared to the ongoing quarterly effect, because the change in fee income in the immediate quarter is determined by the change in beginning variable account balances to average variable account balances for the current quarter. The change in fee income in the next subsequent quarter is determined by the change in average account values to ending variable account values that occurred due to the market changing in the preceding quarter.


	However, in all following quarters, the ongoing effect of changes in the market occurring in the current quarter will be determined by the difference in beginning of quarter to end of quarter variable account balances. For purposes of this guidance, the change in account values is assumed to correlate with the change in the relevant index.

The above table excludes the impact of an impairment of the deferred dealer commission asset within the Investment Management segment. For instance, a review of the deferred dealer commission asset was performed as of March 10, 2003. Based on information currently available, it is estimated that a decline of approximately 3% in the equity markets from March 10, 2003 levels may trigger a loss, which would range from approximately $7.4 million to $11.4 million after-tax with the application of assumed discount rates ranging between 10% to 18% for purposes of measuring the fair value of the deferred dealer commission asset. The estimated balance of the deferred dealer commission asset as of March 10, 2003 was approximately $50 million.

The above examples are based upon the estimated annual effect on earnings for each one-percentage point change in relevant equity market indices. Taking one-fourth of this annual estimate would generate the expected effect of the equity market change on quarterly results, with the exception of DAC unlocking and GMDB incurred cost calculations where the effect is fully reflected in one quarter. The estimated annual effect in millions of dollars per one-percentage change and the changes in each of the relevant market indices used in the above examples, are listed in the following table.

As the above table indicates, the annual effect of a one percent change in equity markets varies depending upon the severity of the change. Presented below are estimated one million dollar effects for various market changes that are currently used by LNC in modeling the Lincoln Retirement segment. These estimated

The following table provides the annual effect for changes in equity markets for the Lincoln Retirement segment related to fee income and other:

The estimated annual effects indicated in the table above are applicable for the first quarter of 2003. For example, assume an estimate is being computed for the quarterly effect on Lincoln Retirement’s fee income due to a 2.5% increase in the markets occurring in the first quarter of 2003. In this example, the expected quarterly effect of a first quarter 2.5% increase is estimated as: ($2.0*1.25/4) = $0.625 million.

The table provided below contains information for use in estimating the first quarter 2003 effect for changes in equity markets for the Lincoln Retirement segment related to GMDB and DAC. For GMDB, quarterly results will include a reserve adjustment. This is due to the fact that LNC has established the GMDB reserves net of anticipated future GMDB fee revenues. As a result, an adjustment will be required to increase GMDB reserves during periods where a GMDB Net Amount At Risk exists.

Based upon the Net Amount At Risk for GMDB at December 31, 2002, the first quarter 2003 GMDB reserve adjustment is estimated at $5.9 million (included in the no change column in the table below).

The estimated quarterly effects indicated in the table above are applicable for the first quarter of 2003. For example, assume an estimate is being computed for the quarterly effect on Lincoln Retirement’s GMDB reserve due to a 2.5% increase in the equity markets occurring in the first quarter of 2003. The estimated quarterly effect is calculated as follows: $(5.9) + 0.8*2.5 = $(3.9) million.

Accounting for Business Combinations and Goodwill and Other Intangible Assets

In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, “Business Combinations” (“FAS 141”), and No. 142, “Goodwill and Other Intangible Assets” (“FAS 142”). FAS 141 is effective for all business combinations initiated after June 30, 2001, and FAS 142 is effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill and indefinite lived intangible assets are no longer amortized, but are subject to impairment tests conducted at least annually in accordance with the new standards. Intangible assets that do not have indefinite lives continue to be amortized over their estimated useful lives. LNC adopted FAS 142 on January 1, 2002. After consideration of the provisions of the new standards regarding proper classification of goodwill and other intangible assets on the consolidated balance sheet, LNC did not reclassify any goodwill or other intangible balances held as of January 1, 2002.

In compliance with the transition provision of FAS 142, LNC completed the first step of the transitional goodwill impairment test during the second quarter of 2002. The valuation techniques used by LNC to estimate the fair value of the group of assets comprising the different reporting units varied based on the characteristics of each reporting unit’s business and operations. A number of valuation approaches, including discounted cash flow modeling, were used to assess the goodwill of the reporting units within LNC’s Lincoln Retirement, Life Insurance and Lincoln UK segments. Valuation approaches combining multiples of revenues, earnings before interest, taxes, depreciation and amortization (“EBITDA”) and assets under management were used to estimate the fair value of the reporting units within LNC’s Investment Manage-

ment segment. The results of the first step of the tests indicated that LNC did not have impaired goodwill. LNC has chosen October 1 as its annual review date. As such, LNC performed another valuation review during the fourth quarter of 2002. The results of the first step of the tests performed as of October 1, 2002 indicated that LNC did not have impaired goodwill. The valuation techniques used by LNC for each reporting unit were consistent with those used during the transitional testing.

As a result of the application of the non-amortization provisions of the new standards, LNC had an increase in net income of $41.7 million ($0.22 per common share on a fully diluted basis) for the year ended December 31, 2002.

In August 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“FAS 144”), which supersedes Statement of Financial Accounting Standards No. 121, and the accounting and reporting provisions of APB Opinion No. 30. FAS 144 is effective for fiscal years beginning after December 15, 2001. LNC adopted FAS 144 on January 1, 2002 and the adoption of the Statement did not have a material impact on the consolidated financial position and results of operations of LNC.

In June 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“FAS 146”), which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)” (“Issue 94-3”). The principal difference between FAS 146 and Issue 94-3 is that FAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred, rather than at the date of an entity’s commitment to an exit plan. FAS 146 is effective for exit or disposal activities after December 31, 2002. Adoption of FAS 146 by LNC will result in a change in timing of when expense is recognized for restructuring activities after December 31, 2002.

Accounting for Stock-Based Compensation — Transition and Disclosure. On December 31, 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“FAS 148”), which provides alternative methods of transition for entities that change to the fair value method of accounting for stock-based employee compensation. In addition, FAS 148 amends the disclosure provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” to require expanded and more prominent disclosure of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements.

The three transition methods provided under FAS 148 are the prospective, the modified prospective and the retroactive restatement methods. LNC will adopt the retroactive restatement method, which requires that companies restate all periods presented to reflect stock-based employee compensation cost under the fair value accounting method in FAS 123 for all employee awards granted, modified or settled in fiscal years beginning after December 15, 1994. FAS 148’s amendment of the transition and annual disclosure requirements of FAS 123 is effective for fiscal years ending after December 15, 2002. LNC will adopt the fair value method of accounting under FAS 123, as amended by FAS 148, as of January 1, 2003 and will present restated financial statements for the years 2002, 2001 and 2000 in its first quarter 2003 filing on Form 10-Q (see Note 1 for pro forma net income and pro forma basic and diluted earnings per share amounts for 2002, 2001 and 2000 and Note 6 for discussion of stock-based employee compensation cost.).

Effective January 1, 2003, LNC’s stock option employee compensation plan and long-term cash incentive compensation plan were revised and combined to provide for performance vesting, and to provide for awards that may be paid out in a combination of stock options, performance shares of LNC stock and cash. The

performance measures for the initial grant under the new plan will be calculated over a three-year period from grant date and will compare LNC’s performance relative to a selected group of peer companies. Comparative performance measures will include relative growth in earnings per share, return on equity and total share performance. Certain participants in the new plans will select from seven different combinations of stock options, performance shares and cash in determining the form of their award. Other participants will have their award paid in performance shares. This plan will replace the current LNC stock option plan; however, the separate stock option incentive plans established by Delaware Investments U.S., Inc. (“DIUS”) and DIAL Holding Company, Inc. (“DIAL”), both wholly-owned subsidiaries of Delaware Management Holdings, Inc., will continue. The revised long-term incentive plan for 2003 is expected to result in about the same amount of total expense as would have been reported in 2002 for the stock option employee compensation plan, if stock options had been expensed, combined with previously expensed accrual for the long-term cash incentive plan. This estimated 2003 expense is subject to uncertainty given that several assumptions are required to be made regarding LNC’s performance.

In January 2003, the Financial Accounting Standards Board issued Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities” (“Interpretation 46”), which requires the consolidation of variable interest entities (“VIE”) by an enterprise if that enterprise has a variable interest that will absorb a majority of the VIE’s expected losses if they occur, receive a majority of the entity’s expected residual returns if they occur, or both. If one enterprise will absorb a majority of a VIE’s expected losses and another enterprise will receive a majority of that VIE’s expected residual returns, the enterprise absorbing a majority of the losses shall consolidate the VIE. VIE refers to an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. This Interpretation applies in the third quarter of 2003 to VIEs in which an enterprise holds a variable interest that is acquired before February 1, 2003. This Interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated.

Among the matters that LNC is currently reviewing in connection with the third quarter 2003 effective date of Interpretation No. 46 to existing VIEs is the potential application to Collateralized Debt Obligation (CDO) pools that are managed by LNC. If the fees earned by LNC for managing these CDOs are required to be included in the analysis of expected residual returns, it is possible that such CDO pools would fall under the consolidation requirements of Interpretation No. 46. While LNC does not currently have access to all information necessary to determine the ultimate effects of such a required consolidation (because LNC is not the trustee or the administrator to the CDOs), based upon currently available information LNC estimates that the effect of consolidation would result in recording additional assets and liabilities on LNC’s consolidated balance sheet of about $1.3 billion. If such liabilities are required to be recorded, LNC would disclose that such liabilities are without recourse to LNC, as LNC’s role of investment manager for such CDO pools does not expose LNC to risk of loss.

Although LNC and the industry continue to review the new rules, at the present time LNC does not believe there are other significant VIEs that would result in consolidation with LNC, beyond the managed CDOs discussed above.

Currently, there are ongoing discussions surrounding the implementation and interpretation of SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities”, by the Financial Accounting Standards Board’s (“FASB”) Derivative Implementation Group regarding receivables and payables that are indexed to a pool of assets; and specific to LNC, modified coinsurance agreements and coinsurance with funds withheld reinsurance agreements that reference a pool of securities. An exposure draft for this issue has been issued by the FASB. It is not expected to be finalized by the FASB until sometime in the second quarter of

2003. If the definition of derivative instruments is altered, this may impact LNC’s prospective reported consolidated net income and consolidated financial position. Until the FASB finalizes the Statement 133 Implementation Issue, LNC is unable to determine what, if any, impact it will have on LNC’s consolidated financial statements.

During 1998, LNC implemented a restructuring plan relating to the integration of existing life and annuity operations with the new business operations acquired from CIGNA Corporation (“CIGNA”) and a second restructuring plan relating to the streamlining of LNC’s corporate center operations. The aggregate charges associated with these two unrelated restructuring plans totaled $34.3 million after-tax ($52.8 million pre-tax) and were included in Underwriting, Acquisition, Insurance and Other Expenses on the Consolidated Statement of Income for the year ended December 31, 1998. These aggregate pre-tax costs include $19.6 million for employee severance and termination benefits, $9.9 million for asset impairments and $23.3 million for costs relating to exiting business activities. The CIGNA restructuring plan was completed in the first quarter of 2000. During the fourth quarter of 2000, $0.5 million (pre-tax) of the original charge to downsize LNC’s corporate center operations was reversed. This plan was completed in the third quarter of 2002 due to the termination of the lease, which resulted from LNC’s purchase and ultimate sale of the abandoned building. The remaining $0.2 million related to the terminated lease was reversed as a reduction in restructuring costs during the third quarter of 2002. Total pre-tax costs of $56.2 million were expended or written-off under these restructuring plans.

During 1999, LNC implemented restructuring plans relating to 1) the downsizing and consolidation of the operations of Lynch & Mayer, Inc. (“Lynch & Mayer”); 2) the discontinuance of HMO excess-of-loss reinsurance programs and 3) the streamlining of Lincoln UK’s operations. The aggregate charges associated with these three unrelated restructuring plans totaled $21.8 million after-tax ($31.8 million pre-tax) and were included in Underwriting, Acquisition, Insurance and Other Expenses on the Consolidated Statement of Income for the year ended December 31, 1999. During the fourth quarter of 1999, $3.0 million (pre-tax) of the original charge recorded for the Lynch & Mayer restructuring plan was reversed as a reduction of restructuring costs due primarily to a change in estimate for space costs. In addition, during the fourth quarter of 1999, $1.5 million (pre-tax) associated with lease terminations was released into income. During the fourth quarter of 2000, the Lynch & Mayer restructuring plan was completed and $0.3 million (pre-tax) of the original charge recorded was reversed as Lynch & Mayer was able to successfully exit certain contracts without any further obligations or penalties. Also, during the fourth quarter of 2000, $1.0 million (pre-tax) of the original charge for the discontinuance of HMO excess-of-loss reinsurance programs was reversed. During the fourth quarter of 2001, the remaining restructuring reserve of $0.2 million relating to the HMO excess-of-loss reinsurance programs was transferred to Swiss Re as part of its acquisition of LNC’s reinsurance operations. Actual pre-tax costs totaling $24.8 million have been expended or written-off for all three plans through December 31, 2002. As of December 31, 2002, a balance of $2.5 million remains in the restructuring reserve for the Lincoln UK plan and is expected to be utilized in the completion of this plan. Additional details of each of the three restructuring plans are discussed in Note 12 to the consolidated financial statements.

During 2000, LNC implemented restructuring plans relating to 1) the downsizing and consolidation of the operations of Vantage Global Advisors, Inc. (“Vantage”); 2) the exit of all direct sales and sales support operations of Lincoln UK and the consolidation of its Uxbridge home office with its Barnwood home office, and 3) the downsizing and consolidation of the investment management operations of Lincoln Investment Management. The Vantage restructuring charge was recorded in the second quarter, the Lincoln UK restructuring charge was recorded in the third and fourth quarters, and the Lincoln Investment Management restructuring was recorded in the fourth quarter of 2000. The aggregate charges associated with all restructuring plans entered into during 2000 totaled $81.8 million after-tax ($107.4 million pre-tax). These charges were included in Underwriting, Acquisition, Insurance and Other Expenses on the Consolidated Statement of Income for the year ended December 31, 2000. The component elements of these aggregate pre-tax costs include employee severance and termination benefits of $33.8 million, write-off of impaired assets of $40.9 million and other exit costs of $32.7 million. During the fourth quarter of 2000, $0.6 million (pre-tax) of

the original charge recorded for the Vantage restructuring plan was reversed as a reduction of restructuring costs due primarily to changes in estimates associated with severance and abandoned leased office space costs. All expenditures and write-offs for the Lincoln Investment Management restructuring plan were completed in the third quarter of 2002 and $0.4 million of the original reserve was released. The release of the reserve was primarily due to LNC’s purchase and ultimate sale of the vacant office space on terms, which were favorable to what was included in the original restructuring plan for rent on this office space. In the fourth quarter of 2002, $1.7 million of the Lincoln UK restructuring reserve was released as a result of new tenants being contracted for several of the abandoned office facilities on terms that were better than originally expected. Actual pre-tax costs totaling $95.0 million have been expended or written off for these plans through December 31, 2002. As of December 31, 2002, a balance of $9.7 million remains in the restructuring reserve for the Lincoln UK plan and is expected to be utilized in the completion of the plan. Additional details of each of the three restructuring plans are discussed in Note 12 to the consolidated financial statements.

During 2001, LNC implemented restructuring plans relating to 1) the consolidation of the Syracuse operations of Lincoln Life & Annuity Company of New York into the Lincoln Retirement segment’s operations in Fort Wayne, Indiana and Portland, Maine; 2) the elimination of duplicative functions in the Schaumburg, Illinois operations of First Penn-Pacific, and the absorption of these functions into the Lincoln Retirement and Life Insurance segments operations in Fort Wayne, Indiana and Hartford, Connecticut; 3) the reorganization of the life wholesaling function within the independent planner distribution channel, consolidation of retirement wholesaling territories, and streamlining of the marketing and communications functions in LFD; 4) the reorganization and consolidation of the life insurance operations in Hartford, Connecticut related to the streamlining of underwriting and new business processes and the completion of outsourcing of administration of certain closed blocks of business; 5) the consolidation of the Boston, Massachusetts investment and marketing office with the Philadelphia, Pennsylvania investment and marketing operations in order to eliminate redundant facilities and functions within the Investment Management segment 6) the combination of LFD channel oversight, positioning of LFD to take better advantage of ongoing “marketplace consolidation” and expansion of the customer base of wholesalers in certain territories and 7) the consolidation of operations and space in LNC’s Fort Wayne, Indiana operations.

The Syracuse restructuring charge was recorded in the first quarter of 2001, the Schaumburg, Illinois restructuring charge was recorded in the second quarter of 2001, the LFD restructuring charges were recorded in the second and fourth quarters of 2001, and the remaining restructuring charges were all recorded in the fourth quarter of 2001. The aggregate charges associated with all restructuring plans entered into during 2001 totaled $24.6 million after-tax ($38.0 million pre-tax). The component elements of these aggregate pre-tax costs include employee severance and termination benefits of $12.2 million, write-off of impaired assets of $3.3 million and other exit costs of $22.5 million primarily related to the termination of equipment leases ($1.4 million) and rent on abandoned office space ($20.0 million). The Syracuse restructuring plan was completed in the first quarter of 2002 with expenditures and write-offs totaling $1.3 million. The total amount expended exceeded the original charge by $0.3 million. The LFD restructuring plan that was initiated in the second quarter of 2001 was completed in the fourth quarter of 2002. Actual pre-tax costs totaling $1.8 million were expended or written off, which was equal to the original reserve. The Life Insurance segment restructuring plan that was initiated in the fourth quarter of 2001 was completed in the fourth quarter of 2002. Actual pre-tax costs totaling $2.3 million dollars were expended or written-off. The amount expended for this plan was in excess of the original reserve by less than $0.1 million. In addition, $0.1 million of excess reserve on the FPP restructuring plan was released during the second quarter of 2002 and $1.5 million of excess reserve on the Fort Wayne restructuring plan was released during the third quarter of 2002. The release of the reserve on the Fort Wayne restructuring plan was due to LNC’s purchase and ultimate sale of the vacant building on terms which were favorable to what was included in the original restructuring plan for rent on this abandoned office space. Actual pre-tax costs totaling $34.0 million have been expended or written off for the four remaining plans through December 31, 2002. As of December 31, 2002, a balance of $1.4 million remains in the restructuring reserves for these plans and is expected to be utilized in the completion of the plans. Additional details of each of these restructuring plans are discussed in Note 12 to the consolidated financial statements.

During the second quarter of 2002, Lincoln Retirement completed a review of its entire internal information technology organization. As a result of that review, Lincoln Retirement decided in the second quarter of 2002 to reorganize its IT organization in order to better align the activities and functions conducted within its own organization and its IT service providers. This change was made in order to focus Lincoln Retirement on its goal of achieving a common administrative platform for its annuities products, to better position the organization and its service providers to respond to changing market conditions, and to reduce overall costs in response to increased competitive pressures. The restructuring plan implemented to achieve these objectives included aggregate pre-tax costs of $1.6 million, composed of $1.4 million for employee severance and $0.2 million for employee outplacement. Actual pre-tax costs expended through December 31, 2002 were $0.9 million. As of December 31, 2002, a balance of $0.7 million remains in the restructuring reserve for this plan and is expected to be utilized in the completion of the plan. Additional details of this restructuring plan are discussed in Note 12 to the consolidated financial statements.

In January 2003, the Life Insurance segment announced that it was realigning its operations in Hartford, Connecticut and Schaumburg, Illinois to enhance productivity, efficiency and scalability while positioning the segment for future growth. The financial impact of the realignment will result in the Life Insurance segment incurring costs of approximately $15-$17 million after-tax during 2003. While some savings may materialize in the second half of 2003, the majority of the savings will be realized in 2004, at which time the run-rate for operating and administrative expenses should be reduced by $15-$20 million pre-tax.

In February 2003, Lincoln Retirement announced plans to consolidate its fixed annuity operations in Schaumburg, Illinois into Fort Wayne, Indiana. Restructuring costs under the plan are expected to be $3-$5 million after-tax and are expected to be incurred during 2003. The consolidation is expected to result in pre-tax savings of approximately $4-$6 million annually beginning in the third quarter of 2003.

On August 30, 2002, LNC acquired The Administrative Management Group, Inc. (“AMG”), an employee benefits record keeping firm for $21.6 million in cash. Contingent payments up to an additional $14 million will be paid over a period of 4 years (2003-2006) if certain criteria are met. Any such contingent payments will be expensed as incurred. AMG, a strategic partner of the Lincoln Retirement segment for several years, provides record keeping services for the Lincoln Alliance Program along with approximately 400 other clients nationwide. As of December 31, 2002, the application of purchase accounting to this acquisition resulted in goodwill of $20.2 million.

The transaction structure involved a series of indemnity reinsurance transactions combined with the sale of certain stock companies that comprised LNC’s reinsurance operation. At closing, an immediate gain of $15.0 million after-tax was recognized on the sale of the stock companies. A gain of $723.1 million after-tax ($1.1 billion pre-tax) relating to the indemnity reinsurance agreements was reported at the time of closing. This gain was recorded as a deferred gain on LNC’s consolidated balance sheet, in accordance with the requirements of FAS 113, and is being amortized into earnings at the rate that earnings on the reinsured business are expected to emerge, over a period of 15 years.

Effective with the closing of the transaction, the former Reinsurance segment’s historical results were moved into “Other Operations.” During December 2001 LNC recognized in Other Operations $5.0 million ($7.9 million pre-tax) of deferred gain amortization. In addition, in December 2001, LNC recognized $7.9 million ($12.5 million pre-tax) of accelerated deferred gain amortization relating to the fact that certain Canadian indemnity reinsurance contracts were novated after the sale, but prior to December 31, 2001.

As part of the dispute settlement, LNC also paid $100 million to Swiss Re in satisfaction of LNC’s $100 million indemnification obligation with respect to personal accident business. As a result of this payment, LNC has no further underwriting risk with respect to the reinsurance business sold. However, because LNC has not been relieved of its legal liabilities to the underlying ceding companies with respect to the portion of the business reinsured by Swiss Re, under FAS 113 the reserves for the underlying reinsurance contracts as well as a corresponding reinsurance recoverable from Swiss Re will continue to be carried on LNC’s balance sheet during the run-off period of the underlying reinsurance business. This is particularly relevant in the case of the exited personal accident and disability income reinsurance lines of business where the underlying reserves are based upon various estimates that are subject to considerable uncertainty.

As a result of developments and information obtained during 2002 relating to personal accident and disability income matters, LNC increased these exited business reserves by $198.5 million after-tax ($305.4 million pre-tax). After giving effect to LNC’s $100 million indemnification obligation, LNC recorded a $133.5 after-tax ($205.4 million pre-tax) increase in reinsurance recoverable from Swiss Re with a corresponding increase in the deferred gain.

The combined effects of the 2002 settlement of disputed matters and exited business reserve increases reduced the $723.1 million after-tax ($1.1 billion pre-tax) deferred gain reported at closing by $44.9 million after-tax ($69 million pre-tax). During 2002, LNC amortized $47 million after-tax ($72.3 million pre-tax) of deferred gain. This includes the amortization of deferred gain from the sale of the direct disability income business in 1999. An additional $1.3 million after-tax ($2 million pre-tax) of deferred gain was recognized due to a novation of certain Canadian business during 2002.

Through December 31, 2002, of the original $2 billion in proceeds received by LNC, approximately $0.56 billion was paid for taxes and deal expenses and approximately $1.0 billion was used to repurchase stock, reduce debt, and support holding company cash flow needs. LNC also paid $195 million to Swiss Re to settle the closing balance sheet disputed matters and $100 million to satisfy LNC’s personal accident business indemnification obligations. The remaining proceeds have been dedicated to the ongoing capital needs of the Lincoln National Life Insurance Company.

Critical Accounting Policy — Personal Accident and Disability Income Reserves

Because of ongoing uncertainty related to personal accident and disability income businesses, the reserves related to these exited business lines carried on LNC’s balance sheet at December 31, 2002 may ultimately prove to be either excessive or deficient. For instance, in the event that future developments indicate that these reserves should be increased, under FAS 113 LNC would record a current period non-cash charge to record the increase in reserves. Because Swiss Re is responsible for paying the underlying claims to the ceding companies, LNC would record a corresponding increase in reinsurance recoverable from Swiss Re. However, FAS 113 does not permit LNC to take the full benefit in earnings for the recording of the increase in the reinsurance recoverable in the period of the change. Rather, LNC would increase the deferred gain recognized upon the closing of the indemnity reinsurance transaction with Swiss Re and would report a cumulative amortization “catch-up” adjustment to the deferred gain balance as increased earnings recognized in the period of change. Any amount of additional increase to the deferred gain above the cumulative amortization “catch-up” adjustment must continue to be deferred and will be amortized into income in future periods over

Accordingly, even though LNC has no continuing underwriting risk, and no cash would be transferred between LNC and Swiss Re, in the event that future developments indicate LNC’s December 31, 2002 personal accident or disability income reserves are deficient or redundant, FAS 113 requires LNC to adjust earnings in the period of change, with only a partial offset to earnings for the cumulative deferred gain amortization adjustment in the period of change. The remaining amount of increased gain would be amortized into earnings over the remaining run-off period of the underlying business.

The Lincoln Retirement segment (formerly known as the Annuities segment), headquartered in Fort Wayne, Indiana, provides tax-deferred investment growth and lifetime income opportunities for its clients through the manufacture and sale of fixed and variable annuities. Through a broad-based distribution network, Lincoln Retirement provides an array of annuity products to individuals and employer-sponsored groups in all 50 states of the United States. Lincoln Retirement distributes some of its products through LNC’s wholesaling unit, LFD, as well as LNC’s retail unit, LFA. In addition, group fixed and variable annuity products and the Alliance program are distributed to the employer-sponsored retirement market through Lincoln Retirement’s Fringe Benefit Division dedicated sales force.

Results of Operations: Lincoln Retirement’s financial results and account values were as follows:


(1)	Cumulative Effect of Accounting Changes relates to the transition adjustment of $(3.6) million recorded in the first quarter of 2001 upon adoption of FAS 133 and the adjustment of $(3.7) million recorded in the second quarter of 2001 upon adoption of EITF 99-20.

Net income decreased $211.4 million or 79% in 2002. The decrease in net income between periods was primarily the result of the decline in the equity markets and an increase in realized losses on investments of $86.2 million, resulting from the decline in value and the sale and write-downs of fixed maturity securities.

In 2002, the S&P 500 index declined 23.4%. The significant decline in the equity markets negatively affected the segment’s earnings through lower fees from lower average variable account values, negative unlocking of deferred acquisition costs (“DAC”) and the present value of in-force (“PVIF”) intangible assets and increases in reserves and benefit payments for guaranteed minimum death benefits (“GMDB”).

Average daily variable annuity account values decreased $4.8 billion or 13% and variable annuity account values at December 31, 2002 were $7.2 billion or 21% lower than at December 31, 2001. The decrease in variable annuity account values was caused primarily by the overall decline in the equity markets in 2002. This decrease reduced fees and lowered net income by $29.9 million. The effect of equity market impact on DAC and PVIF from retrospective unlocking and net changes in amortization decreased net income by $18.4 million. The current year negative unlocking was due to actual equity market performance lagging the expected market performance used in LNC’s DAC assumptions. Increases in GMDB reserves and benefit payments decreased net income by $40.4 million from 2001. In addition, in the fourth quarter of 2002 the segment had reduced net income of $30.3 million due to prospective unlocking of various assumptions underlying DAC, PVIF and GMDB calculations, including the reversion to the mean net growth assumption. The tax benefit from the Separate Account Dividend Received Deduction (“DRD”) was $17.7 million lower in 2002 than in 2001 due to lower fees, primarily resulting from the decline in the equity markets.

Decreased earnings from investment partnerships resulted in a negative variance of $21.7 million compared to 2001. Partially offsetting the negative variances were $17.6 million from higher investment margins. Overall investment spreads on fixed annuity products was relatively flat between years: 2.04% in 2002 versus 2.05% in 2001. For annuity products spread, the yield on earning assets is calculated as net investment income on fixed product investment portfolios divided by the average earning assets, the average crediting rate is calculated using interest credited on annuity products less bonus credits and excess dollar cost averaging (“DCA”) interest, divided by the average fixed account values net of coinsured account values. Fixed account values reinsured under modified coinsurance agreements are included in account values for this calculation. (See discussion on investment margins and the interest rate risk due to falling interest rates within Item 7A, Quantitative and Qualitative Disclosures About Market Risk.)

Average fixed annuity account values increased $2.1 billion in 2002 resulting in an increase in income of $17.7 million. The increase in fixed annuity account values was due to the positive net cash flows for fixed annuities, reflecting strong sales of the StepFive®, Lincoln Select and Lincoln ChoicePlus^SM Fixed annuity products. (See below for further discussion of net flows.) These strong sales increases could be interrupted if the interest rates decrease significantly and remain lower. In the event that LNC is not able to achieve spread targets, sales of fixed annuities could be significantly reduced.

The amortization of the Lincoln Retirement segment’s deferred acquisition costs is impacted by the change in market value of variable annuity accounts. Statement of Financial Accounting Standard No. 97, “Accounting by Insurance Companies for Certain Long-Duration Contracts & Realized Gains & Losses on Investment Sales” (“FAS 97”) requires that acquisition costs for variable annuity contracts be amortized over the lives of the contracts in relation to the incidence of estimated gross profits. Estimated gross profits on variable annuity contracts vary based on surrenders, fee income, expenses and realized gains/losses on investments. The amortization is adjusted retrospectively (DAC unlocking) when estimates of current or future gross profits to be realized from variable annuity contracts are revised. Because equity market movements have a significant impact on the value of variable annuity accounts and the fees earned on these accounts, estimated future profits increase or decrease with movements in the equity markets. Movements in equity markets also have an impact on reserves and payments for the guaranteed minimum death benefit feature within certain annuity contracts. The Lincoln Retirement segment’s assumption for the long-term

annual gross growth rate of the equity markets used in the determination of DAC amortization and GMDB benefits is 9%, which is reduced by mortality and expense charges (“M&E”) and asset management charges resulting in a net variable account growth assumption of less than 9%. As equity markets do not move in a systematic manner, LNC uses a methodology referred to as “reversion to the mean” to maintain its long-term gross growth rate assumption while also giving consideration to the effect of short-term swings in the equity markets. The application of this methodology results in the use of a higher or lower future gross equity market growth assumption for a period of four years subsequent to the valuation date which, together with actual historical gross equity growth, is expected to produce a 9% gross return.

The use of a reversion to the mean assumption is common within the industry; however, the parameters used in the methodology are subject to judgment and vary within the industry. An important aspect of LNC’s application of the reversion to the mean is the use of caps and floors on the growth rate assumption, which limit the gross growth rate assumption to reasonable levels above and below the long-term assumption. In the fourth quarter 2002, LNC adjusted its reversion to the mean gross growth rate assumption to 9%. This change along with changes to assumptions for variable annuity persistency and revisions to amortization periods resulted in DAC and PVIF adjustments reducing income by $8.8 million. Going forward, as the growth rate of the equity market varies from LNC’s growth rate assumption, the period over which the reversion to the mean gross growth rate assumption needs to be earned will be four years. The segment is reviewing the appropriate cap or floor levels and will incorporate this into the methodology. On a quarterly basis, LNC reviews the assumptions of its DAC amortization model and records a retrospective adjustment to the amount expensed, (i.e. unlocks the DAC). On an annual basis, LNC reviews and adjusts as necessary its assumptions for prospective amortization of DAC, as well as its other intangible asset, present value of in-force (“PVIF”).

The GMDB reserves are a function of the net amount at risk (“NAR”), mortality, persistency, and incremental death benefit M&E expected to be incurred over the period of time for which the NAR is positive. At any given point in time, the NAR is the difference between the potential death benefit payable and the total account balance, with a floor value of zero (when account values exceed the potential death benefit there is no amount at risk). As part of the estimate of future NAR, gross equity growth rates which are consistent with those used in the DAC valuation process are utilized. On average, the current gross equity growth rate would project to a zero NAR over roughly four years from the balance sheet date. The fourth quarter of 2002 change to the reversion to the mean assumption resulted in an increase to GMDB reserves and reduced income by $21.5 million. Projections of account values and NAR followed by computation of the present value of expected NAR death claims using product pricing mortality assumptions less expected GMDB M&E revenue during the period for which the death benefit options are assumed to be in the money are made each valuation date for every variable annuity contract with a GMDB benefit feature. If equity market returns exactly match LNC’s reversion to the mean rate and actual mortality and lapse experience is as assumed, the GAAP reserve plus interest and GMDB M&E revenue would exactly cover the future expected GMDB payments as they arise.

As discussed above, the decline of the equity markets effect has resulted in increased GMDB reserves and benefit payments which negatively effected Lincoln Retirement’s income. Although there is no method currently prescribed under generally accepted accounting principles for GMDB reserving, LNC uses a method that recognizes that there is an amount at risk that will result in future payments and that over time the equity market growth will reduce the payment stream. This approach is expected to cover future GMDB payments, net of future GMDB fee income. Currently, there are few companies that reserve for the liability caused by the decline in the equity markets with some companies recognizing the cost on a pay as you go basis. At December 31, 2002, LNC’s net amount at risk (“NAR”) was $4.6 billion and the GAAP reserve was $84.5 million. The reserve for statutory accounting was $144.1 million, reflecting the more conservative market performance and mortality assumptions required under statutory accounting.

In evaluating the relative GMBD exposures that exist within LNC’s variable annuity business relative to industry peers, it is important to distinguish between the various types of GMDB structures, and other factors

At December 31, 2002 LNC had $19.2 billion of variable annuity account value, about 52% of LNC’s total, that was subject to a return of premium type GMDB benefit. LNC’s average variable annuity with a return of premium feature has an average account value of $32,000 and an average remaining premium base of $26,300 resulting in an average NAR of $5,700. The average attained age of these contract holders is just over 50 with less than 9% over age 70. The GAAP GMDB reserve on these accounts was $27.2 million on a total NAR of $1.8 billion.

At December 31, 2002 LNC had $9.1 billion of variable annuity account value, about 25% of LNC’s total, that is subject to a high water mark type GMDB benefit. LNC’s average variable annuity with a high water mark feature has an average account value of $58,400 and average NAR of $19,800. The average attained age of these contract holders is just over 60 with 24% over age 70. The GAAP GMDB reserve on these accounts was $56.9 million on a total NAR of $2.8 billion.

At December 31, 2002 only $262 million of variable account value, less than 1% of LNC’s total, was subject to roll-up type GMDB benefit. LNC’s average variable annuity with a roll-up feature has an average account value of $91,000 and average NAR of $17,700. The average attained age of these contract holders is just under 63 with 28% over age 70. The GAAP GMDB reserve on these accounts was $0.4 million on a total NAR of $40 million.

At December 31, 2002 LNC had $8.5 billion of variable annuity account value, about 23%, that was not subject to any GMDB benefit. These accounts average $45,800 in account value. The average attained age of these contract holders is 58 with 20% over 70.

LNC’s contract holders overall average attained age is just over 53 with only 13% over age 70. LNC average attained ages are lower than industry average (per The Gallup Organization’s 2001 Survey) due to the mix of business that includes significant amounts of qualified and employer sponsored business.

LNC’s average non-qualified contract holder’s attained age is just under 64 with 35% over age 72 compared to the industry average attained age of 65 with 35% over age 72.

LNC has variable annuity contracts containing GMDB’s which have a dollar for dollar withdrawal feature. Under such a feature, withdrawals reduce both current account value and the GMDB amount on a dollar for dollar basis. For contracts containing this dollar for dollar feature, the account holder could withdraw a substantial portion of their account value resulting in a GMDB which is multiples of the current account value. LNC’s exposure to this dollar for dollar risk is somewhat mitigated by the fact that LNC does not allow for partial 1035 exchanges on non-qualified contracts. To take advantage of the dollar for dollar feature, the contract holder must take constructive receipt of the withdrawal and pay any applicable surrender charges. LNC will report the appropriate amount of the withdrawal that is taxable to the IRS, as well as indicating whether or not tax penalties apply under the premature distribution tax rules. LNC closely monitors its dollar for dollar withdrawal GMDB exposure and works with key broker dealers that distribute LNC’s variable annuity products. As of December 31, 2002, there were 276 contracts for which the death benefit to account value ratio was greater than ten to one. The net amount at risk on these contracts was $19.3 million. Effective May of 2003, the GMDB feature offered on new sales will be a pro-rata GMDB feature whereby each dollar of withdrawal will reduce the GMDB benefit in proportion to the current GMDB to account value ratio.

As illustrated in the discussion of Lincoln Retirement’s results of operations above, the segment’s income is extremely sensitive to swings in the equity markets. Refer to the First Quarter 2003 Guidance for Estimated Effect of Equity Market Volatility section for estimates of the effect of movements in the equity markets on Lincoln Retirement’s earnings.

The $89.4 million or 25% decrease in net income was due in part to an increase in realized loss on investments and derivative instruments of $39.1 million. These investment losses were due primarily to losses

Weak performance of the equity markets in 2001 caused variable annuity account values to be depressed throughout 2001. Fee income, which is calculated daily based on the ending variable annuity account values, decreased $48.9 million between years as a result of market depreciation experienced in the last quarter of 2000 and overall in 2001 and to a lesser extent, net outflows for variable annuities in 2000. Average variable annuity account values decreased by $6.2 billion or 15% in 2001 from 2000. Variable annuity net flows (including the fixed portion of variable contracts) were essentially zero for 2001 due to a strong second half of the year. Partially offsetting the decrease in fee income was a $6.2 million positive fee income rate variance related to a change in mix of the variable annuity business. The downturn in the equity markets also contributed to an increase of $7.3 million in benefit payments and reserve requirements for guaranteed minimum death benefits. Average fixed annuity account values decreased by $331 million or 1.9% in 2001 from the average in 2000 due to net outflows in 2000. This decreased earnings by $1.4 million between years. As a result of improved retention and lower account values in 2001, surrender charges decreased $6.9 million between years.

Increased operating and administrative expenses of $16.2 million also contributed to the decrease in net income between years. This increase was due primarily to higher information technology costs including computer software write-offs and equipment amortization, as well as increased severance and relocation costs related to LNC’s initiative to build a high performance culture.

Net investment income decreased between years due primarily to reduced earnings of $5.2 million on investment partnerships. Overall investment spreads on fixed annuity products (excluding the impact of investment income earned on surplus supporting the segment which includes investment partnerships) decreased between years: 2.05% in 2001 versus 2.14% in 2000.

The Lincoln Retirement segment experienced negative DAC unlocking in the first and third quarters of 2001 and positive unlocking in the second and fourth quarters of 2001 due to movements in the market. DAC unlocking created a negative variance in earnings of $4.0 million compared to 2000. Due to changes in assumptions for prospective DAC amortization made at the beginning of 2001, the segment experienced a decrease in DAC amortization expense of $37.8 million relative to 2000. This unlocking created a positive variance of $4.5 million between years, which was caused by improved persistency in 2001 and lower expense projections.


(1)	Incremental Deposits represent gross deposits reduced by transfers from other Lincoln Annuity products.

In order to achieve profitable future earnings growth for both fixed and variable annuity products the ability to attract new deposits and to retain existing accounts is crucial. In 2002, the Lincoln Retirement segment experienced a continuation of the trend of positive net flows that began in the third quarter of 2001. For the year, total annuity deposits were $6.4 billion, flat with 2001. However, withdrawals were $5.9 billion, an improvement of $0.5 billion resulting in positive net flows of $0.5 billion.

The improvement in net flows is reflective of LNC’s goal of maintaining positive net flows by growing deposits and retaining existing accounts. LNC has experienced six consecutive quarters of positive net flows. This improvement is largely attributable to LNC’s balanced array of products and distribution breadth.

Although American Legacy Variable Annuity gross deposits were down 14%, its incremental deposits decreased only 2% in 2002. In addition, Lincoln ChoicePlus^SM with its multi-manager variable annuity experienced a $302 million or 40% increase in gross deposits in 2002. In the first quarter of 2002, LFD launched Lincoln ChoicePlus in UBS PaineWebber, one of the largest distributors of variable annuity products in the country. Also, in April 2002, LFD launched Lincoln ChoicePlus in Salomon Smith Barney, another key distributor of variable annuity products. Sales of the SEI Variable Annuity product line, distributed through SEI, declined 30% to $57 million in 2002. Effective February 28, 2003, SEI Investments will no longer take applications for new contract sales in the SEI Variable Annuity Program. Total fixed annuity gross deposits (excluding the fixed portion of variable annuity gross deposits) were $1.9 billion in 2002, a $0.2 billion or 12% increase. The increase was reflective of the strong sales of the StepFive, Lincoln Select Fixed Annuity and the Alliance Program Fixed Annuities.

At December 31, 2002, 52% of Lincoln Retirement’s account values contained the most conservative type of GMDB which is return of premium. There are two other primary types of GMDB’s in the portfolio, the high-water mark and the 5% step-up. The 5% step-up product accounts for less than 1 percent of Lincoln Retirement’s variable annuity account values. LNC is currently reviewing this feature and other guarantees. In the future they may be changed or discontinued.

LNC’s efforts to grow deposits by introducing innovative products that meet the changing needs of its customers and to retain existing accounts through targeted conservation efforts and by offering better replacement alternatives for current customers have yielded positive results. In addition, Lincoln Retirement’s improvement in flows is even more powerful when looking at current industry activity. Aggressive pricing strategies aimed at increasing market share which are prevalent in the marketplace, but counter to LNC’s strategy, include significant commission specials that are 100-200 basis points above LNC’s; aggressive living benefit riders that give the customer the opportunity to transfer market risk to the company at their discretion and could ultimately spell disaster for either client or company; and combination high bonus and high commission products that could promote inappropriate sales behavior. LNC has been able to grow new deposits without employing, to any significant extent, the various aggressive strategies listed above. This progress can be attributed to not only its strong product line-up and distribution breadth, but also the implementation of more stringent standards and controls on internal transfers.

In looking at annuity withdrawals and the overall profitability of the business, it is important to look beyond the mere total dollar amount of withdrawals and assess how total withdrawals compare to total retained account values. These measures of account persistency are referred to as lapse rates, which are key elements to assessing underlying profitability. By comparing actual lapse rates to the rates assumed in designing the annuity product, it is possible to gauge whether performance is better or worse than pricing. Overall lapse rates were 10.47% in 2002, 9.72% in 2001 and 11.95% in 2000. In all three years, overall lapse rates have been more favorable than expected in pricing assumptions. The improvement in persistency over the three year period has partially countered the reduction in fee income resulting from lower average variable annuity account values caused by market depreciation.

To sustain and further improve overall retention levels, LNC is utilizing targeted conservation efforts and is exploring other retention initiatives. In addition, LNC believes that maintaining a strong and balanced portfolio of fixed and variable annuities provides a platform for maintaining positive net flows. If equity markets continue to decline, LNC may see increased exchange activity in 2003, particularly if consumers move funds to products that provide an account value floor (i.e. living benefits).

LNC has been focused over the last several years on growing new deposits. This effort has been concentrated on both product and distribution breadth. As a result of the continued volatility of the equity markets, sales of fixed annuities have increased in spite of the historically low interest rate environment. LNC’s fixed annuity sales in 2001 through 2002 were bolstered by product offerings that were introduced in 2001 including the Lincoln Select Fixed Annuity and the StepFive® Fixed Annuity. The guarantees of the StepFive Fixed Annuity made it an important product for LNC in the Financial Institutions channel. New product offerings launched in 2002 in the Financial Institutions channel include AccelaRate and ChoiceGuarantee. The market value adjusted (“MVA”) feature of the Lincoln Select Fixed Annuity is expected to be more attractive in the Wirehouse/ Regional channel during a volatile interest rate environment. This feature increases or decreases the cash surrender value of the annuity based on a decrease or increase in interest rates. Contractholders participate in gains when the contract is surrendered in a falling interest rate market, and LNC is protected from losses up to a cap when the contract is surrendered in a rising interest rate market. A new version of Lincoln Select that provides the individual with a higher interest rate but a larger potential penalty for early withdrawal or surrender is being developed. LNC continues to approach the fixed annuity marketplace opportunistically and only offer rates that are consistent with LNC’s required spreads. If interest rates drop further, it may result in reduced product offerings and could impact net flows.

In 2002, an enhanced low cost variable annuity product, Multi-Fund 5 was launched. In addition, LNC expanded the ChoicePlus and American Legacy product offerings in New York to include Bonus, L-share and A-share (American Legacy only) contracts. Annuities with living benefit riders, that provide equity market performance guarantees, are becoming much more prevalent in the industry. LNC is evaluating various product approaches and designs in this area that will provide a competitive benefit while still falling within LNC’s risk tolerance levels for such guarantees.

LFD, LNC’s wholesaling distribution arm and internal partner of Lincoln Retirement, provides a wholesaling unit for the distribution of the Lincoln ChoicePlus variable annuity, Lincoln ChoicePlus fixed annuity and StepFive fixed annuity product lines. In 2002, LFD contributed significantly to the level of ChoicePlus^SM Variable Annuity sales which reached $1.0 billion, an increase of 40% from 2001. LFD has also been a driver of fixed annuity products with $1.2 billion of sales in 2002. LNC is continuing to build and reinvent its strategic partnerships as part of its ongoing marketing strategy, while selectively working on other alliances that will provide increased access for LNC annuity products through various distribution channels. American Legacy variable annuity gross deposits were $1.7 billion in 2002, a decrease of 14% from 2001. One means for improving American Legacy annuity sales would be the use of a dedicated wholesaling team of Lincoln Insurance Planning Consultants focused strictly on American Legacy Variable Annuity products. Recently, LNC and American Funds Distributors (“AFD”) have agreed to transition the wholesaling of American Legacy to LFD. Currently, AFD uses wholesalers who focus on both American Funds mutual funds as well as the American Legacy Variable Annuity products. Segment management believes that this change to a dedicated team focused on key broker/dealer relationships developed in conjunction with AFD, has the potential to renew growth in American Legacy VA sales. The transitioning of wholesaling and distribution responsibility for the American Legacy variable annuities from AFD to LFD will provide LFD with two distinct annuity product areas: The single-manager (American Legacy) and the multi-manager (ChoicePlus^SM and Multi-Fund®).

President Bush’s proposed 2003 budget legislation contains a variety of changes to the taxation of corporations and shareholders. Of particular importance to the Lincoln Retirement segment are proposed

changes intended to mitigate the double taxation of dividends. At this point, the potential impact of this developing legislative proposal on annuities products is uncertain. Concerns expressed in this regard by the industry have been favorably received by key Bush administration officials, with indications that these matters are being given careful consideration during the ongoing drafting of the legislative proposal. Also unknown at this time is the impact, if any, that the proposed legislation may have on the Lincoln Retirement segment future corporate tax burden, including how corporate dividends would be treated under the proposed new approach to corporate taxation. At this point, LNC is unable to predict, with any degree of certainty, the likelihood or final form in which this proposed legislation might become law.

Tax legislation, along with current economic and market conditions continue to be very uncertain which may adversely affect annuity sales for the industry and Lincoln Retirement. Although LNC is committed to its two-pronged approach of growing new deposits and retaining existing assets to manage its net flows; achieving positive net flows in 2003 may be difficult for the industry and Lincoln Retirement. LNC expects to continue to strengthen its distribution breadth and emphasize expense management as key profitability drivers in an increasingly challenging market.

The Life Insurance segment, headquartered in Hartford, Connecticut, creates and protects wealth for its clients through the manufacture and sale of life insurance products throughout the United States. The Life Insurance segment offers term life, universal life, variable universal life, interest-sensitive whole life and corporate owned life insurance. A majority of the Life Insurance segment’s products are currently distributed through LFD and LFA. In the third quarter 2002, the Life Insurance segment entered into a marketing agreement to distribute life insurance products through the M Financial Group, a well-respected and successful nationwide organization of independent firms serving the needs of affluent individuals and corporations. In addition to the marketing agreement, most business sold through M Financial Group will be subject to a 50% modified coinsurance arrangement.

Results of Operations: The Life Insurance segment’s financial results, first year premiums by product, account values and in-force amounts were as follows:


(1)	Cumulative Effect of Accounting Changes relates to the transition adjustment of $(0.2) million recorded in the first quarter of 2001 upon adoption of FAS No. 133 and the adjustment of $(5.3) million recorded in the second quarter of 2001 upon adoption of EITF 99-20.

Net income decreased $24.1 million or 10% in 2002 from the prior year. Excluding the amortization of goodwill in 2001, net income decreased $47.8 million or 19%. A significant contributor to the decrease in net income between periods was an increase in realized losses on investments of $26.0 million primarily resulting from the write-down of fixed maturity securities in 2002. In 2001, the Life Segment reported two restructuring charges which reduced 2001 net income by $3.5 million. There were no restructuring charges for the segment in 2002. Also, in 2001 net income was negatively affected by $5.5 million to due the cumulative effect of the adopting FAS. No. 133 and EITF 99-20. There were no accounting principles adopted in 2002 requiring a cumulative adjustment.

In addition to the items noted above, other factors contributing to the decline in net income in 2002 compared to 2001 were less favorable mortality, declining investment margins, poor results in investment partnerships and declines in the equity markets.

Mortality experience (mortality assessments less net death benefits and negative DAC unlocking) in 2002 was less favorable relative to 2001 and resulted in a $13.1 million reduction in income. Volatility is expected from mortality risk, but LNC attempts to lessen the impact of volatility on earnings by reinsuring approximately 90% of the new business written by the Life Insurance segment. Investment yields declined at a faster pace than reductions in crediting rates which reduced investment margins $10.5 million. (See discussion on investment margins and the interest rate risk due to falling interest rates within Item 7A, Quantitative and Qualitative Disclosures About Market Risk.) In addition, decreased earnings from investment partnerships resulted in a negative variance of $6.7 million.

Life insurance in-force, increased 8% from December 31, 2001 due to strong sales growth over the last year and continued favorable persistency. Total sales as measured by first year premiums were up $154.8 million or 25% and retail sales were up $113.9 million or 20% in 2002. Sales of universal life (“UL”), whole life and term life insurance products improved by 69%, 15% and 5%, respectively. Due to the volatile equity markets experienced over the last several quarters, there has been a sustained flight to interest-sensitive products from variable universal life insurance (“VUL”). As a result, sales of VUL products were down 41% from the prior year period.

Account values of $12.1 billion at December 31, 2002 increased $0.7 billion or 6% from December 31, 2001. The drivers of this increase were positive cash flows, net of policyholder assessments, of approximately $0.3 billion across all products during the last twelve months, the transfer of the Legacy Life block of business ($0.15 billion) from the Lincoln Retirement segment in the first quarter of 2002 and interest earned on the

FAS 97 requires that acquisition costs for universal life insurance (“UL”) policies and variable universal life insurance (“VUL”) policies be amortized over the lives of the contracts in relation to the incidence of estimated gross profits, consistent with the treatment noted previously for variable annuities. Factors affecting estimated gross profits are surrender charges; investment, mortality net of reinsurance ceded and expense margins; and realized gains/losses on investments. For VUL policies, estimated gross profits are affected by fee income as well. For the Life Insurance segment, based on the current mix of life insurance in-force on the books, the factors that have the most significant impact on estimated gross profits are mortality (net of reinsurance) and interest margins. Market movement, which has the greatest impact on DAC amortization for the Retirement segment relative to its variable annuity block of business, has less impact on DAC amortization for the Life Insurance segment. The Life Insurance segment earns fee income on its VUL product line based on the ending daily VUL account values. This product only makes up 14% of the segment’s total account values at December 31, 2002.

On a quarterly basis, LNC reviews the assumptions of its DAC amortization model and records a retrospective adjustment to the amount expensed, (i.e. unlocks the DAC). On an annual basis, LNC reviews and adjusts as necessary its assumptions for prospective amortization of DAC, as well as its other intangible asset, PVIF. Although the Life Insurance segment is not as sensitive to the performance of the equity markets as the Lincoln Retirement segment, the negative performance of the equity markets resulted in negative retrospective DAC unlocking in 2002 of $2.4 million. In addition, negative DAC unlocking of $3.9 million related to changes in various prospective assumptions occurred in 2002.

As illustrated in the discussion of the Life Insurance segment’s results of operations above, the segment earnings are not particularly sensitive to swings in the equity markets. Refer to the First Quarter 2003 Guidance for Estimated Effect of Equity Market Volatility section for estimates of the effect of movements in the equity markets on Life Insurance’s earnings.

The $16.2 million or 6% decrease in net income in 2001 was due primarily to increased realized losses on investments and derivative instruments of $26.3 million. The Life Insurance segment also incurred two restructuring charges in the second and fourth quarters of 2001 of $2.0 million and $1.5 million, respectively. The $2.0 million charge recorded in the second quarter of 2001 related to a restructuring plan with the objective of eliminating duplicative staff functions in the Schaumburg, Illinois operations of First Penn-Pacific by transitioning them into the Annuities and Life Insurance segment operations in Fort Wayne, Indiana and Hartford, Connecticut, respectively, in order to reduce ongoing operating costs. The $1.5 million charge recorded in the fourth quarter of 2001 was for the reorganization and consolidation of the life insurance operations in Hartford, Connecticut related to the streamlining of underwriting and new business processes and the completion of outsourcing of administration of certain closed blocks of business.

Life Insurance experienced less favorable mortality throughout 2001 after having a favorable year in 2000. Partially contributing to the downturn in mortality experience were the losses of $1.1 million recorded for the September 11 terrorist attacks. The Life Insurance segment also experienced lower earnings on investment partnerships. The Life Insurance segment’s 2001 income was positively impacted by growth in life insurance in-force from sales, favorable persistency and lower general and administrative expenses. General and administrative expenses decreased due to expense reduction initiatives implemented in the second half of 2001. In 2000 and 2001, the Life Insurance segment did not experience DAC unlocking that resulted in a significant impact on earnings.

Sales as measured by first year premiums were down overall in 2001 by $33.7 million or 5%. This decline was due to a $39.8 million decrease in Corporate Owned Life Insurance (“COLI”) sales. COLI sales, which

First year premiums on retail products increased by $6.1 million or 1% between years. UL sales increased $3.4 million or 1% between years. Although this overall increase is modest, sales in the fourth quarter of 2001 were $98 million, a 20% increase over the prior year quarter. Sales rebounded nicely in the fourth quarter after a volatile year for UL sales. VUL sales were up $9.8 million or 4% between years. These results were encouraging given the performance of the equity markets in 2001.

Partially offsetting the increased retail UL/ UVL sales levels noted above was a decrease in term life sales of $11.1 million or 26% between years. Term life sales for the first six months of 2001 lagged the prior year period largely due to strong first half of 2000 sales that were bolstered by the impending enactment of the Valuation of Life Insurance Model Regulation (“Regulation XXX”). Regulation XXX required companies to increase reserves relative to certain term life and permanent insurance policies with secondary guarantees as of January 1, 2000. There was a rush of term business in anticipation of the related price increases for implementation of Regulation XXX with sales up in the first half of 2000 due to a back log of business at December 31, 1999. Term sales increased incrementally each quarter in 2001 and for the fourth quarter were 20% higher compared to the same quarter in 2000.

Account values increased $0.6 billion or 6% to $11.4 billion at December 31, 2001 from $10.8 billion at the prior year-end. Positive cash flows for the year of $1.2 billion were the main contributor to the increase between years. Cash flows in 2001 were flat compared to the prior year. VUL account values were down between years by $62 million due to market depreciation.

The Life Insurance segment offers a broad portfolio of Life Insurance products. In addition to Term, the segment offers three distinct permanent insurance product types: Universal Life, Variable Universal Life and Interest Sensitive Whole Life. Within these product types are wealth accumulation and wealth transfer specific products, including single life and survivorship versions of all three. Insurance riders such as return of premium and long-term care benefit provisions are available with certain products. .In addition, the segment offers both UL and VUL versions of COLI. This allows the segment to effectively align its portfolio of products with the primary affluent market segments, and to also provide products that perform under a variety of market conditions.

Given the economic environment of the recent past, portfolio breadth has proven its value. The industry has experienced a dramatic shift from variable to fixed products over the last year, driven primarily by the equity market decline and a flight to conservatism exacerbated by the events of September 11, 2001. Over the last 12 months, the Life segment’s mix of business has shifted dramatically from VUL to UL, but the dollar decline in VUL sales has been more than offset by the dollar increase in UL sales. Universal Life accounted for 79% of total retail UL/ VUL sales in 2002 versus 56% of those sales in 2001. In times like these, when clients have less tolerance for market risk, it is important to have a competitive fixed Universal Life portfolio.

The Life Insurance segment has continued to develop products that meet the changing needs of its target affluent market. Throughout 2002, the segment revamped its entire retail UL portfolio. In March 2002, it introduced a new single life series of products with Lincoln UL^LPR and Lincoln UL^DB. The Lapse Protection Rider (“LPR”) product is an upgrade to the product introduced in 2001 which offers the innovative lapse protection rider, designed to provide flexibility and guaranteed death benefit coverage – important features in today’s market. The Death Benefit (“DB”) product is designed to offer cost-efficient coverage for people less interested in guarantees. In August of 2002, new survivorship versions of both the LPR and DB products were also introduced. Overall, the response to these new products has been very positive. In 2003, the segment plans to continue to be aggressive in product development.

Estate tax reform was a major legislative debate in 2002, which is expected to continue. Among a variety of alternatives being considered is a temporary extension of the one-year estate tax repeal that will occur in 2010 under current law. If this occurs, inheritance taxes on a state-by-state basis may be increased to offset the projected reduction in revenues to state governments. More costly to both federal and state governments would be a permanent repeal of estate taxes. The outlook for permanent repeal remains highly uncertain, particularly in light of increasing federal and state budgetary concerns.

To date, the impact on LNC’s life insurance sales of the recent changes in estate tax laws has not been significant to overall sales for the Life Insurance segment. Total survivorship sales as a percent of overall retail sales dropped from 29% of the total first year premiums in 2001 to 22% of the total in 2002. If estate taxes are permanently repealed, LNC believes there will continue to be a demand for survivorship products to meet a variety of tax, business and family needs. The Life Insurance segment’s survivorship wealth transfer products support a wide variety of financial planning needs such as business succession and charitable giving, not just management of estate tax exposure.

The Application of the Valuation of Life Insurance Policies Model Regulation (“AXXX”) was developed to clarify statutory reserve requirements for particular policy designs under the NAIC Valuation of Life Insurance Policies Model Regulation (“Regulation XXX”). AXXX will increase statutory reserves for universal life policies sold beginning in 2003 with secondary guarantees using shadow accounts and for specified premium guarantees that are prefunded. The secondary guarantee promises to keep a policy in force as long as certain conditions are met, regardless of whether the policy has any cash value.

Regardless of the value in the actual account value, the policy will not lapse as long as the shadow account is positive. A shadow account is a hypothetical account that accumulates actual premium payments and interest less fees based on the secondary guarantee assumptions. However, the shadow account does not provide any cash value to the policyholder. All companies offering secondary guarantees that allow prefunding will be impacted to a greater or lesser degree depending on product design. A prefunded policy is one where premiums are paid earlier than is necessary to maintain the policy’s benefits.

To reflect the financial requirements of AXXX, Lincoln is repricing single life and survivorship products that offer secondary guarantees using shadow accounts. The products are scheduled to be released in the latter part of first quarter 2003. Lincoln also markets universal life products that do not offer secondary guarantees, which will not be impacted by AXXX. LNC believes that secondary guarantees are going to continue to be critical to LNC’s target affluent market and that the repriced versions of these products should remain competitive. However, LNC may lose market share if competitors are slow to replace their secondary guarantees for AXXX.

New regulations have set forth the IRS’ views regarding the tax treatment of split dollar funding arrangements. Split dollar is a premium funding mechanism that has been used for many years, with IRS approval, to provide life insurance benefits to a firm’s key executives, or to provide life insurance benefits to family members of closely held firms, etc. In some cases, split dollar funding may not be as attractive under the new IRS rules.

Further affecting some split dollar programs have been accounting reforms under Sarbanes-Oxley, which prohibit publicly traded companies from extending credit to their directors or executives. However, most of the products sold by LNC for use in split dollar arrangements are sold to closely held companies, limited partnerships and family owned businesses, not for publicly traded companies. Segment management believes that given LNC’s target market, and the fact that the amount of split dollar sales in relationship to the level of total first year life premium sold is insignificant to the Life Insurance segment, the impacts of these changes should have minimal overall effect on sales.

A variety of legislative proposals are being considered that would effect corporate owned life insurance. LNC believes that life insurance remains a legitimate method of corporate funding of anticipated future commitments as well as protection from unpredictable events such as the loss of key business executives. The Life Insurance segment continues to approach COLI as an opportunistic market strategy. LNC’s COLI product is only marketed to organizations for coverage of officers and require the prospective permission of officers to be covered under the COLI policy. Given the continuing legislative debates over corporate owned life insurance LNC management is not currently able to determine what impact this environment will have on product design or sales. At December 31, 2002, Life Insurance had $684 million of account values for COLI, representing less than 6% of total segment account values.

The Life Insurance segment experienced strong retail sales growth in 2002. Sales trends over the next year for both UL and VUL products will likely continue to be heavily influenced by the equity markets performance and the uncertainty of the regulatory environment as well as the continued competitive environment. There should continue to be a demand among the affluent for sophisticated life products to meet a variety of tax, business and family needs. LNC’s balanced portfolio of products is nicely positioned to take advantage of this demand. The Life Insurance segment expects to continue to hold firm its operating fundamentals of: strong distribution relationships, solid underwriting, mortality and investment management and strong expense controls as it strives to be among the top five generators of new premiums in the life insurance industry. The Life Insurance segment’s earnings can be expected to reflect some volatility due to short-term effects of swings in mortality and morbidity.

The Investment Management segment, headquartered in Philadelphia, Pennsylvania, offers a variety of asset management services to retail and institutional clients located throughout the United States and certain foreign countries. Its product offerings include mutual funds and managed accounts. It also provides investment management and account administration services for variable annuity products, 401(k) plans, “529” college savings plans, pension, endowment, and trust and other institutional accounts. The primary operating companies within this segment are the subsidiaries of Delaware Management Holdings, Inc. (“Delaware”). Retail products are primarily marketed by LFD and Delaware Distributors, L.P. through financial intermediaries including LFA. Institutional products, including large case 401(k) plans, are marketed by a separate sales force within Delaware working closely with pension consultants.

Diversity of investment styles, as well as diversity of clients served, are prudent ways to manage risk in varying market environments. Delaware, historically known for a conservative, “value” equity investment style has now evolved into an investment manager with strong and diversified offerings across all major asset classes including value and growth equity investment styles; high-grade, high-yield and municipal fixed income investment styles; balanced and quantitative investment styles; and international and global equity and fixed income investment styles.

Results of Operations: The Investment Management segment’s financial results were as follows:


(1)	Cumulative Effect of Accounting Change relates to the second quarter 2001 adoption of EITF 99-20.

Net income for 2002 increased $13.8 million or 117% over 2001. Excluding the effect of goodwill amortization in 2001, net income decreased $2.4 million or 9% in 2002. The decrease in income is primarily a result of declines in the equity markets reducing retail and institutional assets under management and revenues. Offsetting the negative effect of the markets on revenues has been a reduction in expenses of $19.2 million, excluding the reduction in expenses from the change in accounting for goodwill amortization and restructuring charges. This improvement in expenses is a result of cost containment efforts, the effect of the equity market decline on variable expenses, $1.7 million reduction in amortization of other intangible assets resulting from certain intangibles being fully amortized in the second quarter of 2001 and $4.2 million for the release of accrued compensation resulting from the fourth quarter 2002 resignation of the segment’s CEO. In addition to lower expenses, positive net cash flows in 2002 partially offset the negative effect of the equity markets on assets under management and revenues.

Net income for 2002 included releases of $0.3 million related to restructuring charges reported in the fourth quarter of 2000 to combine the investment management operations for fixed income products of Lincoln Investment Management and Delaware in Philadelphia.

As illustrated in the discussion of the Investment Management segment’s results of operations above, the segment’s earnings are sensitive to swings in the equity markets. Refer to the First Quarter 2003 Guidance for Estimated Effect of Equity Market Volatility section for estimates of the effect of movements in the equity markets on Investment Management’s earnings.

The Investment Management segment has a deferred dealer commission asset of approximately $53 million as of December 31, 2002 relating to upfront sales commissions paid to brokers for the sale of “Class B” shares of Delaware Investments retail mutual funds. The asset is amortized over the estimated period of time that it is expected to be realized or recovered f


Indiana		35-1140070
(State of Incorporation)		(I.R.S. Employer Identification No.)


Title of each class		Exchanges on which registered

Common Stock		New York, Chicago and Pacific
Common Share Purchase Rights		New York, Chicago and Pacific
$3.00 Cumulative Convertible Preferred Stock, Series A		New York and Chicago
7.40% Trust Originated Preferred Securities, Series C*		New York
5.67% Trust Originated Preferred Securities, Series D*		New York, Chicago and Pacific
7.65% Trust Preferred Securities, Series E*		New York


PART I
	Item 1. Business
	Item 2. Properties
	Item 3. Legal Proceedings
	Item 4. Submission of Matters to a Vote of Security Holders
PART II
	Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
	Item 6. Selected Financial Data
	Item 7. Management’s Discussion and Analysis of Results and Financial Condition
CONSOLIDATED BALANCE SHEETS
CONSOLIDATED STATEMENTS OF INCOME
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
PART III
SCHEDULE 1 -- SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT
BALANCE SHEETS Lincoln National Corporation (Parent Company Only)
SCHEDULE II -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Continued)
STATEMENTS OF INCOME Lincoln National Corporation (Parent Company Only)
STATEMENTS OF CASH FLOWS Lincoln National Corporation (Parent Company Only)
SCHEDULE III -- SUPPLEMENTARY INSURANCE INFORMATION
SCHEDULE IV -- REINSURANCE
SCHEDULE V -- VALUATION AND QUALIFYING ACCOUNTS
EXHIBIT INDEX FOR THE ANNUAL REPORT ON FORM 10-K For the Year Ended December 31, 2002
SIGNATURE PAGE
CERTIFICATION
CERTIFICATION
Agreement, Waiver and General Release
Historical Ratio of Earnings to Fixed Charges
List of Subsidiaries of LNC
Consent of Ernst & Young LLP


Common Stock Data: (per share)	1st Qtr		2nd Qtr		3rd Qtr		4th Qtr

2002
High	$	53.650	$	52.540	$	42.080	$	35.950
Low	$	47.200	$	40.750	$	29.120	$	25.150
Dividend Declared	$	0.320	$	0.320	$	0.320	$	0.335
2001
High	$	48.250	$	52.300	$	52.750	$	49.450
Low		38.000		41.280		41.000		40.000
Dividend Declared	$	0.305	$	0.305	$	0.305	$	0.320



		Year Ended December 31

		2002		2001			2000		1999		1998


		(millions of dollars, except per share data)
Total revenue		$	4,635.5	$	6,378.0		$	6,847.1	$	6,803.7	$	6,087.1
Income before cumulative effect of accounting changes			91.6		605.8			621.4		460.4		509.8
Cumulative Effect of Accounting Changes			—		(15.6	)		—		—		—

	Net income	$	91.6	$	590.2		$	621.4	$	460.4	$	509.8
Per Share Data:(1)
	Net Income — Diluted	$	0.49	$	3.05		$	3.19	$	2.30	$	2.51
	Net Income — Basic	$	0.50	$	3.13		$	3.25	$	2.33	$	2.54
	Common stock dividends	$	1.295	$	1.235		$	1.175	$	1.115	$	1.055


For the fiscal year ended December 31, 2002	Commission File Number 1-6028


Item					Page

PART I
	1.	Business
		A.	Business Overview			2
		B.	Description of Business Segments:
			1.	Lincoln Retirement		5
			2.	Life Insurance		8
			3.	Investment Management		10
			4.	Lincoln UK		11
		C.	Other Matters:
			1.	Regulatory		12
			2.	Miscellaneous		12
			3.	Available Information		13
	2.	Properties				13
	3.	Legal Proceedings				13
	4.	Submission of Matters to a Vote of Security Holders				14
PART II
	5.	Market for Registrant’s Common Equity and Related Stockholder Matters				14
	6.	Selected Financial Data				14
	7.	Management’s Discussion and Analysis				15
	7A.	Quantitative and Qualitative Disclosures About Market Risk				73
	8.	Financial Statements and Supplementary Data				82
	9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosures				149
PART III
	10.	Directors and Executive Officers of the Registrant				149
	11.	Executive Compensation				150
	12.	Security Ownership of Certain Beneficial Owners and Management				150
	13.	Certain Relationships and Related Transactions				151
	14.	Controls and Procedures				151
	15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K				151
		Index to Exhibits				164
		Signatures				166
		Certifications				168



	December 31

	2002		2001		2000		1999		1998


	(millions of dollars, except per share data)
Assets	$	93,133.4	$	98,001.3	$	99,844.1	$	103,095.7	$	93,836.3
Long-term debt		1,119,2		861.8		712.2		712.0		712.2
Company-obligated mandatorily redeemable preferred securities of subsidiary trusts holding solely junior subordinated debentures		392.7		474.7		745.0		745.0		745.0
Shareholders’ equity		5,296.3		5,263.5		4,954.1		4,263.9		5,387.9
Per Share Data:(1)
Shareholders’ equity (Including accumulated other comprehensive income)	$	29.82	$	28.10	$	25.92	$	21.76	$	26.59
Shareholders’ equity (Excluding accumulated other comprehensive income)	$	25.97	$	27.13	$	25.85	$	24.14	$	23.86
Market value of common stock	$	31.58	$	48.57	$	47.31	$	40.00	$	40.91



												Increase
			Year Ended December 31									(Decrease)

			2002			2001			2000			2002			2001


			(in millions)
Life insurance and annuity premiums			$	295.6		$	1,363.4		$	1,403.3			(78	%)		(3	%)
Health insurance premiums				20.3			340.6			409.8			(94	%)		(17	%)
Insurance fees				1,434.4			1,544.0			1,661.4			(7	%)		(7	%)
Investment advisory fees				183.3			197.2			213.2			(7	%)		(8	%)
Net investment income				2,608.3			2,679.6			2,747.1			(3	%)		(2	%)
Equity in earnings of unconsolidated affiliates				(0.6	)		5.7			(0.4	)
Realized gain (loss) on investments and derivative instruments				(271.5	)		(114.5	)		(28.3	)
Gain (loss) on sale of subsidiaries				(8.3	)		12.8			—
Other revenue and fees				373.9			349.2			441.0			7	%		(21	%)

	Total Revenue			4,635.4			6,378.0			6,847.1			(27	%)		(7	%)
Life insurance and annuity benefits				2,504.4			3,107.6			3,108.2			(19	%)		—
Health benefits				355.1			302.1			449.0			18	%		(33	%)
Underwriting, acquisition, insurance and other expenses				1,677.7			2,083.2			2,314.1			(19	%)		(10	%)
Interest and debt expenses				96.6			121.0			139.5			(20	%)		(13	%)
Federal income taxes				(90.0	)		158.3			214.9

		Income before cumulative effect of accounting changes		91.6			605.8			621.4
Cumulative effect of accounting changes				—			(15.6	)		—

		Net Income	$	91.6		$	590.2		$	621.4			(84	%)		(5	%)
Items Included in Net income:
	Realized Gain (Loss) on Investments and Derivative Instruments (after-tax)		$	(176.4	)	$	(73.6	)	$	(17.5	)
	Gain (Loss) on Sale of Subsidiaries (after-tax)			(9.4	)		15.0
	Restructuring Charges (after-tax)			2.0			(24.7	)		(80.2	)
	FAS 113 Reserve Development on Business Sold through Indemnity Reinsurance (after-tax)			(199.1	)		—			—
	Cumulative Effect of Accounting Changes (after-tax)			—			(15.6	)		—
	Goodwill Amortization (after-tax)			—			43.4			45.1


		Market Effects		Ongoing Effects of
		Reported in		Market Changes
		Fourth		from 4Q02 on			Current Effects in			Total Effect in
Segment		Quarter 2002		1Q03			First Quarter 2003			First Quarter 2003

Retirement	Fees Q1 Effect*	$	—	$	—		$	—		$	—
	Fees Q4 Effect*	$	2.8	$	(0.5	)	$	—		$	(0.5	)
	Total Fee Income	$	2.8	$	(0.5	)	$	—		$	(0.5	)
	Other	$	—	$	—		$	—		$	—
	GMDB	$	2.5	$	—		$	(5.9	)	$	(5.9	)
	DAC	$	0.6	$	—		$	—		$	—
Retirement	Total Effect	$	5.9	$	(0.5	)	$	(5.9	)	$	(6.4	)
Life Insurance	Total Effect	$	0.6	$	—		$	(0.2	)	$	(0.2	)
Investment Management	Total Effect	$	1.4	$	0.1		$	—		$	0.1
Lincoln UK	Fee Income*	$	0.5	$	(0.1	)	$	—		$	(0.1	)
	DAC/ PVIF	$	1.4	$	—		$	(0.9	)	$	(0.9	)
Lincoln UK	Total Effect	$	1.9	$	(0.1	)	$	(0.9	)	$	(1.0	)
LNC Total	Total Effect	$	9.8	$	(0.5	)	$	(7.0	)	$	(7.5	)


	20% +		11 – 20%		6 – 10%		1 to 5%				1 to 5%		6 – 10%
	Decline		Decline		Decline		Decline		No Change		Increase		Increase		11% +


	($ Millions for each 1% Change in Relevant Market Index)
Fee Income		(1.6)		(1.8)		(1.9)		(2.0)		—		2.0		2.1		2.2
Other		(0.5)		(0.5)		(0.5)		(0.5)		—		0.5		0.5		0.5


Item 1.	*Business*



		December 31

		2002			2001			2000			1999			1998


		(in billions)
Account Values
Variable Annuities		$	27.4		$	34.6		$	39.4		$	41.5		$	33.4

Fixed Annuities		$	20.1			18.0			16.6			18.2			18.1
Reinsurance Ceded			(2.0	)		(1.5	)		(1.2	)		(1.4	)		(1.6	)

	Total Fixed Annuities		18.1			16.5			15.4			16.8			16.5
	Total Account Values	$	45.5		$	51.1		$	54.8		$	58.3		$	49.9



		December 31

		2002		2001		2000		1999		1998


		(in billions)
Account Values
Universal Life		$	8.2	$	7.5	$	6.9	$	6.6	$	6.3
Variable Universal Life			1.7		1.8		1.8		1.6		1.2
Interest-Sensitive Whole Life			2.2		2.1		2.1		2.0		1.8

	Total Life Insurance Account Values	$	12.1	$	11.4	$	10.8	$	10.2	$	9.3

In Force — Face Amount
Universal Life and Other		$	126.0	$	121.2	$	115.9	$	109.3	$	105.8
Term Insurance			127.9		113.2		100.1		85.7		67.1

	Total In-Force	$	253.9	$	234.4	$	216.0	$	195.0	$	172.9