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Annuity Risk Management

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  1. 18th Annual Meeting of the IABA Annuity Risk Management Stephen Turer FSA, MAAAVice President of Individual Annuity Pricing August 4, 2011 Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates.

  2. Lincoln’s Actuarial Presence 184 Actuaries 60 Students Hartford, CT Life/Annuity Product Management Executive Benefits Product Management Radnor & PHL, PA Corporate Center Equity Risk Management Greensboro, NC Life/Annuity Product Management Product Risk and Liability Valuation Fort Wayne, IN Valuation Management Reporting Defined Contribution Product Management Omaha, NE Group Protection

  3. Annuity Risk Management • Overview of Products and Market • Product Mix • Description of GLWB • Current Events and Trends • Macro Risk Management • Company Mix of Business and Strategy • Micro Risk Management • Case Study on Dynamic Lapse in Variable Annuity • Variable Annuity Hedging Program • Reserves and Surplus • Question and Answer Session

  4. Guaranteed Minimum Accumulation Benefit (GMAB) Guaranteed Minimum Income Benefit (GMIB) Guaranteed Lifetime Withdrawal Benefit (GLWB) Guaranteed Minimum Withdraw Benefit (GMWB) Hybrid Overview of Products and MarketVariable Annuity Living Benefit Guarantees 4Q 2006 4Q 2010 Total VA Sales = $40.4B 38% Elected Living Benefits Total VA Sales = $37.6B 58% Elected Living Benefits Source: LIMRA GLB Election Reports

  5. Overview of Products and MarketGuaranteed Lifetime Withdrawal Benefit(GLWB) • Guaranteed growth of annual income when not taking withdrawals • Protected and predictable lifetime income level • General withdrawal benefit value proposition to clients: • Protect principal against market loss via withdrawals or death benefit • Access to account value • Tax-deferred growth Account Value ($) Policy Years

  6. Overview of Products and MarketIndustry Timeline & Evolution 2004 2005 2006 2007 2008 2009 2010+ Annual Step-Up Lifetime GMWB 5% roll-up 7%+ roll-up Age-banding & 10% roll-up Product De-risking Product Innovation & Risk Mgmt Reaction to Financial Crisis Impact on Living Benefits • Early Industry Reaction • Several players exited the business • Removed products/features • Reduced rollups & guarantee income • Increased rider charge • Tightened investment restrictions • Latest Industry Reactions • Increasing rider charge • Developing new risk management features • Asset transfer programs/ risk managed funds • Increasing rollups & guaranteed income • Product features based on market condition • Offering multiple guarantee options

  7. Overview of Products and MarketProduct Environment Trend Current Areas of Focus Average Product Richness, May ‘08 – May ‘11 • Maximize guarantee benefits while limiting market exposure risk • Implementation of asset transfer programs and risk managed investment options 2011 2008 Expected areas of development 2009 • Protection for long term care needs thru Hybrid/Combo products • Guarantees tied to interest rates or market indices GMxB rider cost Initial withdrawal as percent of single premium deposit, Age 60 at issue and starting withdrawal after a 5-year wait

  8. Asset Transfer Programs Reduces downside risk of account value with complex portfolio insurance mechanisms Customized and non-discretionary algorithms rebalance asset allocation in response to the ratio of Account value and Benefit base Risk Managed Funds Volatility Targeting Maintain a constant realized fund volatility through volatility forecast CPPI/ Capital Protection Dampen loss in market decline Key Benefits Appeal to loss averse customers by reducing downside risk Enhance risk-adjusted return of underlying account value Reduce expected cost and residual risk of insurer’s hedging Potential for higher guarantees and/or lower rider charge Overview of Products and MarketProduct Environment Trend

  9. Macro Risk ManagementPowerful Distribution Platforms Drive Diverse Mix of Business Bank Independent Planner Wire/ Regional Managing General Agents Consultants/Benefit Brokers Individual Life MoneyGuard Group Protection Variable Annuities Fixed Annuities Defined Contribution Sales by Channel1 Sales by Product1 550 Wholesalers LFD 8,000 Advisors LFN 150 Group Benefit Wholesalers Work Site 300 Retirement Focused 1 January 2009 through March 2011 Normalized Sales (Life, MoneyGuard and Group Protection: Paid Annualized Premiums as reported; Annuity/Defined Contribution: at 5% of Deposits) 9

  10. Macro Risk ManagementAnnuities: Solid, Consistent Performance due to Connected Product Design, Distribution and Risk Management MGA Wire Bank IP LFN Sales By Channel Hedge Effectiveness 2008 1Q 2011 ($ Billions) 12/31/08 12/31/10 Total 1Q 2011 Sales $2.6 billion VA Product Guarantees2 Company A 7.9% Company F 6.6% Company B 7.0% Lincoln 6.4% Company C 7.0% Company G 6.4% Company D 6.8% Company H 6.3% Company E 6.7% 1 Excluding goodwill; See Appendix slide Return on Average Stockholders’ Equity – Retirement Solutions 2 Initial withdrawal as % of principal, buying at 60 and holding to 65. As of November 2010 10

  11. Micro Risk ManagementProduct Design Product Innovation and Responsiveness Comprehensive Risk Management Retirement Income Security Distribution Depth and Breadth Operational Effectiveness

  12. Front End Product Design Policyholder Behavior Hedge Program Financial Models In-Force Management Micro Risk ManagementPolicyholder Behavior in Product Design • Policyholder Behavior is managed, but not eliminated, through: • Product design • Conservative actuarial assumptions • Experience studies • Product Positioning • Assumptions: • Fund Mapping • Lapses • Mortality • Income Start • Spousal / Beneficiary Continuation

  13. Micro Risk ManagementPolicyholder Behavior in Product Design Question: Given the difference of GMWB features by generation can one policyholder behavior assumption work for all? None-lifetime GMWB benefits with either a 5% or 7% Maximum Withdrawal Rate Generation 1 2003-2004 Generation 2 2005-2006 Lifetime GMWB with and without 5% roll-up Generation 3 2007- early 2009 Lifetime GMWB with highest roll-up and most generous features Generation 4 Late 2009 & 2010 Lifetime GMWB after the financial crisis with scaled back features

  14. Micro Risk ManagementPolicyholder Behavior in Product Design • Base Lapse • Vary by surrender charge schedule (CSDC) • Vary by distribution channel (wire, bank, planner, etc) • Vary by ‘income’ vs ‘comfort’ buyer • Vary by age • Dynamic Lapse Adjustment • Is a multiple applied to the base lapse assumption to compensate for the fact that the presence of a GMWB feature may change lapse rates

  15. Micro Risk ManagementPolicyholder Behavior in Product Design • Slope of Dynamic Lapse Assumption • Need to balance conservatism versus the cost to hedging • One Sided vs. Two Sided • Do lapse only decrease (one sided) or do lapses increase and decrease (two sided) • Frequency of step-up may influence this decision • Availability of richer features (Gen 1 vs. Gen 3 or Gen 4) • Parameters for dynamic lapse formula • Account Value • Guarantee Value; PV(GA) vs. (GA) • Qualified vs. Nonqualified • Income vs. Comfort • Demographics (age, gender, …, investment mix)

  16. Micro Risk ManagementPolicyholder Behavior in Product Design Guaranteed Amount can equal • ‘GA’ = Charge basis generally Greater of (deposit or ASU) • Issues with lifetime GWMB (does deposit = lifetime risk?) • PV(GA) = Present value of future benefits • Question at what discount rate? • Key considerations if using a discount rate: • How market sensitive are investors? • Does the discount rate relate to reality? • At what market drop will customer adjust lapse experience • Will lapse rate burnout at an ultimate rate or hit 0% on extreme drops?

  17. Micro Risk ManagementPolicyholder Behavior in Product Design • Chart Basis • 100,000 Deposit • Age 55 – 4,000 MAW • Age 65 – 5,000 MAW • Age 75 – 5,000 MAW • Assume Immediate Income for Chart Below • A2000 (no improvement) • Present value of future benefits divided by 100,000 = PV(GA) / 100,000 PV (GA) is the Present Value of the Guaranteed Amount

  18. Micro Risk ManagementPolicyholder Behavior in Product Design • Female, Age 60, Income at year 10, 5% Roll-up, various investment mixes • Numbers in the chart are ratios of the 4% discount rate

  19. Micro Risk ManagementVariable Annuity Hedging Program Full Reinsurance 3 Greek Hedging Cost Delta Hedging Static Hedging No Protection Effectiveness • Managing VA guarantees requires balancing cost and effectiveness

  20. Micro Risk ManagementVariable Annuity Hedging Program

  21. Overview of Risk Based Capital • RBC is held in addition to Stat. Reserves • Total Asset Requirement (TAR) • Company Action Level • Companies normally quote a % of RBC • C1, C2, C3, C4, Covariance • Annuity Required Capital • C3P2 has stochastic requirement • TAR average of worst 10% scenarios • RBC equal difference TAR minus Stat. Reserve

  22. Disclosure • This presentation and certain oral statements made on LNC’s behalf may contain information that includes or is a “forward-looking statement” within the meaning of the Private Securities Litigation Reform Act of 1995 (“PSLRA”). A forward-looking statement is a statement that does not strictly relate to a historical fact. A forward look statement includes any statement that may predict, forecast, indicate or imply future results, performance or achievements, and may contain words like: “believe”, “anticipate”, “expect”, “estimate”, “project”, “will”, “shall” and other words or phrases with similar meaning. LNC claims the protection afforded by the safe harbor for forward-looking statements provided by the PSLRA. • Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from the results contained in the forward-looking statements, legislative and regulatory changes and proceedings, changes in interest rates, sudden or prolonged declines in the equity markets, continued economic decline and credit-related illiquidity, deviation in actual experience regarding future persistency, mortality, morbidity, interest rates or equity market returns from Lincoln’s assumptions used in pricing its products, in establishing related insurance reserves, and in the amortization of intangibles that may result in an increase in reserves and a decrease in net income; and changes in general economic or business conditions. These risks and uncertainties, as well others, are described in LNC’s 2008 Form 10-K, Forms 8-K, and other documents filed with the Securities and Exchange Commission. 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 presentation. • Lincoln Financial Group (LFG) is the marketing name for Lincoln National Corporation and its affiliates. Affiliates are separately responsible for their own financial and contractual obligations. • Insurance products are issued by insurance affiliates of Lincoln Financial Group