Contact Name

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

þ         ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the Fiscal Year Ended December 31, 2006

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from               to              

Commission File Number: 2-17039

NATIONAL WESTERN LIFE INSURANCE COMPANY
(Exact name of Registrant as specified in its charter)

COLORADO
84-0467208
(State of Incorporation)
(I.R.S. Employer Identification Number)

850 EAST ANDERSON LANE, AUSTIN, TEXAS 78752-1602
(Address of Principal Executive Offices)

(512) 836-1010
(Telephone Number)

Securities registered pursuant to Section 12 (b) of the Act:
None

Securities registered pursuant to Section 12 (g) of the Act:
None
(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.   Yes o   No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.  Yes o   No þ

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:  Yes 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. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated file” in Rule 12b-2 of the Exchange Act. (Check One)

Large accelerated filer  o     Accelerated filer  þ     Non-accelerated filer   o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o   No þ



The aggregate market value of the common stock (based upon the closing price) held by non-affiliates of the Registrant on June 30, 2006 was $540,988,546.

As of March 9, 2007, the number of shares of Registrant's common stock outstanding was:   Class A - 3,420,824 and Class B - 200,000.

DOCUMENTS INCORPORATED BY REFERENCE

None

2



   
     
     
 
PART I
Page
     
Business
4
Risk Factors
9
Unresolved Staff Comments
11
Properties
12
Legal Proceedings
12
Submission of Matters to a Vote of Security Holders
12
     
 
PART II
 
     
Market for Registrant's Common Equity and Related Stockholder Matters
13
Selected Consolidated Financial Data
15
Management's Discussion and Analysis of Financial Condition and Results of Operations
16
Quantitative and Qualitative Disclosures About Market Risk
42
Financial Statements and Supplementary Data
42
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
42
Controls and Procedures
42
Other Information
45
     
 
PART III
 
     
Directors and Executive Officers of the Registrant
45
Executive Compensation
48
Security Ownership of Certain Beneficial Owners and Management
65
Certain Relationships and Related Transactions
67
Principal Accountant Fees and Services
68
     
 
PART IV
 
     
Exhibits and Financial Statement Schedules
68
     
 
Signatures
129


PART I
ITEM 1. BUSINESS

General

National Western Life Insurance Company (hereinafter referred to as "National Western", "Company", or "Registrant") is a stock life insurance company, chartered in the State of Colorado in 1956, and doing business in forty-nine states, the District of Columbia, and four U.S. territories or possessions. National Western is also licensed in Haiti, and although not otherwise licensed, accepts applications from and issues policies to residents of various countries in Central and South America, the Caribbean, the Pacific Rim, Eastern Europe and Asia. Such policies are underwritten, accepted, and issued in the United States upon applications submitted by independent contractor broker-agents. The Company provides life insurance products for the savings and protection needs of approximately 149,000 policyholders and for the asset accumulation and retirement needs of 124,000 annuity contractholders.

During 2006, the Company's total assets increased 5% to $6.7 billion at December 31, 2006 from $6.4 billion at December 31, 2005. The Company generated revenues of $521.9 million, $441.0 million, and $434.1 million in 2006, 2005, and 2004, respectively. In addition, National Western generated net income of $76.3 million, $77.3 million and $122.2 million (including $54.7 million from a change in accounting principle) in 2006, 2005, and 2004, respectively.

The Company's financial information, including information in this report filed on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to the above reports, are accessible free of charge through the Company's Internet site at www.nationalwesternlife.com or may be viewed at the United States Securities and Exchange Commission ("SEC") Public Reference Room in Washington, D.C. or at the SEC's Internet site at www.sec.gov.

Products

National Western offers a broad portfolio of individual whole life, universal life and term insurance plans, and annuities, including supplementary riders.

Life Products. The Company's life products provide protection for the life of the insured and, in some cases, allow for cash value accumulation on a tax-deferred basis. These product offerings include universal life insurance ("UL"), interest-sensitive whole life, and traditional products such as term insurance coverage. Interest sensitive products such as UL accept premiums that are applied to an account value. Deducted from the account value are cost of insurance charges which vary by age, gender, plan, and class of insurance, as well as various expense charges. Interest is credited to account values at a fixed interest rate generally determined in advance and guaranteed for a policy year at a time, subject to minimum guaranteed rates specified in the policy contract. A slight variation to this general interest crediting practice involves equity-indexed universal life ("EIUL") policies whose credited interest may be linked in part to an outside index such as the S&P 500Ò Composite Stock Price Index ("S&P 500 IndexÒ") at the election of the policyholder. These products offer both flexible and fixed premium modes and provide policyholders with flexibility in the available coverage, the timing and amount of premium payments and the amount of the death benefit, provided there are sufficient policy funds to cover all policy charges for the coming year. Traditional products generally provide for a fixed death benefit payable in exchange for regular premium payments.

Annuity Products. Annuity products sold include flexible premium and single premium deferred annuities, equity-indexed annuities, and single premium immediate annuities. These products can be tax qualified or nonqualified annuities. A fixed single premium deferred annuity ("SPDA") provides for a single premium payment at the time of issue, an accumulation period, and an annuity payout period commencing at some future date. A flexible premium deferred annuity ("FPDA") provides the same features but allows, generally with some conditions, additional payments into the contract. Interest is credited to the account value of the annuity initially at a current rate of interest which is guaranteed for a period of time, typically the first year. After this period, the interest credited is subject to change based upon market rates and product profitability subject to a minimum guaranteed rate specified in the contract. Interest accrues during the accumulation period generally on a tax-deferred basis to the contractholder. After a number of years specified in the annuity contract, the owner may elect to have the proceeds paid as a single payment or as a series of payments over a period of time. The owner is permitted at any time during the accumulation period to withdraw all or part of the annuity account balance subject to contract provisions such as surrender charges and market value adjustments. An equity-indexed deferred annuity ("EIA") performs essentially in the same manner as SPDAs and FPDAs with the exception that, in addition to a fixed interest crediting option, the contractholder has the ability to elect an interest crediting mechanism that is linked, in part, to an outside index such as the S&P 500 IndexÒ. A single premium immediate annuity ("SPIA") foregoes the accumulation period and immediately commences an annuity payout period.


Distributions of the Company's direct premium revenues and deposits by product type are provided below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
Annuities:
             
Single premium deferred
 
$
8,216
   
10,389
   
8,156
 
Flexible premium deferred
   
163,415
   
225,941
   
342,509
 
Equity-indexed deferred
   
303,613
   
298,227
   
512,709
 
Single premium immediate
   
10,750
   
23,383
   
28,653
 
                     
Total annuities
   
485,994
   
557,940
   
892,027
 
                     
Universal life insurance
   
146,742
   
133,579
   
119,554
 
Traditional life and other
   
18,046
   
16,629
   
15,830
 
                     
Total direct premiums and deposits collected
 
$
650,782
   
708,148
   
1,027,411
 

Operating Segments

The Company manages its business between Domestic Insurance Operations and International Insurance Operations. For segment reporting purposes, the Company's annuity business, which is predominantly domestic, is separately identified.

Domestic Insurance Operations. The Company is currently licensed to do business in all states and the District of Columbia, except for New York. Products marketed are annuities, universal life insurance, and traditional life insurance, which include both term and whole life products. The majority of domestic sales are the Company's annuities. National Western markets and distributes its domestic products primarily through independent national marketing organizations ("NMO"). These NMOs assist the Company in recruiting, contracting, and managing independent agents. The Company's agents are independent contractors who are compensated on a commission basis. At December 31, 2006, the Company's NMO relationships had contracted approximately 10,200 independent agents with the Company. Nearly 20% of these contracted agents submitted policy applications to the Company in the past twelve months.

International Insurance Operations. National Western's international operations focus on foreign nationals in upper socioeconomic classes. Insurance products are issued primarily to residents of countries in Central and South America, the Caribbean, the Pacific Rim, Eastern Europe, and Asia. Issuing policies to residents of countries in these different regions provides diversification that helps to minimize large fluctuations that could arise due to various economic, political, and competitive pressures that may occur from one country to another. Products issued to international residents are almost entirely universal life and traditional life insurance products. However, certain annuity and investment contracts are also available. At December 31, 2006, the Company had 68,100 international life insurance policies in force representing nearly $13.3 billion in face amount of coverage.

International applications are submitted by independent contractor broker-agents, many of whom have been submitting policy applications to National Western for 20 or more years. The Company had approximately 4,000 independent international broker-agents contracted at December 31, 2006, nearly 46% of which submitted policy applications to the Company in the past twelve months.

There are some inherent risks of accepting international applications which are not present within the domestic market that are reduced substantially by the Company in several ways. As previously described, the Company accepts applications from foreign nationals in upper socioeconomic classes who have substantial financial resources. This targeted customer base coupled with National Western's conservative underwriting practices have historically resulted in claims experience, due to natural causes, similar to that in the United States. The Company minimizes exposure to foreign currency risks by requiring payment of premiums and claims in United States dollars. Finally, nearly forty years of experience with the international products and the Company's longstanding independent broker-agent relationships further serve to minimize risks.


Geographical Distribution of Business. The following table depicts the distribution of the Company's premium revenues and deposits.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
United States domestic products:
             
Annuities
 
$
475,867
   
548,967
   
882,530
 
Life insurance
   
35,780
   
36,594
   
31,501
 
                     
Total domestic products
   
511,647
   
585,561
   
914,031
 
                     
International products:
                   
Annuities
   
10,127
   
8,973
   
9,497
 
Life insurance
   
129,008
   
113,614
   
103,883
 
                     
Total international products
   
139,135
   
122,587
   
113,380
 
                     
Total direct premiums and deposits collected
 
$
650,782
   
708,148
   
1,027,411
 

Although many agents sell National Western's products, the Company's annuity sales in any year typically reflect one or two NMOs whose agents sold 10% or more of the Company’s total annuity sales. In 2006, there were two such NMOs who accounted for 22.1% and 12.2% of total annuity sales, respectively. Similarly, domestic life insurance sales in any year may include one or two NMOs who accounted for 10% or more of total domestic life insurance sales. In 2006, there were two NMOs who generated 22.8% and 13.3%, respectively, of total domestic life insurance sales. These NMOs were not the same NMOs who produced more than 10% of total annuity sales. International life insurance sales are much more diversified by agency and in 2006 were geographically attributed to Latin America (75%), the Pacific Rim (13%), and Eastern Europe (12%).

Segment Financial Information. A summary of financial information for the Company's segments is as follows:

   
Domestic
 
International
             
   
Life
 
Life
     
All
     
   
Insurance
 
Insurance
 
Annuities
 
Others
 
Totals
 
   
(In thousands)
 
Revenues, excluding
                 
realized gains (losses):
                 
2006
 
$
43,222
   
106,613
   
350,665
   
18,697
   
519,197
 
2005
   
42,165
   
93,577
   
277,889
   
17,528
   
431,159
 
2004
   
44,116
   
87,850
   
283,827
   
14,847
   
430,640
 
                               
Segment earnings: (A)
                               
2006
 
$
297
   
12,191
   
56,559
   
5,566
   
74,613
 
2005
   
2,809
   
13,559
   
47,915
   
6,559
   
70,842
 
2004
   
2,522
   
12,133
   
45,473
   
5,066
   
65,194
 
                               
Segment assets: (B)
                               
2006
 
$
381,490
   
715,064
   
5,467,733
   
103,087
   
6,667,374
 
2005
   
366,939
   
631,477
   
5,256,146
   
94,064
   
6,348,626
 
2004
   
361,176
   
568,723
   
4,960,837
   
84,481
   
5,975,217
 

Notes to Table:

(A) Amounts exclude realized gains and losses on investments, net of taxes.
(B) Amounts exclude other unallocated assets.


Additional information concerning these industry segments is included in Note 13, Segment and Other Operating Information, of the accompanying consolidated financial statements.

Competition and Ratings

National Western competes with over 400 life and health insurance company groups in the United States consisting of approximately 2,000 companies, as well as other financial intermediaries such as banks and securities firms who market insurance products. Competitive factors are primarily the breadth and quality of products offered, established positions in niche markets, pricing, relationships with distribution, commission structures, perceived stability of the insurer, quality of underwriting and customer service, and cost efficiency. Operating results of life insurers are subject to fluctuations not only from this competitive environment but also due to economic conditions, interest rate levels and changes, performance of investments, and the maintenance of strong insurance ratings from independent rating agencies.

In order to compete successfully, life insurers have turned their attention toward distribution, technology, defined end market targets, speed to the market in terms of product development, and customer relationship management as ways of gaining a competitive edge. The Company's management believes that it competes primarily on the basis of its longstanding reputation for commitment in serving international markets, its financial strength and stability, and its ability to attract and retain distribution based upon product and compensation.

Ratings with respect to financial strength are an important factor in establishing the competitive position of insurance companies. Ratings are important to maintaining public confidence and impact the ability to market products. The following summarizes the Company's financial strength ratings.

Rating Agency
Rating
   
Standard & Poor's
A (Strong)
   
A.M. Best
A- (Excellent)

A.M. Best and Standard & Poor’s ratings are a consideration of the Company’s claims paying ability and are not a rating of the Company’s investment worthiness. The rating agencies generally review the Company's rating on an annual basis during the second calendar quarter of the year. The above ratings were assigned with a stable outlook during 2006. However, there is no assurance that the Company's ratings will continue for a certain period of time or that they will not be changed. In the event the Company's ratings are downgraded, the Company's business may be negatively impacted.

Risk Management

The Company's product designs, underwriting standards and risk management techniques are utilized to protect against disintermediation risk and greater than expected mortality and morbidity risk. Disintermediation risk is limited through the use of surrender charges, certain provisions not allowing surrender of the policy, and market value adjustment features. Investment guidelines including duration targets, asset allocation tolerances and return objectives help to ensure that disintermediation risk is managed within the constraints of profitability criteria. Prudent underwriting is applied to select and price insurance risks and the Company regularly monitors mortality experience relative to its product pricing assumptions. Enforcement of disciplined claims management serves to further protect against greater than expected mortality.

A significant aspect of the Company’s business is managing the linkage of its asset characteristics with the anticipated behavior of its policy obligations and liabilities, a process commonly referred to as asset-liability matching. The Company maintains an Asset-Liability Committee (“ALCO”) consisting of senior level members of the Company who assist and advise the Company’s Board of Directors in monitoring the level of risk the Company is exposed to in managing its assets and liabilities in order to attain the risk-return profile desired. Certain members of the ALCO meet as frequently as necessary, to review and recommend for board of director ratification, current period interest crediting rates to policyholders based upon existing and anticipated investment opportunities. These rates apply to new sales and to products after an initial guaranteed period, if applicable. Rates are established after the initial guaranteed period based upon asset portfolio yields and each product’s required interest spread, taking into consideration current competitive market conditions.


Substantially all international products contain a currency clause stating that premium and claim "dollars" refer to lawful currency of the United States. Policy applications submitted by international insurance brokers are generally associated with individuals in upper socioeconomic classes who desire the stability and inflationary hedge of dollar denominated insurance products issued by the Company. The favorable demographics of this group typically results in a higher average policy size, and persistency and claims experience (from natural causes) similar to that in the United States. By accepting applications submitted on residents outside the United States, the Company is able to further diversify its revenue, earnings, and insurance risk.

The Company follows the industry practice of reinsuring (ceding) portions of its insurance risks with a variety of reinsurance companies. The use of reinsurance allows the Company to underwrite policies larger than the risk it is willing to retain on any single life and to continue writing a larger volume of new business. The maximum amount of life insurance the Company normally retains is $250,000 on any one life subject to a minimum reinsurance session of $50,000. However, the use of reinsurance does not relieve the Company of its primary liability to pay the full amount of the insurance benefit in the event of the failure of a reinsurer to honor its contractual obligation. Consequently, the Company avoids concentrating reinsurance risk with any one reinsurer and only participates in reinsurance treaties with reputable carriers.

The Company maintains a system of disclosure controls and procedures, including internal controls designed to provide reasonable assurance that assets are safeguarded and transactions are properly authorized, executed and recorded. The Company recognizes the importance of full and open presentation of its financial position and operating results and to this end maintains a Disclosure Controls and Procedures Committee comprised of senior executives who possess comprehensive knowledge of the Company's business and operations. This Committee is responsible for evaluating disclosure controls and procedures and for the gathering, analyzing, and disclosing of information as required to be disclosed under the securities laws. It assists the Chief Executive Officer and Chief Financial Officer in their responsibilities of making the certifications required under the securities laws regarding the Company's disclosure controls and procedures. It ensures that material financial information is properly communicated up the Company's hierarchy to the appropriate person or persons and that all disclosures are made in a timely fashion. This Committee reports directly to the Audit Committee of the Company.

Regulatory and Other Issues

Regulation. The Company's insurance business is subject to comprehensive state regulation in each of the states it is licensed to conduct business. The laws enforced by the various state insurance departments provide broad administrative powers with respect to licensing to transact business, licensing and appointing agents, approving policy forms, regulating unfair trade and claims practices, establishing solvency standards, fixing minimum interest rates for the accumulation of surrender values, and regulating the type, amounts, and valuations of permitted investments, among other things. The Company is required to file detailed annual statements with each of the state insurance supervisory departments in which it does business. The Company's operations and financial records are subject to examination by these departments at regular intervals. Statutory financial statements are prepared in accordance with accounting practices prescribed or permitted by the Colorado Division of Insurance, the Company's principal insurance regulator. Prescribed statutory accounting practices are largely dictated by the Statutory Accounting Principles adopted by the National Association of Insurance Commissioners ("NAIC").

The NAIC, as well as state regulators, continually evaluates existing laws and regulations pertaining to the operations of life insurers. To the extent that initiatives result as a part of this process, they may be adopted in the various states in which the Company is licensed to do business. It is not possible to predict the ultimate content and timing of new statutes and regulations adopted by state insurance departments and the related impact upon the Company's operations although it is conceivable that they may be more restrictive.

Although the federal government does not directly regulate the life insurance industry, federal measures previously considered or enacted by Congress, if revisited, could affect the insurance industry and the Company's business. These measures include the tax treatment of life insurance companies and life insurance products, as well as changes in individual income tax structures and rates. Even though the ultimate impact of any of these changes, if implemented, is uncertain, the persistency of the Company's existing products and the ability to sell products could be materially affected.


Risk-Based Capital Requirements. The NAIC established risk-based capital ("RBC") requirements to help state regulators monitor the financial strength and stability of life insurers by identifying those companies that may be inadequately capitalized. Under the NAIC's requirements, each insurer must maintain its total capital above a calculated threshold or take corrective measures to achieve the threshold. The threshold of adequate capital is based on a formula that takes into account the amount of risk each company faces on its products and investments. The RBC formula takes into consideration four major areas of risk which are: (i) asset risk which primarily focuses on the quality of investments; (ii) insurance risk which encompasses mortality and morbidity risk; (iii) interest rate risk which involves asset-liability matching issues; and (iv) other business risks. For each category, the RBC requirements are determined by applying specified factors to various assets, premiums, reserves, and other items, with the factor being higher for items with greater underlying risk and lower for items with less risk. The Company's statutory capital and surplus at December 31, 2006, was significantly in excess of the threshold RBC requirements.

Effects of Inflation. The rate of inflation as measured by the change in the average consumer price index has not had a material effect on the revenues or operating results of the Company during the three most recent fiscal years.

Employees. The Company had approximately 273 employees as of December 31, 2006 substantially all of which worked in the Company’s home office in Austin, Texas.


ITEM 1A. RISK FACTORS

Company performance is subject to varying risk factors. If any of the following risks manifests into actual occurrences, the Company’s operations, financial position or financial performance could be negatively impacted.

We are subject to changing interest rates, market volatility, and general economic conditions which may affect the risk and returns on both our investment portfolio and our products.

We are exposed to significant capital market risk related to changes in interest rates. Substantial and sustained changes, up or down, in market interest rate levels can materially affect the profitability of our products, the market value of our investments, and ultimately the reported amount of stockholders’ equity.

A rise in interest rates will increase the net unrealized loss position of our investment portfolio and may subject the Company to disintermediation risk. Disintermediation risk is the risk that policyholders may surrender their contracts in a rising interest rate environment, requiring the Company to liquidate investments in an unrealized loss position (i.e. the market value less than the carrying value of the investments). With respect to fixed income security investments the Company maintains in an “Available for Sale” category, rising interest rates will cause declines in the market value of these securities. These declines are reported in our financial statements as an unrealized investment loss and a reduction of stockholders’ equity.

A decline in interest rates could expose the Company to reduced profitability due to minimum interest rate guarantees that are required in our products by regulation. A key component of profitability is investment spread, or the difference between the yield on our investments and the rates we credit to policyholders on our products. A narrowing of investment spreads could negatively affect operating results. Although the Company has the ability to adjust the rates credited on products in order to maintain our required investment spread, a significant decline in interest rate levels could affect investment yields to the point where the investment spread is compromised due to minimum interest rate guarantees. In addition, the potential for increased policy surrenders and cash withdrawals, competitor activities, and other factors could further limit the Company’s ability to maintain crediting rates on its products at levels necessary to avoid sacrificing investment spread.

We are subject to general domestic and international economic conditions that may be less favorable than currently exists or is anticipated.

The demand for financial and insurance products is subject to factors such as consumer sentiment and behavior, business investment and government spending, the volatility and strength of capital markets, inflation, and overall economic climate. Further, since we accept applications from residents in North America, Latin America, Eastern Europe and the Pacific Rim, we are exposed to economic conditions in multiple geographic locations. Economic downturns in any of these geographic locations characterized by political, social or economic instability, higher unemployment, lower family income or consumer spending could negatively affect the demand for the Company’s products. Accordingly, the Company’s overall success depends, in part, upon the ability to succeed despite these differing and dynamic conditions.


Our investment portfolio is subject to credit quality risks which may lessen the value of invested assets and the Company’s book value per share.

The Company substantially invests monies received in investment grade, fixed income investment securities in order to meet its obligations to policyholders and provide a return on its deployed capital. Consequently, we are subject to the risk that issuers of these securities may default on principal and interest payments, particularly in the event of a major downturn in economic and/or business climate. At December 31, 2006, approximately 2.7% of the Company’s $5.5 billion fixed income securities portfolio was comprised of issuers who were investment grade at the time the Company acquired them but were subsequently downgraded for various reasons. A substantial increase in defaults from these or other issuers could negatively impact the Company’s financial position and results.

For the Company’s equity-indexed products, over the counter derivative instruments are purchased from a number of highly rated counterparties to fund the equity-index credit to policyholders. In the event that any of these counterparties fails to meet their contractual obligations under these derivative instruments, the Company would be financially at risk for providing the credits due that the counterparty reneged on. The failure of the counterparty to perform could negatively impact the Company’s financial position and results.

We are subject to incurring difficulties in marketing and distributing our products through our current and future distribution channels.

The Company distributes its life and annuity products through independent broker-agents. There is substantial competition, particularly in the Company’s domestic market, for independent broker-agents with the demonstrated ability to market and sell insurance products. Competition for these individuals or organizations typically centers on products, compensation, home office support and the insurer’s financial strength ratings. The Company’s future sales and financial condition are dependent upon avoiding significant interruptions in attracting and retaining independent broker-agents.

We are subject to a downgrade in our financial strength ratings which may negatively effect our ability to attract and retain independent distributors, make our products less attractive to consumers, and may have an adverse effect on our operations.

Financial strength ratings have grown to become an important criteria in establishing the competitive position of insurers. Ratings generally reflect the rating agencies’ view of a particular company’s financial strength, operating performance, and ability to meet its obligations to policyholders. However, some of the rating factors often relate to the particular views of the rating agency, their independent economic modeling, the general economic climate, and other circumstances outside of the insurer’s control. Accordingly, we cannot predict with any certainty what actions rating agencies may take. A downgrade in our financial strength rating, or an announced potential downgrade, could affect our competitive position and make it more difficult to market our products vis-à-vis competitors with higher financial strength ratings. In extreme situations, a significant downgrade action by one or more rating agency could induce existing policyholders to cancel their policies and withdraw funds from the Company. These events could have a material adverse effect on our financial position and liquidity.

We are subject to competition from new sources as well as companies having substantially greater financial resources which could have an adverse impact upon our business levels and profitability.

In recent years, there has been considerable consolidation among companies in the insurance and financial sectors resulting in large, well-capitalized entities that offer products comparable to the Company. Frequently, these larger organizations are not domiciled in the United States or are financial services entities attempting to establish a position in the insurance industry. These larger competitors often enjoy economies of scale which produce lower operating costs and the wherewithal to absorb greater risk allowing them to price products more competitively and, in turn, attract independent distributors. Consequently, the Company may encounter additional product pricing pressures and be challenged to maintain profit margin targets and profitability criteria. Because of these competitive presences, the Company may not be able to effectively compete without negative affects on our financial position and results.


We are subject to regulation and changes to existing laws that may affect our profitability or means of operations.

The Company is subject to extensive laws and regulations which are complex and subject to change. In addition, these laws and regulations are enforced by a number of different authorities including, but not limited to, state insurance regulators, the Securities and Exchange Commission, state attorney generals, and the U.S. Department of Justice. Compliance with these laws and regulations is time consuming and any changes may materially increase our compliance costs and other expenses of doing business. The regulatory framework at the state and, increasingly, federal level pertaining to insurance products and practices is advancing and could affect not only the design of our products but our ability to continue to sell certain products.

Life insurer products generally offer tax advantages to policyholders via the deferral of income tax on policy earnings during the accumulation phase of the product, be it an annuity or a life insurance product. Periodically, Congress has considered legislation that would reduce or eliminate this tax deferral advantage inherent to the life insurance industry and subject the industry’s products to treatment more equivalent with other investments. In the event that the tax-deferred status of life insurance products is revised or reduced by Congress all life insurers would be adversely impacted.

We may be subject to unfavorable judicial developments, including the time and expense of litigation, which potentially could affect our financial position and results.

In the ordinary course of business, we are involved in various legal actions common to the life insurance industry, some of which may occasionally assert claims for large amounts. These actions, for example, could include allegations of improper sales practices in connection with the sale of life insurance or bad faith in the handling of insurance claims. While we are not a party to any lawsuit that we believe will have a material adverse effect on our financial position or operations, given the inherent unpredictability of litigation, there can be no assurance that such litigation, current or in the future, will not have such a material adverse effect on the Company’s results of operation or cash flows in any particular reporting period.

We are subject to policy claims experience which can fluctuate from period to period and vary from past results or expectations.

The Company’s earnings are significantly influenced by policy claims received and will vary from period to period depending upon the amount of claims incurred. In any given quarter or year, there is very limited predictability of claims experience. The liability established for future policy benefits is based upon a number of different factors. In the event our future claim experience does not match our past results or pricing assumptions, our operating results could be materially and adversely affected.

We are subject to assumption inaccuracies regarding future mortality, persistency, and interest rates used in determining deferred policy acquisition costs. 

Deferred policy acquisition costs (and deferred sales inducement amounts) are calculated using a number of assumptions related to policy persistency, mortality and interest rates. Actual results could differ significantly from the related assumptions which could have a material and adverse impact on the Company’s operating results.

We are dependent upon managing ever-evolving technology initiatives for effectively managing the Company’s business.

The Company’s business operations are technology dependent for maintaining accurate records, administering complex contract provisions, and complying with increasingly demanding regulation. While systems developments can streamline many processes and in the long term reduce the cost of doing business, these initiatives can present short-term cost and implementation risks. Projections of expenses, implementation time frames and the ultimate enhancement values may be different from expectations and escalate over time. The Company also faces rising costs and time constraints in meeting data security compliance requirements of new and proposed regulations. The increasing volume and sophistication of computer viruses, hackers and other external threats may increase the vulnerability of the Company’s systems to data breaches. These increased risks and expanding requirements expose the Company to potential data loss and damages and significant increases in compliance and litigation costs.


ITEM 1B. UNRESOLVED STAFF COMMENTS

None.


ITEM 2. PROPERTIES

The Company leases approximately 72,000 square feet of office space in Austin, Texas. This lease expires in 2010 and specifies lease payments that gradually increase over the term of the lease. Currently, lease payments are $0.6 million per year plus taxes, insurance, maintenance, and other operating costs. Additionally, the Company’s wholly-owned subsidiary, The Westcap Corporation, owns two buildings adjacent to the Company’s principal office space totaling approximately 21,000 square feet that are leased and utilized by the Company. The Company’s affiliate, Regent Care Building, Limited Partnership, owns a 65,000 square foot building in Reno, Nevada, which is leased and utilized by another of the Company’s affiliates, Regent Care Operations, Limited Partnership, for use in its nursing home operations. Lease costs and related operating expenses for facilities of the Company’s subsidiaries are currently not significant in relation to the Company’s consolidated financial statements. The intercompany lease costs related to The Westcap Corporation and the nursing home have been eliminated for consolidated reporting purposes.

ITEM 3. LEGAL PROCEEDINGS

In the course of an audit of a charitable tax-exempt foundation, the Internal Revenue Service (“IRS”) raised an issue under the special provisions of the Internal Revenue Code (“IRC”) governing tax-exempt private foundations as to certain interest-bearing loans from the Company to another corporation in which the tax-exempt foundation owns stock. The issue is whether such transactions constitute indirect self-dealing by the foundation, the result of which would be excise taxes on the Company by virtue of its participation in such transactions. By letter to the Company dated August 21, 2003, the IRS proposed an initial excise tax liability in the total amount approximating one million dollars as a result of such transactions. The Company disagrees with the IRS analysis. The Company is contesting the matter and expects to prevail on the merits. On October 14, 2003, in response to the IRS letter, the Company requested that this issue instead be referred to the IRS National Office for technical advice. The IRS audit team agreed and the matter was referred in November of 2003 to the IRS National Office. Such technical advice when issued by the IRS National Office will be in the form of a memorandum analyzing the issue which will be binding on the IRS audit team.

The Company is a defendant in three class action lawsuits, and one class has been certified regarding an alleged violation of section 17200 of the California Business and Professions Code. Management believes that the Company has good and meritorious defenses and intends to continue to vigorously defend itself against these claims.

The Company is involved or may become involved in various other legal actions, in the normal course of business, in which claims for alleged economic and punitive damages have been or may be asserted, some for substantial amounts. Although there can be no assurances, at the present time, the Company does not anticipate that the ultimate liability arising from potential, pending, or threatened legal actions, will have a material adverse effect on the financial condition or operating results of the Company.


ITEM 4. SUBMISSION OF MATTERS TO A VOTE
OF SECURITY HOLDERS

No matters were submitted to a vote of the Company’s security holders during the fourth quarter of 2006.



PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS

Market Information

The principal market on which the Class A common stock of the Company trades is The NASDAQ Stock Market® under the symbol “NWLIA”. The high and low sales prices for the Class A common stock for each quarter during the last two years are shown in the following table.

     
High
 
Low
           
2006:
First Quarter
$
232.29
 
200.00
 
Second Quarter
 
239.65
 
209.00
 
Third Quarter
 
237.36
 
222.59
 
Fourth Quarter
 
243.00
 
224.05
 
         
2005:
First Quarter
$
175.85
 
166.63
 
Second Quarter
 
197.99
 
160.00
 
Third Quarter
 
213.70
 
194.69
 
Fourth Quarter
 
220.00
 
181.95

Equity Security Holders

The number of stockholders of record on March 9, 2007 was as follows:

 
Class A Common Stock
 
4,635
 
Class B Common Stock
 
2

Dividends

During 2006, the Company paid cash dividends on its Class A and Class B common stock in the amounts of $1,231,497 and $36,000, respectively. During 2005, the Company paid cash dividends on its Class A and Class B common stock in the amounts of $1,160,017 and $34,000, respectively. Payment of dividends is within the discretion of the Company’s Board of Directors. The Company’s general policy is to reinvest earnings internally to finance the development of new business.

Securities Authorized For Issuance Under Equity Compensation Plans

The Company has one equity compensation plan that was approved by security holders. Under the plan, 128,465 shares of the Company’s Class A common stock may be issued upon exercise of the outstanding options at December 31, 2006. The weighted average exercise price of the outstanding options is $123.00 per option. Excluding the outstanding options, 26,477 shares of the common stock remain available for future issuance under the plan at December 31, 2006. The Company has no equity compensation plans that have not been approved by security holders.


Performance Graph

The following graph compares the change in the Company's cumulative total stockholder return on its common stock with the NASDAQ - U.S. Companies Index and the NASDAQ Insurance Stock Index. The graph assumes that the value of the Company's common stock and each index was $100 at December 31, 2001, and that all dividends were reinvested.







ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following five-year financial summary includes comparative amounts derived from the audited consolidated financial statements.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
2003
 
2002
 
   
(In thousands except per share amounts)
 
Earnings Information:
                     
Revenues:
                     
Life and annuity premiums
 
$
15,805
   
14,602
   
14,025
   
13,916
   
13,918
 
Universal life and annuity contract
                               
revenues
   
106,320
   
96,765
   
89,513
   
80,964
   
76,173
 
Net investment income
   
379,768
   
310,213
   
315,843
   
298,974
   
236,714
 
Other income
   
17,304
   
9,579
   
11,259
   
7,061
   
6,726
 
Realized gains (losses) on
                               
investments
   
2,662
   
9,884
   
3,506
   
(1,647
)
 
(16,144
)
Total revenues
   
521,859
   
441,043
   
434,146
   
399,268
   
317,387
 
Benefits and expenses:
                               
Life and other policy benefits
   
35,241
   
39,162
   
34,613
   
37,180
   
31,299
 
Amortization of deferred policy
                               
acquisition costs
   
90,358
   
87,955
   
88,733
   
53,829
   
35,799
 
Universal life and investment
                               
annuity contract interest
   
213,736
   
150,692
   
173,315
   
176,374
   
150,479
 
Other operating expenses
   
65,709
   
46,349
   
35,441
   
48,776
   
36,938
 
Total expenses
   
405,044
   
324,158
   
332,102
   
316,159
   
254,515
 
Earnings before Federal income taxes
                               
and cumulative effect of change in
                               
accounting principle
   
116,815
   
116,885
   
102,044
   
83,109
   
62,872
 
Federal income taxes
   
40,472
   
39,618
   
34,572
   
27,327
   
20,806
 
Earnings before cumulative effect of
                               
change in accounting principle
   
76,343
   
77,267
   
67,472
   
55,782
   
42,066
 
Cumulative effect or change in
                               
accounting principle, net of tax
   
-
   
-
   
54,697
   
-
   
-
 
Net earnings
 
$
76,343
   
77,267
   
122,169
   
55,782
   
42,066
 
                                 
                                 
Diluted Earnings Per Share:
                               
Earnings from operations
 
$
20.88
   
21.24
   
18.73
   
15.64
   
11.84
 
Cumulative effect of change in
                               
accounting principle
   
-
   
-
   
15.18
   
-
   
-
 
Net earnings
 
$
20.88
   
21.24
   
33.91
   
15.64
   
11.84
 
                                 
Balance Sheet Information:
                               
                                 
Total assets
 
$
6,693,443
   
6,369,008
   
5,991,685
   
5,297,720
   
4,137,247
 
                                 
Total liabilities
 
$
5,760,459
   
5,495,000
   
5,183,013
   
4,617,862
   
3,530,041
 
                                 
Stockholders’ equity
 
$
932,984
   
874,008
   
808,672
   
679,858
   
607,206
 
                                 
Book value per common share
 
$
257.67
   
241.89
   
225.62
   
191.69
   
172.26
 


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. Certain information contained herein or in other written or oral statements made by or on behalf of National Western Life Insurance Company or its subsidiaries are or may be viewed as forward-looking. Although the Company has taken appropriate care in developing any such information, forward-looking information involves risks and uncertainties that could significantly impact actual results. These risks and uncertainties include, but are not limited to, matters described in the Company’s SEC filings such as exposure to market risks, anticipated cash flows or operating performance, future capital needs, and statutory or regulatory related issues. However, National Western, as a matter of policy, does not make any specific projections as to future earnings, nor does it endorse any projections regarding future performance that may be made by others. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments. Also, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future developments, or otherwise.

Management’s discussion and analysis of financial condition and results of operations (“MD&A”) of National Western Life Insurance Company for the three years ended December 31, 2006 follows. This discussion should be read in conjunction with the Company’s consolidated financial statements and related notes beginning on page 74 of this report.

Overview

The Company provides life insurance products on a global basis for the savings and protection needs of policyholders and annuity contracts for the asset accumulation and retirement needs of contractholders both domestically and internationally. The Company accepts funds from policyholders or contractholders and establishes a liability representing future obligations to pay the policy or contract-holders and their beneficiaries. To ensure the Company will be able to pay these future commitments, the funds received as premium payments and deposits are invested in high quality investments, primarily fixed income securities.

Due to the business of accepting funds to pay future obligations in later years, the underlying economics and relevant factors affecting the life insurance industry include the following:

Ÿ  
level of premium revenues collected
Ÿ  
persistency of policies and contracts
Ÿ  
returns on investments
Ÿ  
investment credit quality
Ÿ  
levels of policy benefits and costs to acquire business
Ÿ  
effect of interest rate changes on revenues and investments including asset and liability matching
Ÿ  
adequate levels of capital and surplus

The Company monitors these factors continually as key business indicators. The discussion below includes these indicators and presents information useful to an overall understanding of the Company’s business performance in 2006, incorporating required disclosures in accordance with the rules and regulations of the Securities and Exchange Commission.



Critical Accounting Policies

Accounting policies discussed below are those considered critical to an understanding of the Company’s financial statements.

Impairment of Investment Securities.  The Company’s accounting policy requires that a decline in the value of a security below its amortized cost basis be evaluated to determine if the decline is other-than-temporary. The primary factors considered in evaluating whether a decline in value for fixed income and equity securities is other-than-temporary include: (a) the length of time and the extent to which the fair value has been less than cost, (b) the financial conditions and near-term prospects of the issuer, (c) whether the debtor is current on contractually obligated principal and interest payments, and (d) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for any anticipated recovery. In addition, certain securitized financial assets with contractual cash flows are evaluated periodically by the Company to update the estimated cash flows over the life of the security. If the Company determines that the fair value of the securitized financial asset is less than its carrying amount and there has been a decrease in the present value of the estimated cash flows since the previous estimate, then an other-than-temporary impairment charge is recognized. When a security is deemed to be impaired a charge is recorded as net realized losses equal to the difference between the fair value and amortized cost basis of the security. Once an impairment charge has been recorded, the fair value of the impaired investment becomes its new cost basis and the Company continues to review the other-than-temporarily impaired security for appropriate valuation on an ongoing basis. Under U.S. generally accepted accounting principles, the Company is not permitted to increase the basis of impaired securities for subsequent recoveries in value.

Deferred Acquisition Costs (“DAC”).  The Company is required to defer certain policy acquisition costs and amortize them over future periods. These costs include commissions and certain other expenses that vary with and are primarily associated with acquiring new business. The deferred costs are recorded as an asset commonly referred to as deferred policy acquisition costs. The DAC asset balance is subsequently charged to income over the lives of the underlying contracts in relation to the anticipated emergence of revenue or profits. Actual revenue or profits can vary from Company estimates resulting in increases or decreases in the rate of amortization. The Company regularly evaluates to determine if actual experience or other evidence suggests that earlier estimates should be revised. Assumptions considered significant include surrender and lapse rates, mortality, expense levels, investment performance, and estimated interest spread. Should actual experience dictate that the Company change its assumptions regarding the emergence of future revenues or profits (commonly referred to as “unlocking”), the Company would record a charge or credit to bring its DAC balance to the level it would have been if using the new assumptions from the inception date of each policy.

DAC is also subject to periodic recoverability and loss recognition testing. These tests ensure that the present value of future contract-related cash flows will support the capitalized DAC balance to be amortized in the future. The present value of these cash flows, less the benefit reserve, is compared with the unamortized DAC balance and if the DAC balance is greater, the deficiency is charged to expense as a component of amortization and the asset balance is reduced to the recoverable amount. For more information about accounting for DAC see Note 1, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.

Deferred Sales Inducements.  Costs related to sales inducements offered on sales to new customers, principally on investment type contracts and primarily in the form of additional credits to the customer’s account value or enhancements to interest credited for a specified period, which are beyond amounts currently being credited to existing contracts, are deferred and recorded as other assets. All other sales inducements are expensed as incurred and included in interest credited to contract holders’ funds. Deferred sales inducements are amortized to income using the same methodology and assumptions as DAC, and are included in interest credited to contract holders’ funds. Deferred sales inducements are periodically reviewed for recoverability.


Future Policy Benefits.  Because of the long-term nature of insurance contracts, the Company is liable for policy benefit payments many years into the future. The liability for future policy benefits represents estimates of the present value of the Company’s expected benefit payments, net of the related present value of future net premium collections. For traditional life insurance contracts, this is determined by standard actuarial procedures, using assumptions as to mortality (life expectancy), morbidity (health expectancy), persistency, and interest rates, which are based on the Company’s experience with similar products. The assumptions used are those considered to be appropriate at the time the policies are issued. An additional provision is made on most products to allow for possible adverse deviation from the assumptions assumed. For universal life and annuity products, the Company’s liability is the amount of the contract’s account balance. Account balances are also subject to minimum liability calculations as a result of minimum guaranteed interest rates in the policies. While management and Company actuaries have used their best judgment in determining the assumptions and in calculating the liability for future policy benefits, there is no assurance that the estimate of the liabilities reflected in the financial statements represents the Company’s ultimate obligation. In addition, significantly different assumptions could result in materially different reported amounts. A discussion of the assumptions used to calculate the liability for future policy benefits is reported in Note 1, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.

Revenue Recognition.  Premium income for the Company’s traditional life insurance contracts is generally recognized as the premium becomes due from policyholders. For annuity and universal life contracts, the amounts collected from policyholders are considered deposits and are not included in revenue. For these contracts, fee income consists of policy charges for policy administration, cost of insurance charges and surrender charges assessed against policyholders’ account balances which are recognized in the period the services are provided.

Investment activities of the Company are integral to its insurance operations. Since life insurance benefits may not be paid until many years into the future, the accumulation of cash flows from premium receipts are invested with income reported as revenue when earned. Anticipated yields on investments are reflected in premium rates, contract liabilities, and other product contract features. These anticipated yields are implied in the interest required on the Company’s net insurance liabilities (future policy benefits less deferred acquisition costs) and contractual interest obligations in its insurance and annuity products. The Company benefits to the extent actual net investment income exceeds the required interest on net insurance liabilities and manages the rates it credits on its products to maintain the targeted excess or “spread” of investment earnings over interest credited. The Company will continue to be required to provide for future contractual obligations in the event of a decline in investment yield. For more information concerning revenue recognition, investment accounting, and interest sensitivity, please refer to Note 1, Summary of Significant Accounting Policies, and Note 3, Investments, in the Notes to Consolidated Financial Statements and the discussions under Investments in Item 7 of this report.

Pension Plans and Other Postretirement Benefits.  The Company sponsors a qualified defined benefit pension plan covering substantially all employees and three nonqualified defined benefit plans covering certain senior officers. In addition, the Company also has postretirement health care benefits for certain senior officers. In accordance with prescribed accounting standards, the Company annually reviews plan assumptions.

The Company annually reviews its pension benefit plan assumptions which include the discount rate, the expected long-term rate of return on plan assets, and the compensation increase rate. The assumed discount rate is set based on the rates of return on high quality long-term fixed income investments currently available and expected to be available during the period to maturity of the pension benefits. The assumed long-term rate of return on plan assets is generally set at the rate expected to be earned based on long-term investment policy of the plans and the various classes of the invested funds, based on the input of the plan’s investment advisors and consulting actuary and the plan’s historic rate of return. The compensation rate increase assumption is generally set at a rate consistent with current and expected long-term compensation and salary policy, including inflation. These assumptions involve uncertainties and judgment and therefore actual performance may not be reflective of the assumptions.

Other postretirement benefit assumptions include future events affecting retirement age, mortality, dependency status, per capita claims costs by age, health care trend rates, and discount rates. Per capita claims cost by age is the current cost of providing postretirement health care benefits for one year at each age from the youngest age to the oldest age at which plan participants are expected to receive benefits under the plan. Health care trend rates involve assumptions about the annual rate(s) of change in the cost of health care benefits currently provided by the plan, due to factors other than changes in the composition of the plan population by age and dependency status. These rates implicitly consider estimates of health care inflation, changes in utilization, technological advances and changes in health status of the participants. These assumptions involve uncertainties and judgment, and therefore actual performance may not be reflective of the assumptions.


Share-Based Payments.  Liability awards under a share-based payment arrangement have been measured based on the award's fair value at the reporting date. The Black-Scholes valuation method has been used to estimate the fair value of the options. This fair value calculation of the options include assumptions relative to the following:

Ÿ  
exercise price
Ÿ  
expected term based on contractual term and perceived future behavior relative to exercise
Ÿ  
current price
Ÿ  
expected volatility
Ÿ  
risk-free interest rates

These assumptions are continually reviewed by the Company and adjustments may be made based upon current facts and circumstances.

Other significant accounting policies, although not involving the same level of measurement uncertainties as those discussed above but nonetheless important to an understanding of the financial statements, are described in Note 1, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.


RESULTS OF OPERATIONS

The Company’s consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). In addition, the Company regularly evaluates operating performance using non-GAAP financial measures which exclude or segregate derivative and realized investment gains and losses from operating revenues and earnings. Similar measures are commonly used in the insurance industry in order to assess profitability and results from ongoing operations. The Company believes that the presentation of these non-GAAP financial measures enhances the understanding of the Company’s results of operations by highlighting the results from ongoing operations and the underlying profitability factors of the Company’s business. The Company excludes or segregates derivative and realized investment gains and losses because such items are often the result of events which may or may not be at the Company’s discretion and the fluctuating effects of these items could distort trends in the underlying profitability of the Company’s business. Therefore, in the following sections discussing consolidated operations and segment operations, appropriate reconciliations have been included to report information management considers useful in enhancing an understanding of the Company’s operations to reportable GAAP balances reflected in the consolidated financial statements.

Consolidated Operations

Revenues.  The following details Company revenues.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Universal life and annuity contract revenues
 
$
106,320
   
96,765
   
89,513
 
Traditional life and annuity premiums
   
15,805
   
14,602
   
14,025
 
Net investment income (excluding derivatives)
   
336,489
   
321,201
   
303,855
 
Other income
   
17,304
   
9,579
   
11,259
 
                     
Operating revenues
   
475,918
   
442,147
   
418,652
 
Derivative income (loss)
   
43,279
   
(10,988
)
 
11,988
 
Realized gains on investments
   
2,662
   
9,884
   
3,506
 
                     
Total revenues
 
$
521,859
   
441,043
   
434,146
 

Universal life and annuity contract revenues - Revenues for universal life and annuity products consist of policy charges for the cost of insurance, administration charges, and surrender charges assessed against policyholder account balances, less reinsurance premiums. The Company has experienced modest growth in its life block of businesses. This growth contributes to higher revenues in the form of cost of insurance charges which were $67.7 million in 2006 compared to $63.3 million in 2005, and $60.1 million in 2004. Administrative charges were $17.1 million, $15.0 million, and $13.0 million for the years ended December 31, 2006, 2005, and 2004, respectively. Surrender charges assessed against policyholder account balances upon withdrawal were $28.7 million in 2006 compared to $25.1 million in 2005 and $23.4 million in 2004.


Traditional life and annuity premiums - Traditional life insurance premiums for products such as whole life and term life are recognized as revenues over the premium-paying period. These are product lines that the Company has not put as much emphasis on relative to interest sensitive products, particularly in its international life insurance operations.

Net investment income - A detail of net investment income is provided below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
Gross investment income:
             
Debt securities
 
$
306,129
   
293,502
   
276,624
 
Mortgage loans
   
8,480
   
9,676
   
12,510
 
Policy loans
   
6,354
   
6,409
   
6,483
 
Other investment income
   
18,407
   
13,975
   
10,351
 
                     
Total investment income
   
339,370
   
323,562
   
305,968
 
Investment expenses
   
2,881
   
2,361
   
2,113
 
                     
Net investment income
                   
(excluding derivatives)
   
336,489
   
321,201
   
303,855
 
                     
Derivative income (loss)
   
43,279
   
(10,988
)
 
11,988
 
                     
Net investment income
 
$
379,768
   
310,213
   
315,843
 

Investment grade debt securities generated approximately 91.0% of total investment income, excluding derivatives in 2006. The mortgage loan investment balance has been steadily declining over the past several years due to the low interest rate environment, which has resulted in loan pre-payments and a decrease of new loan fundings. Other investment income for 2006 includes $1.2 million related to income received on various profit participation arrangements compared to $2.8 million recorded in 2005 and $1.5 million recorded in 2004. In addition, proceeds of $4.3 million were received in 2006 from a class action settlement on a disposed debt security.

Net investment income performance is analyzed excluding derivative income (loss), which is a common practice in the insurance industry, in order to assess underlying profitability and results from ongoing operations. Net investment income performance is summarized as follows:

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands except percentages)
 
Excluding derivatives:
             
Net investment income
 
$
336,489
   
321,201
   
303,855
 
Average invested assets, at amortized cost
 
$
5,514,196
   
5,205,983
   
4,693,661
 
Yield on average invested assets
   
6.10
%
 
6.17
%
 
6.47
%
                     
Including derivatives:
                   
Net investment income
 
$
379,768
   
310,213
   
315,843
 
Average invested assets, at amortized cost
 
$
5,548,266
   
5,252,259
   
4,731,169
 
Yield on average invested assets
   
6.84
%
 
5.91
%
 
6.68
%

The average invested asset decline in yield is due to the overall interest rate level decline and the Company obtaining lower yields on newly invested funds. In addition, prepayments, calls, and maturities of higher yielding debt securities have added to the yield decrease as these funds are reinvested at lower rates. Refer to the Derivatives discussion following this section for a more detailed explanation.


Derivatives income (loss) - Index options are derivative financial instruments used to fully hedge the equity return component of the Company’s equity-indexed products, which were first introduced for sale in 1997. In 2002, the Company began selling an equity-indexed universal life product in addition to its equity-indexed annuities. Any income or loss from the sale or expiration of the options, as well as period-to-period changes in fair values, are reflected as a component of net investment income. However, increases or decreases in income from these options are substantially offset by corresponding increases or decreases in amounts credited to equity-indexed annuity and life policyholders.

Income and losses from index options are due to market conditions. Index options are intended to act as hedges to match the returns on the S&P 500 Index® and the rise or decline in this index causes index option values to likewise rise or decline. While income from index options fluctuates with the index, the contract interest expense to policyholder accounts for the Company’s equity-indexed products also fluctuates in a similar manner and direction. In 2006 and 2004, the S&P 500 Index® increased and the Company recorded income from index options and likewise increased contract interest expenses. In 2005, the S&P 500 Index® decreased resulting in index option losses and a reduction in contract interest expenses.

Derivative components included in net investment income and the corresponding contract interest amounts are detailed below for each date presented.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
Derivatives:
             
Unrealized income (loss)
 
$
27,108
   
(9,579
)
 
(13,262
)
Realized income (loss)
   
16,171
   
(1,409
)
 
25,250
 
                     
Total income (loss) included in net investment income
 
$
43,279
   
(10,988
)
 
11,988
 
                     
Total contract interest
 
$
213,736
   
150,962
   
173,315
 

Other income - Other income revenues consists primarily of gross income associated with nursing home operations of $11.2 million, $8.9 million, and $8.3 million in 2006, 2005, and 2004, respectively. In addition, the Company received $5.5 million related to lawsuit settlements during 2006. In 2004, a lawsuit settlement of $2.2 million was awarded to the Company relating to an investment previously owned and is also included in other income.

Realized gains on investments - The net gains reported in 2006 of $2.7 million consisted of gross gains of $5.3 million primarily from calls and sales of debt securities, sale of real estate during the year, offset by gross losses of $2.6 million, which includes the impairments highlighted in the table below, and from calls and sales of debt and equity securities.

In past years, the realized losses on investments have primarily resulted from impairment writedowns on investments in debt securities and valuation allowances recorded on mortgage loans. The Company records impairment writedowns when a decline in value is considered other-than-temporary and full recovery of the investment is not expected. Impairment writedowns are summarized in the following table.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
Impairment or valuation writedowns:
             
Bonds
 
$
99
   
1,926
   
3,647
 
Mortgage loans
   
2,100
   
-
   
632
 

The mortgage loan valuation writedown in 2006 involves a New Orleans property whose value was negatively impacted by Hurricane Katrina.


Benefits and Expenses. The following details benefits and expenses.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Life and other policy benefits
 
$
35,241
   
39,162
   
34,613
 
Amortization of deferred policy acquisition costs
   
90,358
   
87,955
   
88,733
 
Universal life and annuity contract interest
   
213,736
   
150,692
   
173,315
 
Other operating expenses
   
65,709
   
46,349
   
35,441
 
                     
Totals
 
$
405,044
   
324,158
   
332,102
 

Life and other policy benefits - Life and other policy benefits reflect death claims of $26.2 million, $30.0 million, and $24.7 million for 2006, 2005, and 2004, respectively. The Company's mortality experience over the past three years has generally been consistent with its product pricing assumptions.

Amortization of deferred policy acquisition costs - Life insurance companies are required to defer certain expenses associated with acquiring new business. The majority of these acquisition expenses consist of commissions paid to agents, underwriting costs, and certain marketing expenses and sales inducements. The Company defers sales inducements in the form of first year interest bonuses on annuity and universal life products that are directly related to the production of new business. These charges are deferred and amortized using the same methodology and assumptions used to amortize other capitalized acquisition costs and the amortization is included in contract interest. Recognition of these deferred policy acquisition costs in the consolidated financial statements is to occur over future periods in relation to the expected emergence of profits priced into the products sold. This emergence of profits is based upon assumptions regarding premium payment patterns, mortality, persistency, investment performance, and expense patterns. Companies are required to review these assumptions periodically to ascertain whether actual experience has deviated significantly from that assumed. If it is determined that a significant deviation has occurred, the emergence of profit patterns is to be "unlocked" and reset based upon the actual experience.

Amortization of deferred policy acquisition costs increased to $90.4 million for the year ended December 31, 2006 compared to $88.0 million and $88.7 million reported in 2005 and 2004. Amortization for 2006 includes a true-up adjustment relative to partial surrenders, mortality assumptions, annuitizations, credited rates and earned rates which increased amortization in the current year by approximately $4.3 million. There were similar adjustments in 2005 and 2004 relative to amortization assumptions that resulted in increased amortization for those years.

Universal life and annuity contract interest - The Company closely monitors its credited interest rates on interest sensitive policies, taking into consideration such factors as profitability goals, policyholder benefits, product marketability, and economic market conditions. As long-term interest rates change, the Company's credited interest rates are often adjusted accordingly, taking into consideration the factors described above. The difference between yields earned on investments over policy credited rates is often referred to as the "interest spread". Raising policy credited rates can typically have an impact sooner than higher market rates on the Company's investment portfolio yield, making it more difficult to maintain the current interest spread.

The Company's approximated average credited rates are as follows:

   
December 31,
 
December 31,
 
   
2006
 
2005
 
2004
 
2006
 
2005
 
2004
 
   
(Excluding equity-indexed products)
 
(Including equity-indexed products)
 
                           
Annuity
   
3.39
%
 
3.59
%
 
3.91
%
 
3.86
%
 
2.86
%
 
3.60
%
Interest sensitive life
   
4.30
%
 
4.94
%
 
4.75
%
 
5.41
%
 
4.63
%
 
4.97
%



Contract interest also includes the performance of the derivative component of the Company's equity-indexed products. As previously noted, the recent market performance of these derivative features decreased contract interest expense in 2005, while also decreasing the Company's investment income given the hedge nature of the options. During 2006 and 2004, the reverse was noted, as the S&P 500 Index® performance was up resulting in higher investment income and contract interest expense. With these credited rates, the Company generally realized its targeted interest spread on its products.

Other operating expenses - Other operating expenses consist of general administrative expenses, licenses and fees, commissions not subject to deferral, and expenses of nursing home operations. Nursing home expenses amounted to $10.2 million, $7.6 million, and $7.2 million in 2006, 2005, and 2004, respectively. In 2006, $13.1 million was recorded related to increased compensation costs resulting from a change in liability classification for the Company’s stock option plan. Compensation costs reported in 2005 and 2004 totaled $0.9 million in both years. A reduction in expenses of $6.5 million due to the final accounting related to a lawsuit settlement is reflected in 2004 amounts. In addition, contractholder account balances were increased $2.3 million in 2004 based on this final settlement.

Federal Income Taxes. Federal income taxes on earnings from continuing operations for 2006, 2005, and 2004 reflect effective tax rates of 34.6%, 33.9%, and 33.9%, respectively, which are lower than the expected Federal rate of 35% primarily due to tax-exempt investment income related to investments in municipal securities and dividends-received deductions on income from stock investments.

Segment Operations

Summary of Segment Earnings

A summary of segment earnings from continuing operations for the years ended December 31, 2006, 2005, and 2004 is provided below. The segment earnings exclude realized gains and losses on investments, net of taxes.

   
Domestic
Life
Insurance
 
International
Life
Insurance
 
Annuities
 
All
Others
 
Totals
 
   
(In thousands)
 
Segment earnings:
                     
                       
2006
 
$
297
   
12,191
   
56,559
   
5,566
   
74,613
 
2005
   
2,809
   
13,559
   
47,915
   
6,559
   
70,842
 
2004
   
2,522
   
12,133
   
45,473
   
5,066
   
65,194
 



Domestic Life Insurance Operations

A comparative analysis of results of operations for the Company's domestic life insurance segment is detailed below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
Premiums and other revenue:
             
Premiums and contract revenues
 
$
22,731
   
22,172
   
23,324
 
Net investment income
   
20,462
   
19,958
   
20,283
 
Other income
   
29
   
35
   
509
 
                     
Total premiums and other revenue
   
43,222
   
42,165
   
44,116
 
                     
Benefits and expenses:
                   
Life and other policy benefits
   
13,656
   
14,932
   
15,141
 
Amortization of deferred policy acquisition costs
   
7,313
   
5,798
   
9,098
 
Universal life insurance contract interest
   
9,168
   
8,842
   
8,585
 
Other operating expenses
   
12,630
   
8,349
   
7,479
 
                     
Total benefits and expenses
   
42,767
   
37,921
   
40,303
 
                     
Segment earnings before Federal income taxes
   
455
   
4,244
   
3,813
 
                     
Federal income taxes
   
158
   
1,435
   
1,291
 
                     
Segment earnings
 
$
297
   
2,809
   
2,522
 

Revenues from domestic life insurance operations include life insurance premiums on traditional type products and revenues from universal life insurance. Revenues from traditional products are simply premiums collected, while revenues from universal life insurance consist of policy charges for the cost of insurance, policy administration fees, and surrender charges assessed during the period. A comparative detail of premiums and contract revenues is provided below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Universal life insurance revenues
 
$
18,286
   
16,322
   
16,807
 
Traditional life insurance premiums
   
6,906
   
7,392
   
7,638
 
Reinsurance premiums
   
(2,461
)
 
(1,542
)
 
(1,121
)
                     
Totals
 
$
22,731
   
22,172
   
23,324
 

In accordance with generally accepted accounting principles, premiums collected on universal life products are not reflected as revenues in the Company's consolidated statements of earnings. Actual domestic universal life premiums are detailed below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Universal life insurance:
             
First year and single premiums
 
$
14,640
   
14,973
   
9,382
 
Renewal premiums
   
14,118
   
14,199
   
14,510
 
                     
Totals
 
$
28,758
   
29,172
   
23,892
 



The Company's U.S. operations have typically emphasized annuity product sales over life product sales but recent efforts have been made to attract new independent agents and to promote life products to improve domestic sales. It is the Company's goal to increase domestic life product sales through increased recruiting of new distribution and the development of new life insurance products. The Company had approximately 10,200 contracted agents as of December 31, 2006.

Policy benefits totaled $13.7 million, $14.9 million, and $15.1 million in 2006, 2005, and 2004, respectively, which are consistent with Company expectations. Net investment income remained consistent with $20.5 million, $20.0 million, and $20.3 million for 2006, 2005, and 2004, respectively. Other operating expenses increased significantly in 2006 due to an increase in compensation costs resulting from the change in liability classification for the Company’s stock option plan. Compensation costs totaled $3.0 million, $0.2 million, and $0.2 million in 2006, 2005, and 2004, respectively.

International Life Insurance Operations

A comparative analysis of results of operations for the Company's international life insurance segment is detailed below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
Premiums and other revenue:
             
Premiums and contract revenues
 
$
78,005
   
70,379
   
64,239
 
Net investment income
   
28,530
   
23,123
   
22,821
 
Other income
   
78
   
75
   
790
 
                     
Total premiums and other revenue
   
106,613
   
93,577
   
87,850
 
                     
Benefits and expenses:
                   
Life and other policy benefits
   
18,161
   
21,232
   
16,626
 
Amortization of deferred policy acquisition costs
   
23,075
   
20,389
   
21,837
 
Universal life insurance contract interest
   
25,675
   
18,118
   
18,631
 
Other operating expense
   
21,051
   
13,359
   
12,418
 
                     
Total benefits and expenses
   
87,962
   
73,098
   
69,512
 
                     
Segment earnings before Federal income taxes
   
18,651
   
20,479
   
18,338
 
                     
Federal income taxes
   
6,460
   
6,920
   
6,205
 
                     
Segment earnings
 
$
12,191
   
13,559
   
12,133
 

As with domestic operations, revenues from the international life insurance segment include both premiums on traditional type products and revenues from universal life insurance. A comparative detail of premiums and contract revenues is provided below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Universal life insurance revenues
 
$
78,008
   
72,010
   
67,059
 
Traditional life insurance premiums
   
11,027
   
9,201
   
8,228
 
Reinsurance premiums
   
(11,030
)
 
(10,832
)
 
(11,048
)
                     
Totals
 
$
78,005
   
70,379
   
64,239
 



International operations have emphasized universal life policies over traditional life insurance products. In accordance with generally accepted accounting principles, premiums collected on universal life products are not reflected as revenues in the Company's consolidated statements of earnings. Actual international universal life premiums collected are detailed below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
Universal life insurance
             
First year and single premiums
 
$
36,758
   
35,575
   
35,681
 
Renewal premiums
   
81,226
   
68,832
   
59,981
 
                     
Totals
 
$
117,984
   
104,407
   
95,662
 

The Company's international life operations have been a significant contributor to the Company's overall growth and represent a market niche where the Company believes it has a competitive advantage. A productive agency force has been developed given the Company's longstanding reputation for supporting its international life products coupled with the instability of competing companies in international markets. In particular, the Company has experienced sizable growth with its equity-indexed universal life products and has collected premiums of $60.5 million, $48.2 million, and $37.2 million for the years ended 2006, 2005, and 2004, respectively.

A detail of net investment income for international life insurance operations is provided below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Net investment income
             
(excluding derivatives)
 
$
25,893
   
23,896
   
23,260
 
Derivative income (loss)
   
2,637
   
(773
)
 
(439
)
                     
Net investment income
 
$
28,530
   
23,123
   
22,821
 

Derivative income and losses fluctuate from period to period based on the S&P 500 Index® performance.

Life and other policy benefits totaled $18.2 million in 2006, $21.2 million in 2005, and $16.6 million in 2004, which are consistent with Company expectations. Amortization of deferred policy acquisition costs was $23.1 million, $20.4 million, and $21.8 million for 2006, 2005, and 2004, respectively. In the first quarter of 2006, a true-up of amortization assumptions resulted in increased amortization of $1.0 million. Contract interest expense was $25.7 million, $18.1 million, and $18.6 million, in 2006, 2005, and 2004, respectively. The universal life contract interest fluctuations are primarily the result of the S&P 500 Index® performance relative to the equity-indexed universal life products and the associated stock market gains and losses which increased or decreased the amounts the Company credited to policyholders.

International sales during 2006 reflect Brazil, Taiwan, and Argentina as the top three international countries based on premiums and contract revenues recorded. As the international life insurance in force continues to grow, the Company anticipates operating earnings to similarly increase. The amount of international life insurance in force has grown from $11.3 billion at December 31, 2004 to $12.2 billion at December 31, 2005, and to $13.3 billion at December 31, 2006.

Other operating expenses reported in 2006 were $21.1 million compared to $13.4 million and $12.4 million in 2005 and 2004. The significant increase in 2006 is due to an increase in compensation costs resulting from the change in liability classification for the Company’s stock option plan. Compensation costs totaled $5.1 million, $0.4 million, and $0.4 million in 2006, 2005, and 2004, respectively.


Annuity Operations

The Company's annuity operations are almost exclusively in the United States. Although some of the Company's investment contracts are available to international residents, current sales are small relative to total annuity sales. A comparative analysis of results of operations for the Company's annuity segment is detailed below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Premiums and other revenue:
             
Premiums and contract revenues
 
$
21,389
   
18,816
   
15,975
 
Net investment income
   
323,326
   
258,485
   
266,151
 
Other income
   
5,950
   
588
   
1,701
 
                     
Total premiums and other revenue
   
350,665
   
277,889
   
283,827
 
                     
Benefits and expenses:
                   
Life and other policy benefits
   
3,424
   
2,998
   
2,846
 
Amortization of deferred policy acquisition costs
   
59,970
   
61,768
   
57,798
 
Annuity contract interest
   
178,893
   
123,732
   
146,099
 
Other operating expenses
   
21,847
   
17,019
   
8,353
 
                     
Total benefits and expenses
   
264,134
   
205,517
   
215,096
 
                     
Segment earnings before Federal income taxes
   
86,531
   
72,372
   
68,731
 
                     
Federal income taxes
   
29,972
   
24,457
   
23,258
 
                     
Segment earnings
 
$
56,559
   
47,915
   
45,473
 

Revenues from annuity operations include primarily surrender charges and recognition of deferred revenues relating to immediate or payout annuities. A comparative detail of the components of premiums and annuity contract revenues is provided below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Surrender charges
 
$
17,260
   
15,271
   
13,031
 
Payout annuity and other revenues
   
4,098
   
3,511
   
2,906
 
Traditional annuity premiums
   
31
   
34
   
38
 
                     
Totals
 
$
21,389
   
18,816
   
15,975
 

As previously noted, the Company's earnings are dependent upon annuity contracts persisting or remaining in force. While revenues decline with a reduction in surrender charges, the Company's earnings benefit. A mandated change in accounting for two-tier annuities in 2004 had the effect of eliminating payout annuity revenues pertaining to this product.


In accordance with generally accepted accounting principles, deposits collected on annuity contracts are not reflected as revenues in the Company's consolidated statements of earnings. Actual annuity deposits collected are detailed below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Equity-indexed annuities
 
$
303,613
   
298,227
   
512,709
 
Other deferred annuities
   
171,631
   
236,330
   
350,665
 
Immediate annuities
   
10,750
   
23,383
   
28,653
 
                     
Totals
 
$
485,994
   
557,940
   
892,027
 

The Company experienced a substantial increase in sales relating to equity-indexed annuities as the stock market rebounded in 2003 and 2004. These indexed products are more attractive for consumers when interest rate levels remain low as has been the market environment the past few years. Equity-indexed annuity deposits as a percentage of total annuity deposits recorded were 62.5%, 53.5%, and 57.5% for the years ended December 31, 2006, 2005, and 2004, respectively. Since the Company does not offer variable products or mutual funds, equity-indexed products provide an important alternative to the Company's existing fixed interest rate annuity products.

Other deferred annuity deposits decreased in 2006 compared to 2005 with $171.6 million recorded in collected deposits compared to $236.3 million, respectively. As a selling inducement, many fixed-rate annuity products include a first year premium or interest rate bonus in addition to the base first year deposit interest rate. These bonuses are credited to the policyholder account but are deferred by the Company and amortized over future periods. The amount deferred was approximately $19.7 million, $21.2 million, and $27.5 million for the years ended December 31, 2006, 2005, and 2004, respectively.


A detail of net investment income for annuity operations is provided below.

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Net investment income
             
(excluding derivatives)
 
$
282,684
   
268,700
   
253,724
 
Derivative income (loss)
   
40,642
   
(10,215
)
 
12,427
 
                     
Net investment income
 
$
323,326
   
258,485
   
266,151
 

Derivative income and losses fluctuate from period to period based on the S&P 500 Index® performance.

As previously described, derivatives are used to hedge the equity return component of the Company's equity-indexed annuity products with any gains or losses from the sale or expiration of the options, as well as period-to-period changes in fair values, reflected in net investment income. The increase in net investment income, excluding derivatives from 2004 to 2006, is due to the increase in the overall size of the asset portfolio as a result of higher sales volume.

A true-up of assumptions in the first quarter of 2006 resulted in increased amortization of deferred policy acquisition costs of $3.1 million. Amortization of deferred policy acquisition costs in 2005 of $61.8 million includes an unlocking adjustment of $1.3 million. Adjustments were made in the assumptions relative to the future spreads on certain equity-index annuity products; modified surrender charges on certain annuities to reflect continuing lower new money rates; and reduced ultimate valuation rates for pay out on annuitization under all annuities. These adjustments resulted in a decrease to the deferred asset balance and an increase in amortization.

The Company is required to periodically adjust for actual experience that varies from that assumed. While management does not currently anticipate any impact from unlocking in 2007, facts and circumstances may arise in the future which require that the factors be reexamined.


Annuity contract interest includes the equity component return associated with the Company's equity-indexed annuities. The detail of equity-indexed annuity contract interest compared to contract interest for all other annuities is as follows:

   
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
   
(In thousands)
 
               
Equity-indexed annuities
 
$
88,094
   
28,224
   
38,942
 
All other annuities
   
101,619
   
110,165
   
129,392
 
                     
Gross contract interest
   
189,713
   
138,389
   
168,334
 
Bonus interest deferred and capitalized
   
(19,700
)
 
(21,200
)
 
(27,491
)
Bonus interest amortization
   
8,880
   
6,543
   
5,256
 
                     
Total contract interest
 
$
178,893
   
123,732
   
146,099
 

In comparison by year, the fluctuation in reported contract interest amounts for equity-indexed annuities is due to sales and the effect of the positive or negative performance of the stock market on option values as noted previously. In addition, the 2004 contract interest figures include an increase of $2.3 million for certain contractholder account balances as part of a lawsuit settlement.

Other operating expenses totaled $21.8 million in 2006 which reflects an increase of $5.0 million due to increased compensation costs resulting from the change in liability classification for the Company’s stock option plan. Compensation costs were $0.4 million in 2005 and 2004. Expenses for 2004 reflect a reduction of $6.5 million for a charge recorded in the prior year. A $9.7 million charge was initially recorded in 2003 relating to a litigation claim which involved certain annuity products, and actual settlement payments made were $3.2 million during 2004.

Other Operations

National Western's primary business encompasses its domestic and international life insurance operations and its annuity operations. However, the Company also has small real estate, nursing home, and other investment operations through its wholly-owned subsidiaries. Most of the income from the Company's subsidiaries is from a life interest in a trust. Gross income distributions from the trust totaled $4.5 million, pre-tax, in 2006 and $3.9 million and $3.7 million in 2005 and 2004, respectively.

The Company acquired a nursing home facility, which opened in late July, 2000 and is operated by an affiliated limited partnership, whose financial operating results are consolidated with those of the Company. Daily operations and management of the nursing home are performed by an experienced management company through a contract with the limited partnership. Nursing home operations generated $1.0 million, $1.3 million, and $1.1 million of operating earnings in 2006, 2005, and 2004, respectively.


INVESTMENTS

General

The Company's investment philosophy emphasizes the careful handling of policyowners' and stockholders' funds to achieve security of principal, to obtain the maximum possible yield while maintaining security of principal, and to maintain liquidity in a measure consistent with current and long-term requirements of the Company.


The Company's overall conservative investment philosophy is reflected in the allocation of its investments, which is detailed below as of December 31, 2006 and 2005. The Company emphasizes investment grade debt securities, with smaller holdings in mortgage loans and policy loans.

   
2006
 
2005
 
   
Carrying
     
Carrying
     
   
Value
 
%
 
Value
 
%
 
   
(In thousands)
     
(In thousands)
     
                   
Debt securities
 
$
5,484,799
   
94.7
 
$
5,249,156
   
94.8
 
Mortgage loans
   
103,325
   
1.8
   
110,639
   
2.0
 
Policy loans
   
86,856
   
1.5
   
86,385
   
1.6
 
Derivatives
   
72,012
   
1.2
   
39,405
   
0.7
 
Equity securities
   
21,203
   
0.4
   
20,295
   
0.4
 
Real estate
   
12,113
   
0.2
   
13,436
   
0.2
 
Other
   
10,709
   
0.2
   
16,577
   
0.3
 
                           
Totals
 
$
5,791,017
   
100.0
 
$
5,535,893
   
100.0
 

Debt and Equity Securities

The Company maintains a diversified portfolio which consists primarily of corporate, mortgage-backed, and public utility fixed income securities. Investments in mortgage-backed securities include primarily U.S. government agency pass-through securities and collateralized mortgage obligations ("CMO"). As of December 31, 2006 and 2005, the Company's debt securities portfolio consisted of the following:

   
2006
 
2005
 
   
Carrying
     
Carrying
     
   
Value
 
%
 
Value
 
%
 
   
(In thousands)
     
(In thousands)
     
                   
Corporate
 
$
2,384,762
   
43.5
 
$
2,320,306
   
44.2
 
Mortgage-backed securities
   
1,817,532
   
33.1
   
1,715,245
   
32.7
 
Public utilities
   
623,649
   
11.4
   
661,333
   
12.6
 
U.S. government/agencies
   
447,573
   
8.2
   
306,260
   
5.8
 
Asset-backed securities
   
122,101
   
2.2
   
161,324
   
3.1
 
States & political subdivisions
   
58,627
   
1.1
   
53,940
   
1.0
 
Foreign governments
   
30,555
   
0.5
   
30,748
   
0.6
 
                           
Totals
 
$
5,484,799
   
100.0
 
$
5,249,156
   
100.0
 

The Company's investment guidelines prescribe limitations as a percent of the total investment portfolio by type of security and all holdings were within these threshold limits at December 31, 2006 and 2005. During 2005 and continuing into 2006, the Company expanded its holdings of U.S. government and private mortgage-backed securities given attractive yields and spreads. Because the Company's holdings of mortgage-backed securities are subject to prepayment and extension risk, the Company has substantially reduced these risks by investing primarily in collateralized mortgage obligations, which have more predictable cash flow patterns than pass-through securities. These securities, known as planned amortization class I ("PAC I"), very accurately defined maturity ("VADM") and sequential tranches are designed to amortize in a more predictable manner than other CMO classes or pass-throughs. Using this strategy, the Company can more effectively manage and reduce prepayment and extension risks, thereby helping to maintain the appropriate matching of the Company's assets and liabilities.


In addition to diversification, an important aspect of the Company's investment approach is managing the credit quality of its investments in debt securities. Thorough credit analysis is performed on potential corporate investments including examination of a company's credit and industry outlook, financial ratios and trends, and event risks. This emphasis is reflected in the high average credit rating of the Company's portfolio with 97% held in investment grade securities. In the table below, investments in debt securities are classified according to credit ratings by Standard and Poor's ("S&P®"), or other nationally recognized statistical rating organizations if securities were not rated by S&P®.

   
2006
 
2005
 
   
Carrying
     
Carrying
     
   
Value
 
%
 
Value
 
%
 
   
(In thousands)
     
(In thousands)
     
                   
AAA and U.S. government
 
$
2,485,122
   
45.3
 
$
2,285,094
   
43.5
 
AA
   
284,965
   
5.2
   
202,092
   
3.9
 
A
   
1,330,980
   
24.3
   
1,360,716
   
25.9
 
BBB
   
1,237,151
   
22.5
   
1,230,799
   
23.5
 
BB and other below investment grade
   
146,581
   
2.7
   
170,455
   
3.2
 
                           
Totals
 
$
5,484,799
   
100.0
 
$
5,249,156
   
100.0
 

National Western does not purchase below investment grade securities. Investments held in debt securities below investment grade are the result of subsequent downgrades of the securities. During 2006, the Company's percentage of below investment grade securities compared to total invested assets decreased from 3.1% to 2.5% as of December 31, 2005 and 2006, respectively. The decrease from year to year is primarily due to principal payments received and settlements from bankruptcy proceedings as well as sales, tenders and a maturity. Also, there were three upgraded and four downgraded securities. The Company's holdings of below investment grade securities as a percentage of total invested assets is relatively small compared to industry averages. These holdings are summarized below.

   
Below Investment Grade Debt Securities
 
               
% of
 
   
Amortized
 
Carrying
 
Fair
 
Invested
 
   
Cost
 
Value
 
Value
 
Assets
 
   
(In thousands except percentages)
 
                   
December 31, 2006
 
$
145,858
   
146,581
   
146,170
   
2.5
%
                           
December 31, 2005
 
$
168,423
   
170,455
   
167,770
   
3.1
%


Holdings in below investment grade securities by category as of December 31, 2006 are summarized below, including 2005 fair values for comparison. The Company is continually monitoring developments in these industries that would affect security valuations.

Below Investment Grade Debt Securities
 
   
Amortized
 
Carrying