National Western Life Insurance Company Form 10-Q March 31, 2007

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended March 31, 2007
 
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
(512) 836-1010
(Address of Principal Executive Offices)
(Telephone Number)
   
   
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 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.
 
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
 
As of May 8, 2007, the number of shares of Registrant's common stock outstanding was: Class A - 3,422,324 and Class B - 200,000.





   
 
Page
   
3
   
3
   
 
March 31, 2007 (Unaudited) and December 31, 2006
3
   
 
For the Three Months Ended March 31, 2007 and 2006 (Unaudited)
5
   
 
For the Three Months Ended March 31, 2007 and 2006 (Unaudited)
6
   
 
For the Three Months Ended March 31, 2007 and 2006 (Unaudited)
7
   
 
For the Three Months Ended March 31, 2007 and 2006 (Unaudited)
8
   
10
   
 
Financial Condition and Results of Operations
19
   
42
   
42
   
42
   
42
   
42
   
43
   
43
   
44


2
 
 
           
 
           
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
  
CONDENSED CONSOLIDATED BALANCE SHEETS
  
(In thousands)
  
           
           
   
(Unaudited)
      
   
March 31,
  
December 31,
  
ASSETS
  
2007
  
2006
  
           
Investments:
          
Securities held to maturity, at amortized cost
 
$
3,642,261
    
3,603,434
 
Securities available for sale, at fair value
   
1,929,249
   
1,902,568
 
Mortgage loans, net of allowances for possible losses ($2,100)
    
105,389
   
103,325
 
Policy loans
   
87,469
   
86,856
 
Derivatives
    
63,815
   
72,012
 
Other long-term investments
   
21,991
   
22,822
 
               
Total investments
    
5,850,174
   
5,791,017
 
               
Cash and short-term investments
    
35,040
   
49,901
 
Deferred policy acquisition costs
   
638,088
   
643,964
 
Deferred sales inducements
    
94,181
   
93,139
 
Accrued investment income
   
63,821
   
64,393
 
Other assets
    
46,174
   
51,029
 
               
   
$
6,727,478
    
6,693,443
 
               
               
Note: The condensed consolidated balance sheet at December 31, 2006, has been derived from the audited consolidated financial statements as of that date.
               
See accompanying notes to condensed consolidated financial statements.
              


3

 
CONDENSED CONSOLIDATED BALANCE SHEETS
  
(In thousands, except share amounts)
  
           
           
   
(Unaudited)
      
   
March 31,
  
December 31,
  
LIABILITIES AND STOCKHOLDERS' EQUITY
  
2007
  
2006
  
           
LIABILITIES:
          
           
Future policy benefits:
          
Traditional life and annuity contracts
  
$
139,166
    
138,382
 
Universal life and annuity contracts
   
5,400,023
   
5,395,075
 
Other policyholder liabilities
    
118,622
   
112,449
 
Federal income tax liability:
              
Current
    
4,777
   
1,666
 
Deferred
   
38,269
   
32,207
 
Other liabilities
   
72,544
   
80,680
 
               
Total liabilities
    
5,773,401
   
5,760,459
 
               
COMMITMENTS AND CONTINGENCIES (Note 5 and 8)
              
               
STOCKHOLDERS' EQUITY:
              
               
Common stock:
              
Class A - $1 par value; 7,500,000 shares authorized; 3,422,324 and
              
3,420,824 issued and outstanding in 2007 and 2006
    
3,422
   
3,421
 
Class B - $1 par value; 200,000 shares authorized, issued,
              
and outstanding in 2007 and 2006
    
200
   
200
 
Additional paid-in capital
   
36,236
   
36,110
 
Accumulated other comprehensive income (loss)
    
758
   
(3,731
)
Retained earnings
   
913,461
   
896,984
 
               
Total stockholders' equity
    
954,077
   
932,984
 
               
   
$
6,727,478
    
6,693,443
 
               
               
Note: The condensed consolidated balance sheet at December 31, 2006, has been derived from the audited consolidated financial statements as of that date.
               
See accompanying notes to condensed consolidated financial statements.
              


4

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
  
 
For the Three Months Ended March 31, 2007 and 2006
  
(Unaudited)
  
(In thousands, except per share amounts)
  
           
           
   
2007
  
2006
  
           
Premiums and other revenue:
          
Traditional life and annuity premiums
 
$
4,733
    
3,991
 
Universal life and annuity contract revenues
    
28,796
   
26,956
 
Net investment income
    
77,026
   
98,687
 
Other income
   
3,316
   
5,198
 
Realized gains on investments
   
241
   
1,423
 
               
Total premiums and other revenue
   
114,112
   
136,255
 
               
Benefits and expenses:
              
Life and other policy benefits
    
10,974
   
11,442
 
Amortization of deferred acquisition costs
   
23,785
   
22,298
 
Universal life and annuity contract interest
    
37,433
   
56,048
 
Other operating expenses
   
14,116
   
25,374
 
               
Total benefits and expenses
   
86,308
   
115,162
 
               
Earnings before Federal income taxes
    
27,804
   
21,093
 
               
Provision (benefit) for Federal income taxes:
              
Current
   
4,314
   
11,487
 
Deferred
   
4,818
   
(4,439
)
               
Total Federal income taxes
    
9,132
   
7,048
 
               
Net earnings
  
$
18,672
    
14,045
 
               
               
Basic Earnings Per Share
  
$
5.16
    
3.88
 
               
               
Diluted Earnings Per Share
  
$
5.11
    
3.84
 
               
               
See accompanying notes to condensed consolidated financial statements.
              


5

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
  
 
For the Three Months Ended March 31, 2007 and 2006
  
(Unaudited)
  
(In thousands)
  
           
           
   
2007
  
2006
  
           
Net earnings
  
$
18,672
    
14,045
 
               
Other comprehensive income (loss), net of effects of
              
deferred policy acquisition costs and taxes:
              
Net unrealized gains (losses) on securities:
              
Net unrealized holding gains (losses) arising during period
    
4,723
   
(10,466
)
Reclassification adjustment for gains included in net earnings
    
(167
)
  
(892
)
Amortization of net unrealized gains
              
related to transferred securities
    
20
   
7
 
               
Net unrealized gains (losses) on securities
    
4,576
   
(11,351
)
               
Foreign currency translation adjustments
    
(87
)
  
65
 
               
Other comprehensive income (loss)
    
4,489
   
(11,286
)
               
Comprehensive income
  
$
23,161
    
2,759
 
               
               
See accompanying notes to condensed consolidated financial statements.
              


6

NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
  
 
For the Three Months Ended March 31, 2007 and 2006
  
(Unaudited)
  
(In thousands)
  
           
           
   
2007
  
2006
  
Common stock:
          
Balance at beginning of year
  
$
3,621
    
3,613
 
Shares exercised under stock option plan
    
1
   
13
 
               
Balance at end of period
    
3,622
   
3,626
 
               
Additional paid-in capital:
              
Balance at beginning of year
    
36,110
   
37,923
 
Shares exercised under the stock option plan, net of tax benefits
    
126
   
491
 
               
Balance at end of period
    
36,236
   
38,414
 
               
Accumulated other comprehensive income:
              
Unrealized gains (losses) on securities:
              
Balance at beginning of year
    
3,148
   
10,401
 
Change in unrealized gains (losses) during period
   
4,576
   
(11,351
)
               
Balance at end of period
    
7,724
   
(950
)
               
Foreign currency translation adjustments:
              
Balance at beginning of year
    
3,122
   
3,300
 
Change in translation adjustments during period
   
(87
)
  
65
 
               
Balance at end of period
    
3,035
   
3,365
 
               
Benefit plan liability adjustment:
              
Balance at beginning of year
    
(10,001
)
  
(3,137
)
Change in benefit plan liability adjustment during period
    
-
   
-
 
               
Balance at end of period
    
(10,001
)
  
(3,137
)
               
Accumulated other comprehensive income (loss) at end of period
    
758
   
(722
)
               
Retained earnings:
              
Balance at beginning of year
   
896,984
   
821,908
 
Cumulative effect of change in accounting principle, net of tax
    
(2,195
)
  
-
 
Net earnings
   
18,672
   
14,045
 
               
Balance at end of period
    
913,461
   
835,953
 
               
Repurchase of common stock
    
-
   
(1,210
)
               
Total stockholders' equity
  
$
954,077
    
876,061
 
               
               
See accompanying notes to condensed consolidated financial statements.
              

7
 
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
  
For the Three Months Ended March 31, 2007 and 2006
  
(Unaudited)
  
(In thousands)
  
           
           
   
2007
  
2006
  
           
Cash flows from operating activities:
          
Net earnings
 
$
18,672
    
14,045
 
Adjustments to reconcile net earnings to net cash
              
from operating activities:
              
Universal life and annuity contract interest
    
37,433
   
56,048
 
Surrender charges and other policy revenues
    
(8,600
)
  
(8,760
)
Realized gains on investments
    
(241
)
  
(1,423
)
Accrual and amortization of investment income
   
(996
)
  
(1,564
)
Depreciation and amortization
    
356
   
385
 
(Increase) decrease in value of derivatives
    
8,590
   
(16,014
)
Increase in deferred policy acquisition and sales inducement costs
   
(1,290
)
  
(296
)
(Increase) decrease in accrued investment income
    
610
   
(1,588
)
(Increase) decrease in other assets
    
5,580
   
(4,798
)
Increase in liabilities for future policy benefits
    
784
   
106
 
Increase in other policyholder liabilities
   
6,173
   
8,335
 
Increase in Federal income tax liability
    
7,788
   
6,359
 
Increase (decrease) in other liabilities
   
(10,547
)
  
15,570
 
Other
    
(1,742
)
  
769
 
               
Net cash provided by operating activities
    
62,570
    
67,174
 
               
Cash flows from investing activities:
              
Proceeds from sales of:
              
Securities held to maturity
    
5,175
   
-
 
Securities available for sale
   
234
   
9,409
 
Other investments
    
171
   
1,865
 
Proceeds from maturities and redemptions of:
              
Securities held to maturity
   
28,571
   
24,736
 
Securities available for sale
    
78,592
   
18,127
 
Derivatives
    
8,570
   
6,849
 
Purchases of:
              
Securities held to maturity
    
(71,837
)
  
(85,278
)
Securities available for sale
    
(87,912
)
  
(48,922
)
Other investments
    
(9,576
)
  
(6,502
)
Principal payments on mortgage loans
   
13,912
   
5,773
 
Cost of mortgage loans acquired
    
(16,066
)
  
(1,733
)
Decrease in policy loans
   
(613
)
  
109
 
Other
    
(938
)
  
(461
)
               
Net cash used in investing activities
   
(51,717
)
  
(76,028
)
               
               
(Continued on next page)
    


8
 
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
  
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED
  
For the Three Months Ended March 31, 2007 and 2006
  
(Unaudited)
  
(In thousands)
  
           
           
   
2007
  
2006
  
           
Cash flows from financing activities:
          
Deposits to account balances for universal life
          
and annuity contracts
 
$
111,937
    
127,625
 
Return of account balances on universal life
              
and annuity contracts
   
(137,622
)
  
(132,621
)
Issuance of common stock under stock option plan
    
127
   
295
 
Repurchases of common stock
    
-
   
(1,210
)
               
Net cash used in financing activities
   
(25,558
)
  
(5,911
)
               
Effect of foreign exchange
    
(156
)
  
222
 
               
Net decrease in cash and short-term investments
    
(14,861
)
  
(14,543
)
Cash and short-term investments at beginning of year
   
49,901
   
31,355
 
               
Cash and short-term investments at end of period
 
$
35,040
    
16,812
 
               
               
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
              
               
Cash paid during the first quarter for:
              
Interest
  
$
10
    
10
 
Income taxes
    
1,254
   
-
 
               
               
               
See accompanying notes to condensed consolidated financial statements.
               
 
9
 
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(1) CONSOLIDATION AND BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for annual financial statements. In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company as of March 31, 2007, and the results of its operations and its cash flows for the three months ended March 31, 2007 and 2006. The results of operations for the three months ended March 31, 2007 and 2006 are not necessarily indicative of the results to be expected for the full year. For further information, refer to the consolidated financial statements and notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2006 accessible free of charge through the Company's internet site at www.nationalwesternlife.com or the Securities and Exchange Commission internet site at www.sec.gov.

The accompanying condensed consolidated financial statements include the accounts of National Western Life Insurance Company and its wholly-owned subsidiaries ("Company"), The Westcap Corporation, NWL Investments, Inc., NWL Services, Inc., and NWL Financial, Inc. All significant intercorporate transactions and accounts have been eliminated in consolidation.

Certain reclassifications have been made to the prior periods to conform to the reporting categories used in 2007.


(2) CHANGES IN ACCOUNTING PRINCIPLES

In September 2005, the AICPA issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts ("SOP 05-1") which is effective for internal replacements occurring in fiscal years beginning after December 15, 2006. SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in FASB No. 97. SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract. The Company has an impact related to the adoption of SOP 05-1 for contracts which have annuitized and relative to reinstatements of contracts in that the unamortized deferred acquisition costs and deferred sales inducement assets must be written-off at the time of annuitization and may not be continued related to reinstatements. SOP 05-1 results in changes in assumptions relative to estimated gross profits which affects unamortized deferred acquisition costs, unearned revenue liabilities, and deferred sales inducement balances as of the beginning of the year. The effect of this SOP on beginning retained earnings as of January 1, 2007 was a decrease of $2.2 million, net of tax, as detailed below.

   
Amounts
  
   
(In thousands)
  
       
Write-off of deferred acquisition cost
  
$
3,321
  
Adjustment to deferred annuity revenue
    
56
 
     
3,377
 
         
Federal income tax
    
(1,182
)
         
Cumulative effect of change in accounting for
        
internal replacements and investment contracts
  
$
2,195
  


10
 
The FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 ("FIN 48"), dated June, 2006. The interpretation requires public companies to recognize the tax benefits of uncertain tax positions only where the position is "more likely than not" to be sustained assuming examination by tax authorities. The amount recognized would be the amount that represents the largest amount of tax benefit that is greater than 50% likely of being ultimately realized. A liability would be recognized for any benefit claimed, or expected to be claimed, in a tax return in excess of the benefit recorded in the financial statements, along with any interest and penalty (if applicable) on the excess. FIN 48 requires a tabular reconciliation of the change in the aggregate unrecognized tax benefits claimed, or expected to be claimed, in tax returns and disclosure relating to accrued interest and penalties for unrecognized tax benefits. Discussion is required for those uncertain tax positions where it is reasonably possible that the estimate of the tax benefit will change significantly in the next 12 months. FIN 48 is effective for fiscal years beginning after December 15, 2006. The adoption of FIN 48 did not have a material impact on the Company's consolidated financial statements.

On February 16, 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments, which amends SFAS No. 133, Accounting for Derivatives and Hedging Activities, and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. Hybrid financial instruments are single financial instruments that contain an embedded derivative. Under SFAS No. 155, entities can elect to record certain hybrid financial instruments at fair value as individual financial instruments. Prior to this amendment, certain hybrid financial instruments were required to be separated into two instruments - a derivative and host - and generally only the derivative was recorded at fair value. SFAS No. 155 also requires that beneficial interests in securitized assets be evaluated for either freestanding or embedded derivatives. SFAS No. 155 is effective for all financial instruments acquired or issued after January 1, 2007. SFAS No. 155 did not have a material effect on the Company's consolidated financial statements on the date of adoption.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and requires additional disclosures about fair value measurements. This Statement does not require any new fair value measurements, but the application of this Statement could change current practices in determining fair value. The Company plans to adopt this guidance effective January 1, 2008. The Company is currently assessing the impact of SFAS No. 157 on the Company's consolidated financial position and results of operations.

In February of 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company is currently assessing the impact of SFAS No. 159.


(3) STOCKHOLDERS' EQUITY

The Company is restricted by state insurance laws as to dividend amounts which may be paid to stockholders without prior approval from the Colorado Division of Insurance. The Company paid no cash dividends on common stock during the three months ended March 31, 2007 and 2006, as it generally follows a policy of retaining any earnings in order to finance the development of business and to meet regulatory requirements for capital.

 

11
 
(4) EARNINGS PER SHARE

Basic earnings per share of common stock are computed by dividing net income by the weighted-average basic common shares outstanding during the period. Diluted earnings per share assumes the issuance of common shares applicable to stock options in the denominator.

   
2007
  
2006
  
           
Numerator for basic and diluted earnings per share:
          
Earnings available to common stockholders
          
before and after assumed conversions
  
$
18,672
    
14,045
 
               
               
Denominator:
              
Basic earnings per share -
              
weighted-average shares
    
3,621
   
3,618
 
               
Effect of dilutive stock options
    
35
   
37
 
               
Diluted earnings per share -
              
adjusted weighted-average
             
shares for assumed conversions
    
3,656
   
3,655
 
               
               
Basic earnings per share
  
$
5.16
    
3.88
 
               
               
Diluted earnings per share
  
$
5.11
    
3.84
 


(5) PENSION AND OTHER POSTRETIREMENT PLANS

(A) Defined Benefit Pension Plans

The Company sponsors a qualified defined benefit pension plan covering substantially all employees. The plan provides benefits based on the participants' years of service and compensation. The Company makes annual contributions to the plan that complies with the minimum funding provisions of the Employee Retirement Income Security Act of 1974 ("ERISA"). The following summarizes the components of net periodic benefit cost.

   
Three Months Ended March 31,
  
   
2007
  
2006
  
   
(In thousands)
  
           
Service cost
  
$
173
    
171
 
Interest cost
    
255
   
244
 
Expected return on plan assets
    
(237
)
  
(228
)
Amortization of prior service cost
    
1
   
1
 
Amortization of net loss
  
88
   
83
 
               
Net periodic benefit cost
$
280
    
271
 

The Company expects to contribute $1.8 million to the plan in 2007. As of March 31, 2007, the Company has contributed $0.3 million to the plan.

12
 
The Company also sponsors a non-qualified defined benefit plan primarily for senior officers. The plan provides benefits based on the participants' years of service and compensation. The pension obligations and administrative responsibilities of the plan are maintained by a pension administration firm, which is a subsidiary of American National Insurance Company ("ANICO"). ANICO has guaranteed the payment of pension obligations under the plan. However, the Company has a contingent liability with respect to the pension plan should these entities be unable to meet their obligations under the existing agreements. Also, the Company has a contingent liability with respect to the plan in the event that a plan participant continues employment with the Company beyond age seventy, the aggregate average annual participant salary increases exceed 10% per year, or any additional employees become eligible to participate in the plan. If any of these conditions are met, the Company would be responsible for any additional pension obligations resulting from these items. Amendments were made to the plan to allow an additional employee to participate and to change the benefit formula for the Chairman of the Company. As previously mentioned, these additional obligations are a liability to the Company. Effective December 31, 2004, this plan was frozen with respect to the continued accrual of benefits of the Chairman and the President of the Company in order to comply with law changes under the American Jobs Creation Act of 2004 ("Act").

Effective July 1, 2005, the Company established a second non-qualified defined benefit plan for the benefit of the Chairman of the Company. This plan is intended to provide for post-2004 benefit accruals that mirror and supplement the pre-2005 benefit accruals under the previously discussed non-qualified plan, while complying with the requirements of the Act.

Effective November 1, 2005, the Company established a third non-qualified defined benefit plan for the benefit of the President of the Company. This plan is intended to provide for post-2004 benefit accruals that supplement the pre-2005 benefit accruals under the first non-qualified plan as previously discussed, while complying with the requirements of the Act.

The following summarizes the components of net periodic benefit costs for these non-qualified plans.

   
Three Months Ended March 31,
  
   
2007
  
2006
  
   
(In thousands)
  
           
Service cost
  
$
407
    
324
 
Interest cost
    
177
   
73
 
Amortization of prior service cost
    
260
   
162
 
Amortization of net loss
    
46
   
-
 
               
Net periodic benefit cost
  
$
890
    
559
 

The Company expects to contribute $1.4 million to these plans in 2007. As of March 31, 2007, the Company has contributed $0.3 million to the plan.

(B) Defined Benefit Postretirement Plans

The Company sponsors two healthcare plans to provide postretirement benefits to certain fully-vested individuals. The following summarizes the components of net periodic benefit costs.

   
Three Months Ended March 31,
  
   
2007
  
2006
  
   
(In thousands)
  
           
Interest cost
  
$
29
    
25
 
Amortization of prior service cost
    
26
   
26
 
               
Net periodic benefit cost
  
$
55
    
51
 


13
 
As previously disclosed in its financial statements for the year ended December 31, 2006, the Company expects to contribute minimal amounts to the plan in 2007.

 
(6) SEGMENT AND OTHER OPERATING INFORMATION

Under Statement of Financial Accounting Standards ("SFAS") No. 131, Disclosures About Segments of an Enterprise and Related Information, the Company defines its reportable operating segments as domestic life insurance, international life insurance, and annuities. These segments are organized based on product types and geographic marketing areas. A summary of segment information for the quarters ended March 31, 2007 and 2006 is provided below.

Selected Segment Information:
                      
   
Domestic
  
International
              
   
Life
  
Life
      
All
      
   
Insurance
  
Insurance
  
Annuities
  
Others
  
Totals
  
   
(In thousands)
  
                       
March 31, 2007:
                      
Selected Balance Sheet Items:
                  
Deferred policy acquisition
                      
costs and sales inducements
  
$
52,491
    
180,409
   
499,369
   
-
   
732,269
 
Total segment assets
    
388,103
   
723,250
   
5,487,541
   
103,794
   
6,702,688
 
Future policy benefits
    
316,880
   
509,015
   
4,713,294
   
-
   
5,539,189
 
Other policyholder liabilities
    
10,812
   
18,605
   
89,205
   
-
   
118,622
 
                                 
Three Months Ended
                                
March 31, 2007:
                                
Condensed Income Statements:
                                
Premiums and contract
                                
revenues
  
$
6,333
    
21,671
   
5,525
   
-
   
33,529
 
Net investment income
    
4,678
   
5,762
   
65,753
   
833
   
77,026
 
Other income
    
14
   
45
   
228
   
3,029
   
3,316
 
                                 
Total revenues
    
11,025
   
27,478
   
71,506
   
3,862
   
113,871
 
                                 
Policy benefits
    
6,141
   
3,677
   
1,156
   
-
   
10,974
 
Amortization of deferred
                                
acquisition costs
    
1,864
   
8,163
   
13,758
   
-
   
23,785
 
Universal life and investment
                                
annuity contract interest
    
2,320
   
5,252
   
29,861
   
-
   
37,433
 
Other operating expenses
    
2,712
   
4,310
   
4,481
   
2,613
   
14,116
 
Federal income taxes
   
(660
)
  
1,995
   
7,303
   
410
   
9,048
 
                                 
Total expenses
    
12,377
   
23,397
   
56,559
   
3,023
   
95,356
 
                                 
Segment earnings (losses)
  
$
(1,352
)
  
4,081
   
14,947
   
839
   
18,515
 


14
 
   
Domestic
  
International
              
   
Life
  
Life
      
All
      
   
Insurance
  
Insurance
  
Annuities
  
Others
  
Totals
  
   
(In thousands)
  
                       
March 31, 2006:
                      
Selected Balance Sheet Items:
                  
Deferred policy acquisition
                      
costs and sales inducements
  
$
46,656
    
170,959
   
504,707
   
-
   
722,322
 
Total segment assets
    
372,095
   
653,254
   
5,303,082
   
96,410
   
6,424,841
 
Future policy benefits
    
310,572
   
456,038
   
4,594,157
   
-
   
5,360,767
 
Other policyholder liabilities
    
11,786
   
18,357
   
78,749
   
-
   
108,892
 
                                 
Three Months Ended
                                
March 31, 2006:
                                
Condensed Income Statements:
                                
Premiums and contract
                                
revenues
  
$
5,834
   
19,384
   
5,729
   
-
   
30,947
 
Net investment income
    
5,196
   
7,014
   
85,998
   
479
   
98,687
 
Other income
    
8
   
23
   
2,707
   
2,460
   
5,198
 
                                 
Total revenues
    
11,038
   
26,421
   
94,434
   
2,939
   
134,832
 
                                 
Policy benefits
    
4,954
   
5,381
   
1,107
   
-
   
11,442
 
Amortization of deferred
                                
acquisition costs
    
1,401
   
4,941
   
15,956
   
-
   
22,298
 
Universal life and investment
                                
annuity contract interest
    
2,270
   
5,941
   
47,837
   
-
   
56,048
 
Other operating expenses
    
5,262
   
8,118
   
9,761
   
2,233
   
25,374
 
Federal income taxes
   
(949
)
  
680
   
6,584
   
235
   
6,550
 
                                 
Total expenses
    
12,938
   
25,061
   
81,245
   
2,468
   
121,712
 
                                 
Segment earnings (losses)
  
$
(1,900
)
  
1,360
   
13,189
   
471
   
13,120
 

Reconciliations of segment information to the Company's condensed consolidated financial statements are provided below.

   
Three Months Ended March 31,
  
   
2007
  
2006
  
   
(In thousands)
  
Premiums and Other Revenue:
          
Premiums and contract revenues
  
$
33,529
    
30,947
 
Net investment income
   
77,026
   
98,687
 
Other income
    
3,316
   
5,198
 
Realized gains on investments
    
241
   
1,423
 
               
Total consolidated premiums and other revenue
  
$
114,112
    
136,255
 


15
 
   
Three Months Ended March 31,
  
   
2007
  
2006
  
   
(In thousands)
  
Federal Income Taxes:
          
Total segment Federal income taxes
  
$
9,048
    
6,550
 
Taxes on realized gains on investments
    
84
   
498
 
               
Total consolidated Federal income taxes
  
$
9,132
    
7,048
 


   
Three Months Ended March 31,
  
   
2007
  
2006
  
   
(In thousands)
  
Net Earnings:
          
Total segment earnings
  
$
18,515
    
13,120
 
Realized gains on investments, net of taxes
    
157
   
925
 
               
Total consolidated net earnings
  
$
18,672
    
14,045
 


   
March 31,
  
   
2007
  
2006
  
   
(In thousands)
  
Assets:
          
Total segment assets
  
$
6,702,688
    
6,424,841
 
Other unallocated assets
    
24,790
   
18,351
 
               
Total consolidated assets
  
$
6,727,478
    
6,443,192
 


(7)  SHARE-BASED PAYMENTS

The Company has a stock and incentive plan ("Plan") which provides for the grant of any or all of the following types of awards to eligible employees: (1) stock options, including incentive stock options and nonqualified stock options; (2) stock appreciation rights, in tandem with stock options or freestanding; (3) restricted stock; (4) incentive awards; and (5) performance awards. The Plan began on April 21, 1995, and was to terminate on April 20, 2005, unless terminated earlier by the Board of Directors. The Plan was amended on June 25, 2004 to extend the termination date to April 20, 2010. The number of shares of Class A, $1.00 par value, common stock which may be issued under the Plan, or as to which stock appreciation rights or other awards may be granted, may not exceed 300,000. These shares may be authorized and unissued shares. The Company has only issued nonqualified stock options.

All of the employees of the Company and its subsidiaries are eligible to participate in the Plan. In addition, directors of the Company, other than Compensation and Stock Option Committee members, are eligible for restricted stock awards, incentive awards, and performance awards. Company directors, including members of the Compensation and Stock Option Committee, are eligible for nondiscretionary stock options. The directors' stock options vest 20% annually following one full year of service to the Company from the date of grant. The officers' stock options vest 20% annually following three full years of service to the Company from the date of grant. Options issued expire after ten years. No awards were issued in 2007 or 2006.

16
 
Through December 31, 2005, the Company classified the Plan as equity awards, and as such, utilized the grant date fair value method to measure compensation. Effective March 10, 2006, as more fully described below, the Company's Plan classification was changed to liability and accordingly, the Company began using the current fair value method to measure compensation cost. A summary of shares available for grant and stock option activity is detailed below.

       
Options Outstanding
  
           
 Weighted-
  
   
Shares
      
 Average
  
   
Available
      
 Exercise
  
   
For Grant
  
Shares
  
 Price
  
                
Balance at January 1, 2007
    
26,477
   
128,465
 
$
123.00
 
Stock Options:
                    
Exercised
    
-
   
(17,020
)
  
100.38
  
Forfeited
    
1,110
   
(1,110
)
  
131.23
  
                     
Balance at March 31, 2007
    
27,587
   
110,335
 
$
126.40
  

The total intrinsic value of options exercised was $2.4 million and $1.9 million for the three months ended March 31, 2007 and 2006, respectively. The total share-based liabilities paid were $2.2 million for the three months ended March 31, 2007. The total fair value of shares vested during the three months ended March 31, 2007 was $0.3 million.

The following table summarizes information about stock options outstanding at March 31, 2007.

   
Options Outstanding
      
       
Weighted-
      
       
Average
      
   
Number
  
Remaining
  
Options
  
   
Outstanding
  
Contractual Life
  
Exercisable
  
Exercise prices:
              
$    85.13
    
81
   
0.1 years
    
81
 
    105.25
    
9,130
   
1.0 years
    
9,130
 
    112.38
    
6,800
   
1.2 years
    
6,800
 
      92.13
    
26,574
   
4.1 years
    
12,198
 
      95.00
    
7,200
   
4.2 years
    
7,200
 
    150.00
    
60,550
   
7.1 years
    
3,800
 
                     
Totals
    
110,335
         
39,209
 
                     
Aggregate intrinsic value
                    
(in thousands)
  
$
13,064
        
$
5,488
  

The aggregate intrinsic value in the table above is based on the closing stock price of $244.80 per share on March 31, 2007.

17
 
In estimating the fair value of the options outstanding at March 31, 2007 and 2006, the Company employed the Black-Scholes option pricing model with assumptions as detailed below.

   
2007
  
2006
  
           
Expected term of options
    
2 to 6 years
    
2 to 6 years
  
Expected volatility:
              
Range
    
15.63% to 23.72
%
  
17.36% to 24.28
%
Weighted-average
    
19.36
%
  
20.09
%
Expected dividends
    
-
   
-
 
Risk-free rate:
              
Range
    
4.57% to 4.95
%
  
4.99% to 5.06
%
Weighted-average
    
4.67
%
  
5.02
%

The Company reviewed the contractual term relative to the options as well as perceived future behavior patterns of exercise. Volatility is based on historical volatility over the expected term.

The pre-tax compensation cost recognized in the financial statements related to the Plan was $1.3 million and $12.5 million for the three months ended March 31, 2007 and 2006, respectively. The related tax benefit recognized was $0.4 million and $4.4 million for the three months ended March 31, 2007 and 2006, respectively.

Effective March 10, 2006, the Company adopted and implemented a limited stock buy-back program which provides option holders the additional alternative of selling shares acquired through the exercise of options directly back to the Company. Option holders may elect to sell such acquired shares back to the Company at any time within ninety (90) days after the exercise of options at the prevailing market price as of the date of notice of election. The buy-back program did not alter the terms and conditions of the Plan, however the program necessitated a change in accounting from the equity classification to the liability classification. The modification affected 35 plan participants who had options outstanding on the date of modification and resulted in $11.7 million of total incremental pre-tax compensation cost due to the change from the equity to liability classification.

As of March 31, 2007, the total compensation cost related to nonvested options not yet recognized was $0.3 million. This amount is expected to be recognized over a weighted-average period of 2 years. The Company recognizes compensation cost over the graded vesting periods.

For the three months ended March 31, 2007 and 2006, the total cash received from the exercise of options under the Plan was $0.1 million and $0.2 million, respectively.


(8) 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 has now been issued by the IRS National Office in the form of a memorandum analyzing the issue which concludes that such loans do not constitute indirect self-dealing. This technical advice memorandum is 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.

18
 
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 2. 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 is or may be viewed as forward-looking. Although the Company has used 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 filings with the Securities and Exchange Commission ("SEC") 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.


OVERVIEW

Insurance Operations - Domestic

The Company is currently licensed to do business in all states except for New York. Products marketed are annuities, universal life insurance, equity-indexed annuities and universal life, and traditional life insurance, which include both term and whole life products. The Company’s domestic sales have historically been more heavily weighted toward annuity products, which include single and flexible premium deferred annuities, single premium immediate annuities, and equity-indexed annuities. Most of these annuities can be sold as tax qualified or nonqualified products. At March 31, 2007, the Company maintained approximately 123,000 annuity policies in force.

National Western markets and distributes its domestic products primarily through independent national marketing organizations ("NMOs"). These NMOs assist the Company in recruiting, contracting, and managing independent agents. The Company currently has approximately 9,100 independent agents contracted. Roughly 19% of these contracted agents have submitted policy applications to the Company in the past twelve months.

Insurance Operations - International

The Company'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, Eastern Europe, Asia and the Pacific Rim. 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 March 31, 2007, the Company had approximately 68,900 international life insurance policies in force representing approximately $13.4 billion in face amount of coverage.

International applications are submitted by independent contractor consultants and broker-agents. The Company has approximately 4,300 independent international consultants and brokers currently contracted, 45% of which have submitted policy applications to the Company in the past twelve months.

19
 
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 the Company'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, claims and other benefits almost entirely in United States dollars. Finally, the Company's nearly forty years of experience with the international products and its longstanding independent consultant and broker-agents relationships further serve to minimize risks.


SALES

Life Insurance

The following table sets forth information regarding the Company's life insurance sales activity as measured by annualized first year premiums. While the figures shown below are in accordance with industry practice and represent the amount of new business sold during the periods indicated, they are considered a non-GAAP financial measure. The Company believes sales are a measure of distribution productivity and are a leading indicator of future revenue trends. However, revenues are driven by sales in prior periods as well as in the current period and therefore, a reconciliation of sales to revenues is not meaningful or determinable.

   
Three Months Ended March 31,
  
   
2007
  
2006
  
   
(In thousands)
  
           
International:
          
Universal life
  
$
1,644
    
1,906
  
Traditional life
    
1,727
    
1,219
  
Equity-indexed life
    
4,727
    
4,135
  
     
8,098
    
7,260
  
               
Domestic:
              
Universal life
    
373
    
695
  
Traditional life
    
75
    
64
  
Equity-indexed life
    
1,422
    
408
  
     
1,870
    
1,167
  
               
Totals
  
$
9,968
    
8,427
  

Life insurance sales as measured by annualized first year premiums increased 18% in the first quarter of 2007 as compared to the first quarter of 2006. Both of the Company's life lines of business, international and domestic, posted increases over the comparable results in the first quarter of 2006 with international sales up 12% and domestic sales 60% greater.

20
 
Company management has placed considerable emphasis on building domestic life insurance sales as a strategic focus and in response to comments from outside rating agencies reviewing the Company. Domestic operations have generally focused more heavily on annuity sales than on life insurance sales. The Company spent the greater part of 2003 and 2004 revamping its domestic life operations by changing the way it contracts distribution for life business, eliminating products and distribution that have not contributed significantly to earnings, and creating new and competitive products. A single premium universal life ("SPUL") product was launched at the end of 2003 beginning a diversification of the Company's product portfolio away from smaller dollar face amount policies. The Company released its first equity-indexed universal life ("EIUL") product for its domestic markets at the end of the third quarter of 2005 and began receiving applications. This product accounted for 76% of domestic life insurance sales in the first three months of 2007 and management anticipates this share to continue throughout the remainder of the year. With the introduction of the EIUL and SPUL products and the discontinued marketing of smaller premium and volume life insurance policies, the Company has seen an increase in the average amount of per policy coverage purchased in its domestic markets as shown in the following table:

   
Average New Policy Face Amount
  
   
Domestic
  
International
  
       
Year ended December 31, 2003
  
$
76,100
    
219,600
 
Year ended December 31, 2004
    
101,700
   
234,500
 
Year ended December 31, 2005
    
137,900
   
245,900
 
Year ended December 31, 2006
    
315,800
    
254,700
  
Three months ended March 31, 2007
    
353,200
    
217,600
  

The Company's international life business consists of applications submitted from residents in various regions outside of the United States, the volume of which typically varies based upon changes in the socioeconomic climates of these regions. Historically, the Company has experienced a simultaneous combination of rising and declining sales in various countries; however, the appeal of the Company's dollar-denominated life insurance products overcomes many of the local and national difficulties. Applications submitted from residents of Latin America and the Pacific Rim perennially have comprised the majority of the Company's international life insurance sales. Over the past few years, effort has been directed toward the sale of a traditional endowment form of life insurance product for residents of Eastern European and the Commonwealth of Independent States (former Soviet Union). More recently, the Company's universal life product offerings have been made available to residents of these countries. While business is still be in a formative phase, sales from these countries have gradually become a larger percentage of overall international sales as shown below.

   
Three Months Ended March 31,
  
   
2007
  
2006
  
       
Percentage of International Sales:
          
Latin America
    
60.6
%
  
70.4
%
Pacific Rim
    
18.6
    
14.6
  
Eastern Europe
    
20.8
    
15.0
  
               
Totals
    
100.0
%
  
100.0
%

Year-to-date, the Company has recorded sales to residents outside of the United States in over thirty different countries with Brazil (27%), Taiwan (18%), and Kazakhstan (13%) making up the largest markets.

21
 
The table below sets forth information regarding the Company's life insurance in force for each date presented.

   
Insurance In Force as of March 31,
  
   
2007
  
2006
  
   
($ in thousands)
  
Universal life:
          
Number of policies
  
75,550
  
78,920
  
Face amounts
  
$
8,007,830
    
8,077,810
  
               
Traditional life:
              
Number of policies
    
52,880
    
54,490
  
Face amounts
  
$
1,756,000
    
1,736,000
  
               
Equity-indexed life:
              
Number of policies
    
20,630
    
16,520
  
Face amounts
  
$
4,519,930
    
3,411,650
  
               
Rider face amounts
  
$
1,817,290
    
1,603,430
  
               
Total life insurance:
              
Number of policies
    
149,060
    
149,930
  
Face amounts
  
$
16,101,050
    
14,828,890
  

Annuities

The following table sets forth information regarding the Company's annuity sales activity as measured by single and annualized first year premiums. Similar to life insurance sales, these figures are considered a non-GAAP financial measure but are shown in accordance with industry practice and depict the Company's sales productivity.

   
Three Months Ended March 31,
  
   
2007
  
2006
  
   
(In thousands)
  
           
Equity-indexed annuities
  
$
68,684
    
59,522
  
Other deferred annuities
    
27,657
    
46,693
  
Immediate annuities
    
1,722
    
4,079
  
               
Total
  
$
98,063
    
110,294
  

Annuity sales for the first three months of 2007 were 11% lower than the comparable period in 2006 continuing a trend that began in the first quarter of 2004. Annuity sales in the first quarter of 2004 represented the tail end of the increase in fixed annuity sales that began in 2003 when the Company achieved nearly $1.2 billion in sales. Annuity sales began trending lower due to a combination of declining interest rates, investors returning to alternative investment vehicles and the Company managing its targeted levels of risk and statutory capital and surplus. During the past couple of years interest rate levels have experienced an infrequent occurrence where the yield curve is inverted, that is, longer term interest rate levels were below shorter term interest rate levels. In such an environment, consumers opt for short term investment vehicles such as bank certificates of deposits rather than longer term choices which include fixed rate annuities.

The Company's mix of annuity sales has shifted the past few years. With a stronger performance in the equity market, sales of equity-indexed annuity products became more prevalent beginning in 2004 and have continued thus far in 2007. Over the past several years sales of equity-indexed products have consistently accounted for more than one-half of all annuity sales and were 70% in the first quarter of 2007. For all equity-indexed products, the Company purchases over the counter options to fully hedge the equity return feature. The options are purchased relative to the issuance of the annuity contracts in such a manner to minimize timing risk. Generally, the index return during the indexing period (if the underlying index increases), less any asset fees and participation rate limits, is credited to the contract holders electing the equity feature at the beginning of the contract year. The Company does not deliberately mismatch or under hedge for the equity feature of these products.

22
 
The sizable increase in annuity sales volume the past several years has required a greater level of asset/liability analysis. The Company monitors its asset/liability matching within the self-constraints of desired capital levels. Despite the amounts of new business, the company's capital level remains substantially above industry averages and regulator targets.

The following table sets forth information regarding annuities in force for each date presented.

   
Annuities in Force as of March 31,
  
   
2007
  
2006
  
   
($ in thousand)
  
           
Equity-indexed annuities
          
Number of policies
  
31,000
  
27,730
  
GAAP annuity reserves
  
$
1,834,094
    
1,624,965
  
               
Other deferred annuities
              
Number of policies
    
79,020
    
83,250
  
GAAP annuity reserves
  
$
2,627,803
    
2,719,428
  
               
Immediate annuities
              
Number of policies
    
12,990
    
12,450
  
GAAP annuity reserves
  
$
248,420
    
246,786
  
               
Total annuities
              
Number of policies
    
123,010
    
123,430
  
GAAP annuity reserves
  
$
4,710,317
    
4,591,179
  
               
Critical Accounting Estimates

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.

23
 
Deferred Policy 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.

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.

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 included in the Company's Annual Report on Form 10-K for the year ended December 31, 2006, and the discussions under Investments in Item 3 of this report.

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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 healthcare 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, healthcare trend rates, and discount rates. Per capita claims cost by age is the current cost of providing postretirement healthcare 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. Healthcare trend rates involve assumptions about the annual rate(s) of change in the cost of healthcare 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 healthcare 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.

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 the Company's annual report on Form 10-K for the year ended December 31, 2006.


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 derivatives 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 derivatives 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.

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Consolidated Operations

Revenues. The following details Company revenues.

 
Three Months Ended March 31,
  
 
2007
2006
  
   
(In thousands)
  
           
Traditional life and annuity premiums
  
$
4,733
    
3,991
 
Universal life and annuity contract revenues
    
28,796
   
26,956
 
Net investment income (excluding derivatives)
    
81,621
   
83,511
 
Other income
    
3,316
   
5,198
 
               
Operating revenues
    
118,466
   
119,656
 
Derivative income (loss)
    
(4,595
)
  
15,176
 
Realized gains on investments
    
241
   
1,423
 
               
Total revenues
  
$
114,112
    
136,255
 

Traditional life and annuity premiums - Traditional life and annuity premiums increased 18.6% in the first three months of 2007 compared to the same period in 2006. Traditional life insurance premiums for products such as whole life and term life are recognized as revenues over the premium-paying period.

Universal life and annuity contract revenues - Revenues for universal life and annuity contract revenues increased 6.8% for the three months in 2007 compared to 2006 and consist of policy charges for the cost of insurance, administration charges, and surrender charges assessed against policyholder account balances. Revenues in the form of cost of insurance charges were $17.9 million in the first quarter of 2007 compared to $16.5 million for the quarter ended March 31, 2006. Surrender charges assessed against policyholder account balances upon withdrawal decreased to $7.6 million in the first quarter of 2007 versus $7.7 million in 2006.

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

 
Three Months Ended March 31,
% of Total
  
2007
2006
2007
2006
  
   
(In thousands)
          
                   
Gross investment income:
                  
Debt securities
  
$
76,316
    
76,125
   
92.7
%
  
90.1
%
Mortgage loans
    
2,208
   
2,638
   
2.7
   
3.1
 
Policy loans
    
1,645
   
1,580
   
2.0
   
1.9
 
Other invested assets
    
2,121
   
4,184
   
2.6
   
4.9
 
                           
Total investment income
    
82,290
   
84,527
   
100.0
%
  
100.0
%
Investment expenses
    
669
   
1,016
             
                           
Net investment income
                          
(excluding derivatives)
    
81,621
   
83,511
             
Derivative income (loss)
  
(4,595
)
  
15,176