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, 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
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84-0467208
|
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(State
of Incorporation)
|
(I.R.S.
Employer Identification Number)
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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 Smaller
reporting company 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 29, 2007 was
$573,134,079.
As of
March 13, 2008, the number of shares of Registrant's common stock outstanding
was: Class A – 3,422,324 and Class B - 200,000.
DOCUMENTS
INCORPORATED BY REFERENCE
None
2
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PART
I
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Page
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Business
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4
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Risk
Factors
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9
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Unresolved
Staff Comments
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13
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Properties
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13
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Legal
Proceedings
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13
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Submission
of Matters to a Vote of Security Holders
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14
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PART
II
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Market
for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
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14
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Selected
Consolidated Financial Data
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16
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Management's
Discussion and Analysis of Financial Condition and Results of
Operations
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17
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Quantitative
and Qualitative Disclosures About Market Risk
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44
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Financial
Statements and Supplementary Data
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44
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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44
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Controls
and Procedures
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44
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Other
Information
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47
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PART
III
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Directors,
and Executive Officers and Corporate Governance
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47
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Executive
Compensation
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50
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
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68
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Certain
Relationships and Related Transactions, and Director
Independence
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70
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Principal
Accountant Fees and Services
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71
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PART
IV
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Exhibits
and Financial Statement Schedules
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71
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Signatures
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132
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PART
I
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
2007, the Company's total assets increased 2.1% to $6.8 billion at December 31,
2007 from $6.7 billion at December 31, 2006. The Company generated revenues of
$474.5 million, $521.9 million, and $441.0 million in 2007, 2006, and 2005,
respectively. In addition, National Western generated net income of $85.4
million, $76.3 million, and $77.3 million in 2007, 2006, and 2005,
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,
fixed 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 contract holder.
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. A
fixed indexed deferred annuity performs essentially in the same manner as SPDAs
and FPDAs with the exception that, in addition to a fixed interest crediting
option, the contract holder 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.
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Years
Ended December 31,
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||||||||||||
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2007
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2006
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2005
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||||||||||
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(In
thousands)
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||||||||||||
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Annuities:
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||||||||||||
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Single
premium deferred
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$ | 3,808 | 8,216 | 10,389 | ||||||||
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Flexible
premium deferred
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112,472 | 163,415 | 225,941 | |||||||||
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Fixed
indexed deferred
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316,848 | 303,613 | 298,227 | |||||||||
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Single
premium immediate
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4,637 | 10,750 | 23,383 | |||||||||
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Total
annuities
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437,765 | 485,994 | 557,940 | |||||||||
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Universal
life insurance
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168,279 | 146,742 | 133,579 | |||||||||
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Traditional
life and other
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24,915 | 18,046 | 16,629 | |||||||||
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Total
direct premiums and deposits collected
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$ | 630,959 | 650,782 | 708,148 | ||||||||
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, 2007, the Company's NMO relationships had
contracted approximately 5,600 independent agents with the
Company. Over 26% of these contracted agents submitted policy
applications to the Company in the past twelve months.
International Insurance
Operations. National Western's international operations generally 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, 2007, the Company had 72,940 international life insurance policies
in force representing nearly $14.8 billion in face amount of
coverage.
International
applications are submitted by independent contractors, consultants and
broker-agents, many of whom have been submitting policy applications to National
Western for 20 or more years. The Company had relationships with
approximately 5,200 independent international individuals at December
31, 2007, nearly 44% 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, over
forty years of experience with the international products and the Company's
longstanding business 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,
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||||||||||||
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2007
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2006
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2005
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(In
thousands)
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||||||||||||
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United
States domestic products:
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Annuities
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$ | 421,497 | 475,867 | 548,967 | ||||||||
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Life
insurance
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60,375 | 35,780 | 36,594 | |||||||||
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Total
domestic products
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481,872 | 511,647 | 585,561 | |||||||||
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International
products:
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||||||||||||
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Annuities
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16,268 | 10,127 | 8,973 | |||||||||
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Life
insurance
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132,819 | 129,008 | 113,614 | |||||||||
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Total
international products
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149,087 | 139,135 | 122,587 | |||||||||
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Total
direct premiums and deposits collected
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$ | 630,959 | 650,782 | 708,148 | ||||||||
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 2007, there were two such NMOs who accounted
for 24.2% and 10.7% 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 2007, there were two NMOs
who generated 23.8% and 19.4%, respectively, of total domestic life insurance
sales. The latter NMO was also the same NMO who produced 24.2% of total annuity
sales. With the independent distribution model the Company employs, the
concentration of sales within a particular NMO is not as an acute concern as
with other distribution relationships given the underlying agents are free to
contract with the Company through any NMO the Company has a relationship with.
International life insurance sales are much more diversified by independent
consultants and contractors and in 2007 were geographically attributed to Latin
America (70%), the Pacific Rim (13%), and Eastern Europe (17%).
Segment Financial
Information. A summary of financial information for the Company's
segments is as follows:
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Domestic
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International
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|||||||||||||||||||
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Life
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Life
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All
|
||||||||||||||||||
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Insurance
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Insurance
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Annuities
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Others
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Totals
|
||||||||||||||||
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(In
thousands)
|
||||||||||||||||||||
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Revenues,
excluding
|
||||||||||||||||||||
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realized
gains (losses):
|
||||||||||||||||||||
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2007
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$ | 44,783 | 113,598 | 292,402 | 20,227 | 471,010 | ||||||||||||||
|
2006
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43,222 | 106,613 | 350,665 | 18,697 | 519,197 | |||||||||||||||
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2005
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42,165 | 93,577 | 277,889 | 17,528 | 431,159 | |||||||||||||||
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Segment
earnings: (A)
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||||||||||||||||||||
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2007
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$ | 342 | 20,179 | 56,299 | 6,278 | 83,098 | ||||||||||||||
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2006
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297 | 12,191 | 56,559 | 5,566 | 74,613 | |||||||||||||||
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2005
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2,809 | 13,559 | 47,915 | 6,559 | 70,842 | |||||||||||||||
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Segment
assets: (B)
|
||||||||||||||||||||
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2007
|
$ | 399,097 | 796,012 | 5,500,226 | 106,039 | 6,801,374 | ||||||||||||||
|
2006
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381,490 | 715,064 | 5,467,733 | 103,087 | 6,667,374 | |||||||||||||||
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2005
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366,939 | 631,477 | 5,256,146 | 94,064 | 6,348,626 | |||||||||||||||
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 hundreds of life and health insurance company groups in
the United States as well as other financial intermediaries such as banks and
securities firms who market insurance products. Competitors in our international
markets include Pan-American Life Insurance, American Fidelity Life Insurance,
and Best Meridian Insurance while domestic market competitors include, among
others, American Equity Investment Life, Sammons Financial Group, AVIVA,
Allstate, Lincoln National Life, and Old Mutual Financial Network. 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. Financial strength ratings are
generally defined as a rating agency’s opinion as to a company’s financial
strength and ability to meet ongoing obligations to policyholders. Accordingly,
ratings are important to maintaining public confidence and impact the ability to
market products. The following summarizes the Company's financial strength
ratings.
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Rating
Agency
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Rating
|
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Standard
& Poor's
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A (Strong)
|
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A.M.
Best
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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 during
2007 with a stable outlook from Standard & Poor’s and a positive outlook
from A.M. Best. The positive outlook from A.M. Best signifies the rating
agency’s bias toward a rating upgrade sometime in the future. However, there is
no assurance that the Company's ratings will continue for a certain period of
time. In the event the Company's ratings are downgraded, the Company's business
may be negatively impacted.
Risk
Management
Similar
to other insurers, the Company is exposed to a wide spectrum of financial,
operational, and other risks as described in Item 1A. “Risk Factors”. Effective
enterprise risk management is a key concern for identifying, monitoring,
measuring, communicating, and managing risks within limits and risk tolerances.
The Company’s Board of Directors and senior management are knowledgeable of and
accountable for key risks. The Board meets at least every other month
and regularly hears reports from the President and Chief Operating Officer, the
Chief Financial and Administrative Officer, the Chief Actuary, the Chief
Investment Officer, and the Chief Compliance Officer. In addition, the Board has
several committees which include the Audit Committee, the Investment Committee,
and the Compensation and Stock Option Committee that regularly convene to
address various aspects of risk.
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.
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 discretionary withdrawals,
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.
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,
2007, 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 290 employees as of December 31, 2007 substantially
all of which worked in the Company’s home office in Austin, Texas. None of the
employees are subject to collective bargaining agreements governing their
employment with the Company.
Company
performance is subject to varying risk factors. This section provides an
overview of possible risk exposures at this point in time that could impact
Company performance in the future. While these scenarios do not represent
expectations of future experience, they are intended to illustrate the potential
impacts if any of the following risks were to manifest into actual
occurrences.
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.
There may
be occasions where the Company could encounter difficulty selling some of its
investments due to a lack of liquidity in the marketplace. If the Company
required significant amounts of cash on short notice during such a period, it
may have difficulty selling investments at attractive prices, in a timely manner
or both.
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.
The
profitability of the Company’s equity-indexed products linked in part to market
indices is significantly affected by the cost of underlying call options
purchased to fund the credits owed to contract holders selecting this form of
interest crediting. If there are little or no gains on the call options
purchased over the expected life of these equity-indexed products, the Company
would incur expenses for credited interest over and above the option costs. In
addition, if the Company does not successfully match the terms of the underlying
call options purchased with the terms of the equity-indexed products, the index
credits could exceed call option proceeds. This would serve to reduce the
Company’s spread on the products and decrease profits.
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, 2007, approximately 2% of the Company’s $5.7
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 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 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.
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 affect 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 are 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. Taxes, if any, are
payable on income attributable to a distribution under a policy/contract for the
year in which the distribution is made. 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
could be liable with respect to liabilities ceded to reinsurers if the
reinsurers fail to meet the obligations assumed by them.
The
Company cedes material amounts of insurance to other unaffiliated insurance
companies through reinsurance. However, these reinsurance arrangements do not
fully discharge the Company’s obligation to pay benefits on the reinsured
business. If a reinsurer fails to meet its obligations, the Company would be
forced to cover these claims. In addition, if a reinsurer becomes insolvent, it
may cause the Company to lose its reserve credits on the ceded business which
require the establishment of additional reserves. To mitigate the risks
associated with the use of reinsurance, the Company carefully monitors the
ratings and financial condition of its reinsurers on a regular basis and
attempts to avoid concentration of credit risks in order to diversify its risk
exposure.
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. Amortization of deferred policy acquisition expenses is
dependent upon actual and expected profits generated by the lines of business
that incurred the related expenses. Due to the uncertainty associated with
establishing these assumptions, the Company cannot, with precision, determine
the exact pattern of profit emergence. Accordingly, actual results could differ
from the related assumptions which could have a material and adverse impact on
the Company’s operating results.
We
are dependent upon effective information technology systems and on development
and implementation of new technologies.
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. These increased risks and
expanding requirements expose the Company to potential data loss and damages and
significant increases in compliance and litigation costs.
The
Company retains confidential information on its systems, including customer
information and proprietary business information. 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. Any
compromise of the security of the Company’s technology systems that results in
the disclosure of personally identifiable customer information could damage the
Company’s reputation, expose it to litigation, and result in significant
technical, legal and other expenses.
Some of
the Company’s information technology systems are older legacy-type systems and
require an ongoing commitment of resources to maintain current standards. These
legacy systems are written in older programming languages with which fewer and
fewer individuals are knowledgeable of and trained in. The Company’s success is
in large part dependent on maintaining and enhancing the effectiveness of
existing legacy systems and failure of these systems for any reason could
disrupt our operations, result in the loss of business and adversely impact our
profitability.
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 was 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 disagreed with the IRS analysis. The
Company contested and 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 was subsequently issued on April 11, 2007 by the IRS National Office in
the form of a memorandum, analyzing the issue, which concluded that such loans
do not constitute indirect self-dealing. By letter of June 5, 2007
from the IRS to the Company, the IRS concurred that based on the results of the
Technical Advice Memorandum, there was no excise tax owed by the Company for the
years under review. This technical advice memorandum is binding on
the IRS audit team.
The
Company is a defendant in three class action lawsuits. The Court has
certified a class consisting of certain California policyholders age 65 and
older alleging violations under California Business and Professions Code section
17200. The Court has additionally certified a subclass of 36
policyholders alleging fraud against their agent, and vicariously, against
National Western Life. Management believes that the Company has good
and meritorious defenses and intends to continue to vigorously defend itself
against these claims. A second class action lawsuit is in discovery
with no class certification motion pending. The third class action
lawsuit was certified as a class by the trail court, but ultimately reversed by
the Texas Supreme Court. Thereupon the plaintiff filed a new motion
for class certification which was denied by the trail court. The
Plaintiff filed a notice of appeal, which has not been perfected. The
Plaintiff and the Company have since filed a joint motion informing the Court of
Appeals that the parties have reached a comprehensive settlement and that the
parties jointly request the court to dismiss the appeal and remand the case to
District Court for an agreed dismissal with prejudice to be entered by the
District Court.
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.
OF
SECURITY HOLDERS
No
matters were submitted to a vote of the Company’s security holders during the
fourth quarter of 2007.
PART
II
RELATED
STOCKHOLDER MATTERS AND ISSUER
PURCHASES
OF EQUITY SECURITIES
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
|
||||
|
2007:
|
First
Quarter
|
$
|
235.25
|
223.05
|
|
|
Second
Quarter
|
271.60
|
249.05
|
|||
|
Third
Quarter
|
268.00
|
228.56
|
|||
|
Fourth
Quarter
|
246.95
|
199.53
|
|||
|
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
|
Equity
Security Holders
The
number of stockholders of record on March 10, 2008 was as follows:
|
Class
A Common Stock
|
4,512
|
||
|
Class
B Common Stock
|
2
|
Dividends
During
2007, the Company paid cash dividends on its Class A and Class B common stock in
the amounts of $1,232,037 and $36,000, respectively. 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. 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, 94,984 shares of the Company’s Class A
common stock may be issued upon exercise of the outstanding options at December
31, 2007. The weighted average exercise price of the outstanding
options is $128.47 per option. Excluding the outstanding options,
27,668 shares of the common stock remain available for future issuance under the
plan at December 31, 2007. 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, 2002, and that
all dividends were reinvested.
Issuer
Purchases of Equity Securities
Effective
March 10, 2006, the Company adopted and implemented a limited stock buy-back
program associated with the Company's 1995 Stock Option and Incentive Plan
("Plan") 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.
During
the months ended November and December 2007, the Company purchased 200 shares
and 400 shares from option holders at an average price of $202.92 and $207.37,
respectively. These purchased shares are reported in the Company's
condensed consolidated financial statements as authorized and
unissued.
The
following five-year financial summary includes comparative amounts derived from
the audited consolidated financial statements.
|
Years
Ended December 31,
|
||||||||||||||||||||
|
2007
|
2006
|
2005
|
2004
|
2003
|
||||||||||||||||
|
(In
thousands except per share amounts)
|
||||||||||||||||||||
|
Earnings
Information:
|
||||||||||||||||||||
|
Revenues:
|
||||||||||||||||||||
|
Life
and annuity premiums
|
$ | 19,513 | 15,805 | 14,602 | 14,025 | 13,916 | ||||||||||||||
|
Universal
life and annuity contract
|
||||||||||||||||||||
|
revenues
|
119,677 | 106,320 | 96,765 | 89,513 | 80,964 | |||||||||||||||
|
Net
investment income
|
318,137 | 379,768 | 310,213 | 315,843 | 298,974 | |||||||||||||||
|
Other
income
|
13,683 | 17,304 | 9,579 | 11,259 | 7,061 | |||||||||||||||
|
Realized
gains (losses) on
|
||||||||||||||||||||
|
investments
|
3,497 | 2,662 | 9,884 | 3,506 | (1,647 | ) | ||||||||||||||
|
Total
revenues
|
474,507 | 521,859 | 441,043 | 434,146 | 399,268 | |||||||||||||||
|
Benefits
and expenses:
|
||||||||||||||||||||
|
Life
and other policy benefits
|
41,326 | 35,241 | 39,162 | 34,613 | 37,180 | |||||||||||||||
|
Amortization
of deferred policy
|
||||||||||||||||||||
|
acquisition
costs
|
88,413 | 90,358 | 87,955 | 88,733 | 53,829 | |||||||||||||||
|
Universal
life and investment
|
||||||||||||||||||||
|
annuity
contract interest
|
164,391 | 213,736 | 150,692 | 173,315 | 176,374 | |||||||||||||||
|
Other
operating expenses
|
55,130 | 65,709 | 46,349 | 35,441 | 48,776 | |||||||||||||||
|
Total
expenses
|
349,260 | 405,044 | 324,158 | 332,102 | 316,159 | |||||||||||||||
|
Earnings
before Federal income taxes
|
||||||||||||||||||||
|
and
cumulative effect of change in
|
||||||||||||||||||||
|
accounting
principle
|
125,247 | 116,815 | 116,885 | 102,044 | 83,109 | |||||||||||||||
|
Federal
income taxes
|
39,876 | 40,472 | 39,618 | 34,572 | 27,327 | |||||||||||||||
|
Earnings
before cumulative effect of
|
||||||||||||||||||||
|
change
in accounting principle
|
85,371 | 76,343 | 77,267 | 67,472 | 55,782 | |||||||||||||||
|
Cumulative
effect of change in
|
||||||||||||||||||||
|
accounting
principle, net of tax
|
- | - | - | 54,697 | - | |||||||||||||||
|
Net
earnings
|
$ | 85,371 | 76,343 | 77,267 | 122,169 | 55,782 | ||||||||||||||
|
Diluted
Earnings Per Share:
|
||||||||||||||||||||
|
Earnings
from operations:
|
||||||||||||||||||||
|
Class
A
|
$ | 23.95 | 21.46 | 21.83 | 19.26 | 16.10 | ||||||||||||||
|
Class
B
|
$ | 12.12 | 10.84 | 11.00 | 9.68 | 8.09 | ||||||||||||||
|
Cumulative
effect of change in
|
||||||||||||||||||||
|
accounting
principle:
|
||||||||||||||||||||
|
Class
A
|
$ | - | - | - | 15.61 | - | ||||||||||||||
|
Class
B
|
$ | - | - | - | 7.85 | - | ||||||||||||||
|
Net
earnings:
|
||||||||||||||||||||
|
Class
A
|
$ | 23.95 | 21.46 | 21.83 | 34.87 | 16.10 | ||||||||||||||
|
Class
B
|
$ | 12.12 | 10.84 | 11.00 | 17.53 | 8.09 | ||||||||||||||
|
Balance
Sheet Information:
|
||||||||||||||||||||
|
Total
assets
|
$ | 6,835,326 | 6,693,443 | 6,369,008 | 5,991,685 | 5,297,720 | ||||||||||||||
|
Total
liabilities
|
$ | 5,823,641 | 5,760,459 | 5,495,000 | 5,183,013 | 4,617,862 | ||||||||||||||
|
Stockholders’
equity
|
$ | 1,011,685 | 932,984 | 874,008 | 808,672 | 679,858 | ||||||||||||||
|
Book
value per common share
|
$ | 279.29 | 257.67 | 241.89 | 225.62 | 191.69 | ||||||||||||||
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, 2007 follows. This discussion should be read in
conjunction with the Company’s consolidated financial statements and related
notes beginning on page 76 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 that follows in this Item includes these
indicators and presents information useful to an overall understanding of the
Company’s business performance in 2007, 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.
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. See the discussion of the
adoption of Statement of Position (“SOP”) 05-1, Accounting by Insurance Enterprises
for Deferred Acquisition Costs in Connection with Modifications or Exchanges of
Insurance Contracts on page 44 of this report.
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, which was frozen effective December 31, 2007,
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. The freeze
ceased future benefit accruals to all participants and closed the Plan to any
new participants. In addition, all participants became immediately 100% vested
in their accrued benefits as of that date.
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
|
|
Ÿ
|
expected
dividends
|
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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Universal
life and annuity contract revenues
|
$ | 119,677 | 106,320 | 96,765 | ||||||||
|
Traditional
life and annuity premiums
|
19,513 | 15,805 | 14,602 | |||||||||
|
Net
investment income (excluding derivatives)
|
334,799 | 336,489 | 321,201 | |||||||||
|
Other
income
|
13,683 | 17,304 | 9,579 | |||||||||
|
Operating
revenues
|
487,672 | 475,918 | 442,147 | |||||||||
|
Derivative
income (loss)
|
(16,662 | ) | 43,279 | (10,988 | ) | |||||||
|
Realized
gains on investments
|
3,497 | 2,662 | 9,884 | |||||||||
|
Total
revenues
|
$ | 474,507 | 521,859 | 441,043 | ||||||||
Universal life and annuity
contract revenues – Revenues for universal life and annuity contract
revenues increased 12.6% in 2007 compared to 2006. Revenues for these
products consist of policy charges for the cost of insurance, administration
charges, and surrender charges assessed against policyholder account balances,
less reinsurance premiums. Cost of insurance charges were $74.3
million in 2007 compared to $67.7 million in 2006, and $63.3 million in
2005. Administrative charges were $20.9 million, $17.1 million, and
$15.0 million for the years ended December 31, 2007, 2006, and 2005,
respectively. Surrender charges assessed against policyholder account
balances upon withdrawal were $33.4 million, in 2007 compared to $28.7 million
in 2006 and $25.1 million in 2005.
Traditional life and annuity
premiums – Traditional life and annuity premiums increased 23.5% in 2007
compared to 2006. Increasing life sales has been a strategic focus
over the past several years. Traditional life insurance premiums for
products such as whole life and term life are recognized as revenues over the
premium-paying period.
Net investment income
- A detail of net investment income is provided below.
|
Years
Ended December 31,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Gross
investment income:
|
||||||||||||
|
Debt
securities
|
$ | 309,708 | 306,129 | 293,502 | ||||||||
|
Mortgage
loans
|
8,513 | 8,480 | 9,676 | |||||||||
|
Policy
loans
|
6,302 | 6,354 | 6,409 | |||||||||
|
Short-term
investments
|
7,059 | 3,118 | 1,416 | |||||||||
|
Other
investment income
|
6,087 | 15,289 | 12,559 | |||||||||
|
Total
investment income
|
337,669 | 339,370 | 323,562 | |||||||||
|
Investment
expenses
|
2,870 | 2,881 | 2,361 | |||||||||
|
Net
investment income
|
||||||||||||
|
(excluding
derivatives)
|
334,799 | 336,489 | 321,201 | |||||||||
|
Derivative
income (loss)
|
(16,662 | ) | 43,279 | (10,988 | ) | |||||||
|
Net
investment income
|
$ | 318,137 | 379,768 | 310,213 | ||||||||
Investment
grade debt securities generated approximately 92.5% of total investment income,
excluding derivatives in 2007. Short-term investments contributed
$7.1 million, $3.1 million, and $1.4 million for the years ended 2007, 2006, and
2005, respectively. The significant increase relative to short-term
investment income in 2007 is attributable to higher asset holdings in these
investments compared to prior years. Other investment income for 2007
includes $0.9 million related to income received on various profit participation
arrangements compared to $1.2 million recorded in 2006 and $2.8 million recorded
in 2005. 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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands except percentages)
|
||||||||||||
|
Excluding
derivatives:
|
||||||||||||
|
Net
investment income
|
$ | 334,799 | 336,489 | 321,201 | ||||||||
|
Average
invested assets, at amortized cost
|
$ | 5,732,212 | 5,514,196 | 5,205,983 | ||||||||
|
Yield
on average invested assets
|
5.84 | % | 6.10 | % | 6.17 | % | ||||||
|
Including
derivatives:
|
||||||||||||
|
Net
investment income
|
$ | 318,137 | 379,768 | 310,213 | ||||||||
|
Average
invested assets, at amortized cost
|
$ | 5,789,502 | 5,548,266 | 5,252,259 | ||||||||
|
Yield
on average invested assets
|
5.50 | % | 6.84 | % | 5.91 | % | ||||||
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 as
well as prepayments, calls, and maturities of debt securities reinvested at
lower rates. The additional income recognized from the other invested
assets in 2006 and 2005, as previously discussed, also contributes to a higher
yield for those years. Refer to the Derivatives discussion
following this section for a more detailed explanation.
Other income - Other
income revenues consists primarily of gross income associated with nursing home
operations of $12.6 million, $11.2 million, and $8.9 million in 2007, 2006, and
2005, respectively. In addition, the Company received $0.5 million
and $5.5 million related to lawsuit settlements during 2007 and
2006.
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 fixed
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 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 2007
and 2005, the S&P 500 Index®
decreased resulting in index option losses and a reduction in contract interest
expenses. In 2006, the S&P 500 Index®
increased and the Company recorded income from index options and likewise
increased contract interest expenses.
Derivative
components included in net investment income and the corresponding contract
interest amounts are detailed below.
|
Years
Ended December 31,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Derivatives:
|
||||||||||||
|
Unrealized
income (loss)
|
$ | (56,204 | ) | 27,108 | (9,579 | ) | ||||||
|
Realized
income (loss)
|
39,542 | 16,171 | (1,409 | ) | ||||||||
|
Total
income (loss) included in net investment income
|
$ | (16,662 | ) | 43,279 | (10,988 | ) | ||||||
|
Total
contract interest
|
$ | 164,391 | 213,736 | 150,692 | ||||||||
Realized gains on
investments - The net gains reported in 2007 of $3.5 million consisted of
gross gains of $5.4 million primarily from calls and sales of debt securities,
(including a $3.7 million gain recorded on a previously impaired debt security),
sale of real estate during the year, offset by gross losses of $1.9 million,
which includes the impairments highlighted in the table below.
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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Impairment
or valuation writedowns:
|
||||||||||||
|
Bonds
|
$ | 67 | 99 | 1,926 | ||||||||
|
Mortgage
loans
|
1,467 | 2,100 | - | |||||||||
The
mortgage loan valuation writedown in 2007 and 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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Life
and other policy benefits
|
$ | 41,326 | 35,241 | 39,162 | ||||||||
|
Amortization
of deferred policy acquisition costs
|
88,413 | 90,358 | 87,955 | |||||||||
|
Universal
life and annuity contract interest
|
164,391 | 213,736 | 150,692 | |||||||||
|
Other
operating expenses
|
55,130 | 65,709 | 46,349 | |||||||||
|
Totals
|
$ | 349,260 | 405,044 | 324,158 | ||||||||
Life and other policy
benefits - Life and other policy benefits reflect death claims of $28.5
million, $26.2 million, and $30.0 million for 2007, 2006, and 2005,
respectively.
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 decreased to $88.4 million for the year
ended December 31, 2007 compared to $90.4 million and $88.0 million reported in
2006 and 2005. An unlocking adjustment was recorded in the current
year which resulted in a decrease of amortization by $8.6
million. This unlocking adjustment was based upon changes to (1)
future mortality assumptions reflecting current experience studies and (2)
future cost of insurance rate assumptions based on company changes to future
cost of insurance rate changes. In addition, a true-up adjustment was
also recorded at December 2007 relative to partial surrender rates, mortality
rates, credited interest rates and earned rates for the current year’s
experience resulting in a $2.7 million decrease in
amortization. Amortization for 2006 includes a true-up adjustment
relative to partial surrenders, mortality assumptions, annuitizations, credited
rates and earned rates which increased amortization in that year by
approximately $4.3 million. There was a similar adjustment in 2005
relative to amortization assumptions that resulted in increased amortization for
that year.
In
accordance with the newly adopted SOP 05-1, Accounting by Insurance Enterprises
for Deferred Acquisition Costs in Connection with Modifications or Exchanges of
Insurance Contracts, ("SOP 05-1") the Company’s amortization of these
deferred policy acquisition costs is expected to increase in 2007 and
in the future. Under this pronouncement, annuitizations and
certain internal replacements of contracts result in the associated unamortized
deferred acquisition costs, unearned revenue liabilities, and deferred sales
inducement assets being written off.
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,
|
|||||||||||||||||||||||
|
2007
|
2006
|
2005
|
2007
|
2006
|
2005
|
|||||||||||||||||||
|
(Excluding
equity-indexed products)
|
(Including
equity-indexed products)
|
|||||||||||||||||||||||
|
Annuity
|
3.41 | % | 3.39 | % | 3.59 | % | 2.84 | % | 3.86 | % | 2.86 | % | ||||||||||||
|
Interest
sensitive life
|
3.23 | % | 4.30 | % | 4.94 | % | 4.30 | % | 5.41 | % | 4.63 | % | ||||||||||||
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
2007 and 2005, while, also decreasing the Company's investment income given the
hedge nature of the options. During 2006, 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 $11.0
million, $10.2 million, and $7.6 million in 2007, 2006, and 2005,
respectively. Compensation costs related to stock options totaled
negative $1.1 million in 2007 as a result of marking the options to fair value
under the liability method of accounting. In 2006, $13.1 million was
recorded related to increase compensation costs resulting from a change to
liability classification for the Company’s stock option
plan. Compensation costs related to stock options reported
in 2005 totaled $0.9 million.
Federal Income Taxes. Federal
income taxes on earnings from continuing operations for 2007, 2006, and 2005
reflect effective tax rates of 31.8%, 34.6%, 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.
During
the second quarter of 2007, upon the completion of a detailed review of the
deferred tax items, the Company identified a $2.3 million error in the net
deferred tax liability. The error, which occurred during various periods prior
to 2005, was corrected in the second quarter of 2007 and resulted in a decrease
in the net deferred tax liability and deferred tax expense. The
adjustment was not material to the current period or any prior period financial
statements.
Segment
Operations
Summary
of Segment Earnings
A summary
of segment earnings from continuing operations for the years ended December 31,
2007, 2006, and 2005 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:
|
||||||||||||||||||||
|
2007
|
$ | 342 | 20,179 | 56,299 | 6,278 | 83,098 | ||||||||||||||
|
2006
|
297 | 12,191 | 56,559 | 5,566 | 74,613 | |||||||||||||||
|
2005
|
2,809 | 13,559 | 47,915 | 6,559 | 70,842 | |||||||||||||||
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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Premiums
and other revenue:
|
||||||||||||
|
Premiums
and contract revenues
|
$ | 25,879 | 22,731 | 22,172 | ||||||||
|
Net
investment income
|
18,863 | 20,462 | 19,958 | |||||||||
|
Other
income
|
41 | 29 | 35 | |||||||||
|
Total
premiums and other revenue
|
44,783 | 43,222 | 42,165 | |||||||||
|
Benefits
and expenses:
|
||||||||||||
|
Life
and other policy benefits
|
14,922 | 13,656 | 14,932 | |||||||||
|
Amortization
of deferred policy acquisition costs
|
7,998 | 7,313 | 5,798 | |||||||||
|
Universal
life insurance contract interest
|
9,463 | 9,168 | 8,842 | |||||||||
|
Other
operating expenses
|
11,898 | 12,630 | 8,349 | |||||||||
|
Total
benefits and expenses
|
44,281 | 42,767 | 37,921 | |||||||||
|
Segment
earnings before Federal income taxes
|
502 | 455 | 4,244 | |||||||||
|
Federal
income taxes
|
160 | 158 | 1,435 | |||||||||
|
Segment
earnings
|
$ | 342 | 297 | 2,809 | ||||||||
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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Universal
life insurance revenues
|
$ | 23,028 | 18,286 | 16,322 | ||||||||
|
Traditional
life insurance premiums
|
6,629 | 6,906 | 7,392 | |||||||||
|
Reinsurance
premiums
|
(3,778 | ) | (2,461 | ) | (1,542 | ) | ||||||
|
Totals
|
$ | 25,879 | 22,731 | 22,172 | ||||||||
The
Company’s premiums and contract revenues have increased 13.8% from 2006 as
efforts have been made to promote domestic life products. It is the
Company's marketing plan to increase domestic life product sales through
increased recruiting of new distribution and the development of new life
insurance products. The Company had approximately 5,600 contracted
agents as of December 31, 2007.
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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Universal
life insurance:
|
||||||||||||
|
First
year and single premiums
|
$ | 15,592 | 14,640 | 14,973 | ||||||||
|
Renewal
premiums
|
16,639 | 14,118 | 14,199 | |||||||||
|
Totals
|
$ | 32,231 | 28,758 | 29,172 | ||||||||
Policy
benefits totaled $14.9 million, $13.7 million, and $14.9 million in 2007, 2006,
and 2005, respectively, which are consistent with Company
expectations. Net investment income decreased to $18.9 million in
2007 as compared to $20.5 million and $20.0 million in 2006 and 2005,
respectively. Other operating expense decreased in 2007 resulting
from negative stock option compensation costs recorded under liability
accounting. The costs increased significantly in 2006 due to an
increase in compensation costs resulting from the change to liability
classification for the Company’s stock option plan. Compensation
costs totaled $0.3 million, $3.0 million, and $0.2 million in 2007, 2006, and
2005, 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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Premiums
and other revenue:
|
||||||||||||
|
Premiums
and contract revenues
|
$ | 88,782 | 78,005 | 70,379 | ||||||||
|
Net
investment income
|
24,690 | 28,530 | 23,123 | |||||||||
|
Other
income
|
126 | 78 | 75 | |||||||||
|
Total
premiums and other revenue
|
113,598 | 106,613 | 93,577 | |||||||||
|
Benefits
and expenses:
|
||||||||||||
|
Life
and other policy benefits
|
22,810 | 18,161 | 21,232 | |||||||||
|
Amortization
of deferred policy acquisition costs
|
24,959 | 23,075 | 20,389 | |||||||||
|
Universal
life insurance contract interest
|
20,993 | 25,675 | 18,118 | |||||||||
|
Other
operating expense
|
15,271 | 21,051 | 13,359 | |||||||||
|
Total
benefits and expenses
|
84,033 | 87,962 | 73,098 | |||||||||
|
Segment
earnings before Federal income taxes
|
29,565 | 18,651 | 20,479 | |||||||||
|
Federal
income taxes
|
9,386 | 6,460 | 6,920 | |||||||||
|
Segment
earnings
|
$ | 20,179 | 12,191 | 13,559 | ||||||||
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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Universal
life insurance revenues
|
$ | 85,633 | 78,008 | 72,010 | ||||||||
|
Traditional
life insurance premiums
|
15,692 | 11,027 | 9,201 | |||||||||
|
Reinsurance
premiums
|
(12,543 | ) | (11,030 | ) | (10,832 | ) | ||||||
|
Totals
|
$ | 88,782 | 78,005 | 70,379 | ||||||||
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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Universal
life insurance
|
||||||||||||
|
First
year and single premiums
|
$ | 44,426 | 36,758 | 35,575 | ||||||||
|
Renewal
premiums
|
91,621 | 81,226 | 68,832 | |||||||||
|
Totals
|
$ | 136,047 | 117,984 | 104,407 | ||||||||
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 $76.8 million, $60.5 million, and $48.2 million for
the years ended 2007, 2006, and 2005, respectively.
A detail
of net investment income for international life insurance operations is provided
below.
|
Years
Ended December 31,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Net
investment income
|
||||||||||||
|
(excluding
derivatives)
|
$ | 26,752 | 25,893 | 23,896 | ||||||||
|
Derivative
income (loss)
|
(2,062 | ) | 2,637 | (773 | ) | |||||||
|
Net
investment income
|
$ | 24,690 | 28,530 | 23,123 | ||||||||
Derivative
income and losses fluctuate from period to period based on the S&P 500
Index®
performance.
Life and
other policy benefits totaled $22.8 million in 2007, $18.2 million in 2006, and
$21.2 million in 2005, which are consistent with Company
expectations. Amortization of deferred policy acquisition costs were
$25.0 million, $23.1 million, and $20.4 million for 2007, 2006, and 2005,
respectively. The Company recorded an unlocking adjustment in 2007
totaling $9.0 million relative to improved mortality assumptions that results in
an increase to the deferred asset balance and a decrease in amortization
expense. In addition, a true-up adjustment of $1.7 million was also
recorded in 2007 resulting in a decrease to amortization. Offsetting
the decrease to amortization by the unlocking and true-up adjustments is an
increase in amortization due primarily to the application of SOP 05-1 which
requires the write-off of deferred balances on contracts that are considered
substantially changed under this new guidance. These balances were
previously carried and amortized over the projected life of the
contract. In 2006, a true-up of amortization assumptions resulted in
increased amortization of $1.0 million. Contract interest expense was
$20.1 million, $25.7 million, and $18.1 million, in 2007, 2006, and 2005,
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.
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 $12.2 billion at December 31, 2005 to $13.3
billion at December 31, 2006 and to $14.8 billion at December 31,
2007.
Other
operating expenses reported in 2007 were $15.3 million compared to $21.1 million
and $13.4 million in 2006 and 2005. The decrease in 2007 results from
negative compensation costs related to stock options recorded under liability
accounting. The significant increase in 2006 is due to an increase in
compensation costs resulting from the change to liability classification for the
Company’s stock option plan. Compensation costs totaled $0.4 million,
$5.1 million, and $0.4 million in 2007, 2006, and 2005,
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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Premiums
and other revenue:
|
||||||||||||
|
Premiums
and contract revenues
|
$ | 24,529 | 21,389 | 18,816 | ||||||||
|
Net
investment income
|
266,953 | 323,326 | 258,485 | |||||||||
|
Other
income
|
920 | 5,950 | 588 | |||||||||
|
Total
premiums and other revenue
|
292,402 | 350,665 | 277,889 | |||||||||
|
Benefits
and expenses:
|
||||||||||||
|
Life
and other policy benefits
|
3,594 | 3,424 | 2,998 | |||||||||
|
Amortization
of deferred policy acquisition costs
|
55,456 | 59,970 | 61,768 | |||||||||
|
Annuity
contract interest
|
133,935 | 178,893 | 123,732 | |||||||||
|
Other
operating expenses
|
16,931 | 21,847 | 17,019 | |||||||||
|
Total
benefits and expenses
|
209,916 | 264,134 | 205,517 | |||||||||
|
Segment
earnings before Federal income taxes
|
82,486 | 86,531 | 72,372 | |||||||||
|
Federal
income taxes
|
26,187 | 29,972 | 24,457 | |||||||||
|
Segment
earnings
|
$ | 56,299 | 56,559 | 47,915 | ||||||||
Revenues
from annuity operations primarily include 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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Surrender
charges
|
$ | 20,238 | 17,260 | 15,271 | ||||||||
|
Payout
annuity and other revenues
|
4,263 | 4,098 | 3,511 | |||||||||
|
Traditional
annuity premiums
|
28 | 31 | 34 | |||||||||
|
Totals
|
$ | 24,529 | 21,389 | 18,816 | ||||||||
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,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Fixed
indexed annuities
|
$ | 316,848 | 303,613 | 298,227 | ||||||||
|
Other
deferred annuities
|
116,280 | 171,631 | 236,330 | |||||||||
|
Immediate
annuities
|
4,637 | 10,750 | 23,383 | |||||||||
|
Totals
|
$ | 437,765 | 485,994 | 557,940 | ||||||||
Indexed
products are more attractive for consumers when interest rate levels remain low
as has been the market environment the past few years. Fixed indexed
annuity deposits as a percentage of total annuity deposits recorded were 72.4%,
62.5%, and 53.5% for the years ended December 31, 2007, 2006, and 2005,
respectively. Since the Company does not offer variable products or
mutual funds, fixed indexed products provide an important alternative to the
Company's existing fixed interest rate annuity products.
Other
deferred annuity deposits decreased in 2007 compared to 2006 with $116.3 million
recorded in collected deposits compared to $171.6 million,
respectively. These product sales have been trending lower over the
past few years due to low interest rates and investor preferences. 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 $20.8 million, $19.8 million, and $21.4 million for
the years ended December 31, 2007, 2006, and 2005, respectively.
A detail
of net investment income for annuity operations is provided below.
|
Years
Ended December 31,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Net
investment income
|
||||||||||||
|
(excluding
derivatives)
|
$ | 281,553 | 282,684 | 268,700 | ||||||||
|
Derivative
income (loss)
|
(14,600 | ) | 40,642 | (10,215 | ) | |||||||
|
Net
investment income
|
$ | 266,953 | 323,326 | 258,485 | ||||||||
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 fixed 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 2005, is due to the increase in the overall
size of the asset portfolio as a result of higher sales volume. Net
investment income for 2006 included additional income from other income items as
previously discussed.
The
Company recorded an unlocking adjustment of $1.8 million and true-up adjustments
of $3.3 million in 2007 resulting in decreased amortization of deferred
acquisition costs. A true-up of assumptions in 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 relative to the
future spreads on certain fixed indexed 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 in 2005 resulted in a decrease to the
deferred asset balance and an increase in amortization in that
year.
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 2008, 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 fixed indexed annuities. The detail of fixed indexed annuity contract
interest compared to contract interest for all other annuities is as
follows:
|
Years
Ended December 31,
|
||||||||||||
|
2007
|
2006
|
2005
|
||||||||||
|
(In
thousands)
|
||||||||||||
|
Fixed
indexed annuities
|
$ | 50,743 | 88,094 | 28,224 | ||||||||
|
All
other annuities
|
94,632 | 101,619 | 110,165 | |||||||||
|
Gross
contract interest
|
145,375 | 189,713 | 138,389 | |||||||||
|
Bonus
interest deferred and capitalized
|
(20,796 | ) | (19,700 | ) | (21,200 | ) | ||||||
|
Bonus
interest amortization
|
9,356 | 8,880 | 6,543 | |||||||||
|
Total
contract interest
|
$ | 133,935 | 178,893 | 123,732 | ||||||||
In
comparison by year, the fluctuation in reported contract interest amounts for
fixed 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. As previously noted, contract interest reflects
variations due to the S&P 500 Index®
performance relative to the fair value of fixed indexed products.
Other
operating expenses totaled $16.9 million in 2007 compared to $21.8 million in
2006. The decrease in 2007 results from negative compensation costs
recorded under liability accounting in the current year. The 2006
expense reflects an increase of $5.0 million due to increased compensation costs
on stock options resulting from the change to liability classification for the
Company’s plan. Compensation costs were $0.4 million in 2007 and
2005.
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 $4.1 million, pre-tax, in 2007 and
$4.5 million and $3.9 million in 2006 and 2005, 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 $1.6
million, $1.0 million, and $1.3 million of operating earnings in 2007, 2006, and
2005, 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, 2007
and 2006. The Company emphasizes investment grade debt securities,
with smaller holdings in mortgage loans and policy loans.
|
2007
|
2006
|
|||||||||||||||
|
Carrying
|
Carrying
|
|||||||||||||||
|
Value
|
%
|
Value
|
%
|
|||||||||||||
|
(In
thousands)
|
(In
thousands)
|
|||||||||||||||
|
Debt
securities
|
$ | 5,659,604 | 95.9 | $ | 5,484,799 | 94.7 | ||||||||||
|
Mortgage
loans
|
99,033 | 1.7 | 103,325 | 1.8 | ||||||||||||
|
Policy
loans
|
83,772 | 1.4 | 86,856 | 1.5 | ||||||||||||
|
Derivatives
|
25,907 | 0.4 | 72,012 | 1.2 | ||||||||||||
|
Equity
securities
|
19,713 | 0.3 | 21,203 | 0.4 | ||||||||||||
|
Real
estate
|
||||||||||||||||