MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND - ------ --------------------------------------------------------------- RESULTS OF OPERATIONS ---------------------
Policyholder Dividends. Policyholder dividends are paid on certain participating policies, primarily in the Life Insurance segment. Policyholder dividends were $41.0 million in 1996, a 2.8% increase over 1995. Policyholder dividends increased 2.8% to $39.9 million in 1995 from $38.8 million in 1994.
Net Operating Income. Net operating income is net income, excluding realized gains and losses on investments (net of related federal income tax) and discontinued operations. Net operating income for 1996 was $203.7 million, an 8.5% increase from 1995. The Company's net operating income increased 8.2% to $187.7 million in 1995 from $173.5 million in 1994.
NLIC's principal sources of funds are premiums and other considerations paid, contract charges earned, net investment income received and proceeds from investments called, redeemed or sold. The principal uses of these funds are the payment of benefits on annuity contracts and life insurance policies, operating expenses and the purchase of investments. Net cash provided by operating activities (reflecting principally (i) premiums and contract charges collected, less (ii) benefits paid on life insurance products, plus (iii) income collected on invested assets, less (iv) commissions and other general expenses paid) was $346.2 million, $187.6 million and $39.9 million for the years ended December 31, 1996, 1995 and 1994, respectively. Net cash used by investing activities (principally reflecting investments purchased less investments called, redeemed or sold) was $771.3 million, $1.72 billion and $1.39 billion in the years ended December 31, 1996, 1995 and 1994, respectively. Net cash provided by financing activities (principally reflecting deposits to investment product and universal life insurance product account balances less withdrawals from such account balances and capital contributions less dividends paid) was $459.5 million, $1.54 billion and $1.34 billion for the years ended December 31, 1996, 1995 and 1994, respectively.
Prepayment risk is an inherent risk of holding MBSs. However, the degree of prepayment risk is particular to the type of MBS held. The Company limits its exposure to prepayments by purchasing less volatile types of MBSs. As of December 31, 1996, $2.97 billion (or 81.0% of the carrying value of the general account MBS portfolio was invested in planned amortization class CMOs (PACs). PACs are securities whose cash flows are designed to remain constant over a variety of mortgage prepayment environments. Other classes in the CMO security are structured to accept the volatility of mortgage prepayment changes, thereby insulating the PAC class. Of the remaining general account MBS portfolio, $2.5 million (or 0.1%) was invested in mortgage-backed pass-through or sequential CMOs. Pass-throughs are securities in which the monthly cash flows of principal and interest (both scheduled and prepayments) generated by the underlying mortgages are distributed on a pro rata basis to the holders of the securities. A sequential MBS is structured to divide the CMO security into sequentially ordered classes. Receipt of principal payments are made currently on all classes. While these securities are more sensitive to prepayment risk than PACs, the Company does not consider them highly volatile securities.
Semi-annual and annual reports are sent to contract owners of the variable annuity and life insurance contracts issued through registered Separate Accounts of the Company.