The Company's principal executive offices are located in Columbus, Ohio. The Company leases its home office complex, consisting of approximately 430,000 square feet, from NMIC and its subsidiaries at One Nationwide Plaza, Two Nationwide Plaza and Three Nationwide Plaza, Columbus, Ohio. The Company believes that its present facilities are adequate for the anticipated needs of the Company.
Management's narrative analysis of the results of operations of NLIC and subsidiaries for the three years ended December 31, 1997 follows. This discussion should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report.
Management's narrative analysis contains forward-looking statements that are intended to enhance the reader's ability to assess the future financial performance of the Company. These forward-looking statements are not based on historical information and are being made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, statements which represent the Company's beliefs concerning future levels of sales and redemptions of the Company's products, investment yields and interest spread, or the earnings or profitability of the Company's activities. Because these statements are subject to numerous assumptions, risks, and uncertainties, actual results could be materially different. The following factors, among others, may have such an impact: changes in economic conditions; movements in interest rates and the stock markets; competitive pressures on product pricing and services; success and timing of business strategies; and the nature and extent of legislation and regulatory actions and reforms. Readers are directed to consider these and the other risks and uncertainties described in more detail elsewhere in documents filed by the Company with the Securities and Exchange Commission. The Company undertakes no obligation to update or revise any forward-looking information, whether as a result of new information, future events, or otherwise.
Net investment income includes the gross investment income earned on investments supporting fixed annuities and certain life insurance products as well as the yield on the Company's general account invested assets which are not allocated to product segments. Net investment income grew from $1.29 billion and $1.36 billion in 1995 and 1996, respectively, to $1.41 billion in 1997 primarily due to increased invested assets to support growth in fixed annuity policy reserves. Fixed annuity policy reserves, which include the fixed option of the Company's variable annuity products, increased $727.8 million in 1996 and $682.4 million in 1997 and were $14.19 billion as of year end 1997. The increase in net investment income due to growth in invested assets was partially offset by declining investment yields in 1997 and 1996 due to lower market interest rates.
Interest credited to policyholder account balances totaled $1.02 billion in 1997 compared to $982.3 million in 1996 and $950.3 million in 1995 and principally relates to fixed annuity products. The growth in interest credited reflects the increase in fixed annuity policy reserves previously discussed partially offset by reduced average crediting rates. The average crediting rate on fixed annuity policy reserves was 6.12% in 1997 compared to 6.30% and 6.58% in 1996 and 1995, respectively.
Operating expenses were $384.9 million in 1997, a 12% increase from 1996 operating expenses of $342.4 million. Operating expenses were $273.0 million in 1995. The increase reflects the growth in the number of annuity and life insurance contracts in-force and the related increase in administrative processing costs. Increased operating expenses in 1997 also reflect the cost of certain technology initiatives.
The Company has developed a plan to address issues related to the Year 2000. The problem relates to many existing computer programs using only two digits to identify a year in the date field. These programs were designed and developed without considering the impact of the upcoming change in the century. If not corrected, many computer applications could fail or create erroneous results by or at the Year 2000. The Company has been evaluating its exposure to the Year 2000 issue through a review of all of its operating systems as well as dependencies on the systems of others since 1996. The Company expects all system changes and replacements needed to achieve Year 2000 compliance to be completed by the end of 1998. Compliance testing will be completed in the first quarter of 1999. The Company charges to expense all costs associated with these system changes as the costs are incurred.
Operating expenses in 1997 include approximately $45 million on technology projects, which includes costs related to Year 2000 and the development of a new policy administration system for traditional life insurance products and other system enhancements. The Company anticipates spending a comparable amount in 1998 on technology projects, including Year 2000 initiatives.
Federal income tax expense was $150.2 million representing an effective tax rate of 34.9% for 1997. Federal income tax expense in 1996 and 1995 was $110.9 million and $99.8 million, respectively, representing effective rates of 35.2% and 34.7%.
The Company sells its products through a broad distribution network comprised of wholesale and retail distribution channels. Wholesale distributors are unaffiliated entities that sell the Company's products to their own customer base and include investment broker/dealers, pension plan administrators and financial institutions. The Company has access to over 1,000 broker/dealers and over 30,000 registered representatives who sell individual and group variable annuities, fixed annuities and variable life insurance in all 50 states and the District of Columbia. Over 250 regional pension plan administrators market the Company's group variable and fixed annuities to employers sponsoring employee retirement programs. The Company currently has relationships with over 180 banks selling individual variable and fixed annuities (under the Company's brand name and on a private-label basis), variable universal life insurance and group pension products.
Retail distributors are representatives of the Company who market products directly to a customer base identified by the Company and include representatives of affiliated sales companies and Nationwide Insurance Enterprise insurance agents. The Company markets products on a retail basis to state and local governments and to teachers through affiliated sales companies. Approximately 4,300 licensed Nationwide Insurance Enterprise insurance agents sell life insurance and individual annuities primarily targeting holders of personal automobile and homeowners' insurance policies issued by the Nationwide Insurance Enterprise.
The following table summarizes certain selected financial data for the Company's Variable Annuities segment for the years indicated.
Variable annuity segment results reflect a sharp increase in policy charge revenues partially offset by increases in amortization of DAC and other operating expenses. The increase in policy charge revenues is attributable to growth in asset fees. Asset fees were $370.2 million in 1997 up 41% from $261.8 million in 1996 and totaled $172.8 million in 1995. The increase in assets fees reflects substantial growth in policy reserve levels as a result of steady premium growth and through market appreciation on investments underlying reserves. Variable annuity policy reserves grew $10.21 billion during 1997 reaching $34.49 billion as of year end 1997 compared to growth in 1996 of $7.52 billion and year end 1996 reserves of $24.28 billion. Total policy charges as a percentage of policy reserves remained relatively stable between 141 and 144 basis points during the last three years presented, reflecting no or minimal changes in the levels of policy charges for most variable annuity products.
The Company has sustained high sales growth over the recent three year period through deeper penetration of existing distribution channels and the addition of new sales outlets. In addition, variable annuity sales reflect growing consumer demand for equity-based retirement savings investments, coupled with a robust stock market and lower interest rates. Significant increases in production through financial institutions, pension plan administrators and public sector markets have contributed strongly to the growth in variable annuity sales in 1997, when sales increased 16% to a record $7.54 billion compared to $6.50 billion in 1996. Variable annuity sales in 1996 represented a 48% increase over 1995 sales of $4.40 billion.
Favorable equity market conditions over the past three years have also contributed significantly to the growth in variable annuity policy reserves. Variable annuity policy reserves reflect market appreciation of $5.21 billion, $2.72 billion and $2.93 billion in 1997, 1996 and 1995, respectively.
The following table summarizes certain selected financial data for the Company's Fixed Annuities segment for the years indicated.
The Life Insurance segment consists of insurance products, including variable universal life insurance and corporate-owned insurance products, that provide a death benefit and may also allow the customer to build cash value on a tax-deferred basis.
The following table summarizes certain selected financial data for the Company's Life Insurance segment for the years indicated.
The growth in operating expenses is due to technology-related costs combined with the increase in variable life insurance policies in-force. Technology-related expenses in 1997 were $16.5 million, compared to $3.2 million in 1996. The majority of the expenses are for a new policy administration system to support traditional life insurance products and for activities to make systems Year 2000 compliant.
The Clinton Administration's 1999 budget proposal contains provisions which, if enacted, would eliminate many tax benefits currently afforded to annuity products and certain life insurance products. These provisions appear to be inconsistent with what the Company believes to be the Administration's desire to encourage private sector long-term savings.
The Company supports social policy that encourages private sector savings, and believes that the provisions contained in the budget proposal clearly run counter to that goal. Annuity products are specifically designed for long-term and retirement savings and play an important role in millions of individuals' financial protection plans. However, there can be no assurance as to whether legislation will be enacted which would contain provisions with possible adverse effects on the Company's ability to sell its annuity and life insurance products.