NFS is the holding company for Nationwide Life Insurance Company (NLIC) and other companies that comprise the domestic life insurance and retirement savings operations of Nationwide, including Nationwide Life Insurance Company of America (NLICA, or Nationwide Provident together with its subsidiaries), effective October 1, 2002. The Company is a leading provider of long-term savings and retirement products in the United States of America. The Company develops and sells a diverse range of products including individual annuities, private and public sector pension plans and other investment products sold to institutions, life insurance and advisory services. As a result of its initial public offering in March 1997 and subsequent stock related transactions since that date, including the issuance of 31.9 million shares in connection with the acquisition of Nationwide Provident, 37.0% of the economic interest in NFS is publicly owned, with the remainder owned by Nationwide Corporation (Nationwide Corp.), which is a majority-owned subsidiary of Nationwide Mutual Insurance Company (NMIC).
The information included herein contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the results of operations and businesses of the Company. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated or projected, forecast, estimated or budgeted in such forward-looking statements include, among other, the following possibilities: (i) change in Nationwide’s control of the Company through its beneficial ownership of 94.4% of the combined voting power of all the outstanding common stock and 63.0% of the economic interest in the Company; (ii) the Company’s primary reliance, as a holding company, on dividends from its subsidiaries to meet debt service obligations and the applicable regulatory restrictions on the ability of the Company’s subsidiaries to pay such dividends; (iii) the potential impact on the Company’s reported consolidated net income that could result from the adoption of certain accounting standards issued by the Financial Accounting Standards Board or other standard-setting bodies; (iv) tax law changes impacting the tax treatment of life insurance and investment products; (v) repeal of the federal estate tax; (vi) heightened competition, including specifically the intensification of price competition, the entry of new competitors and the development of new products by new and existing competitors; (vii) adverse state and federal legislation and regulation, including limitations on premium levels, increases in minimum capital and reserves and other financial viability requirements, restrictions on mutual fund distribution payment arrangements such as revenue sharing and 12b-1 payments; (viii) failure to expand distribution channels in order to obtain new customers or failure to retain existing customers; (ix) inability to carry out marketing and sales plans, including, among others, development of new products and/or changes to certain existing products and acceptance of the new and/or revised products in the market; (x) changes in interest rates and the equity markets causing a reduction of investment income and/or asset fees, an acceleration of the amortization of deferred policy acquisition costs (DAC) and/or value of business acquired (VOBA), reduction in the value of the Company’s investment portfolio or separate account assets, or a reduction in the demand for the Company’s products; (xi) general economic and business conditions which are less favorable than expected; (xii) competitive, regulatory or tax changes that affect the cost of, or demand for the Company’s products; (xiii) unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations; (xiv) deviations from assumptions regarding future persistency, mortality, morbidity and interest rates used in calculating reserve amounts and in pricing the Company’s products; (xv) failure to successfully integrate Nationwide Provident into NFS; and (xvi) adverse litigation results and/or resolution of litigation and/or arbitration.
See note 2 to the consolidated financial statements included in the F pages of this report for a discussion of the Company’s significant accounting policies, including recently issued accounting pronouncements.
For investment products (principally individual and group annuities) and universal life insurance products, DAC is being amortized with interest over the lives of the policies in relation to the present value of estimated future gross profits from projected interest margins, asset fees, cost of insurance, policy administration and surrender charges, less policy benefits and policy maintenance expenses. The DAC asset related to investment products and universal life insurance products is adjusted to reflect the impact of unrealized gains and losses on fixed maturity securities available-for-sale as described in note 2(b) to the consolidated financial statements included in the F pages to this report.
As part of the regular quarterly analysis of DAC, at the end of the third quarter of 2002, the Company determined that using actual experience to date and assumptions consistent with those used in the second quarter of 2002, its individual variable annuity DAC balance would be outside a pre-set parameter of acceptable results. The Company also determined that it was not reasonably possible that the DAC would return to an amount within the acceptable parameter within a prescribed period of time. Accordingly, the Company unlocked its DAC assumptions for individual variable annuities and reduced the DAC asset to the amount calculated using the revised assumptions. Because the Company unlocked the net separate
Therefore, in 2002, the Company recorded an acceleration of DAC amortization totaling $347.1 million before tax, or $225.6 million, net of $121.5 million of federal income tax benefit, which has been reported in the following segments in the amounts indicated, net of tax: Individual Annuity - $213.4 million, Institutional Products - $7.8 million and Life Insurance - $4.4 million. The acceleration of DAC amortization was the result of unlocking certain assumptions underlying the calculation of DAC for investment products and variable universal life insurance products. The most significant assumption changes were the resetting of the Company’s anchor date for reversion to the mean calculations to September 30, 2002, resetting the assumption for annual net separate account growth to 8 percent during the three-year reversion period for all investment products and variable life insurance products and increasing future lapses and costs related to GMDB on individual variable annuity contracts. These adjustments were primarily driven by the sustained downturn in the equity markets.
As a result of the acquisition of Nationwide Provident in 2002 (see note 18 to the consolidated financial statements included in the F pages of this report) and the application of purchase accounting, the Company reports an intangible asset representing VOBA.
VOBA reflects the estimated fair value of the business in-force and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the life insurance and annuity contracts existing as of the closing date of the Nationwide Provident acquisition. The value assigned to VOBA is supported by an independent valuation study that was commissioned by the Company and executed by a team of qualified valuation experts, including actuarial consultants. The expected future cash flows used in determining such value were based on actuarially determined projections, by each major line of business, of future policy and contract charges, premiums, mortality and morbidity, separate account performance, surrenders, changes in reserves, operating expenses, investment income and other factors. These projections took into account all known or expected factors at the valuation date, based on the judgment of management. The actual experience on purchased business may vary from projections due to differences in renewal premiums, investment spreads, investment gains or losses, mortality and morbidity costs, or other factors.
Amortization of VOBA occurs with interest over the anticipated lives of the major lines of business to which it relates (initially ranging from 13 to 30 years) in relation to estimated gross profits, gross margins or premiums, as appropriate. If estimated gross profits, gross margins or premiums differ from expectations, the amortization of VOBA is adjusted on a retrospective or prospective basis, as appropriate.
For those products amortized in relation to estimated gross profits, the most significant assumptions that are involved in the estimation of future gross profits include future net separate account performance, surrender/lapse rates, interest margins and mortality. The Company’s long-term assumption for net separate account performance is currently 8 percent. If actual net separate account performance varies from the 8 percent assumption, the Company assumes different performance levels over the next three years, such that the mean return equals the long-term assumption. This process is referred to as a reversion to the mean. The assumed net separate account return assumptions used in the VOBA models are intended to reflect what is anticipated. However, based on historical returns of the S&P 500 Index, the Company’s policy regarding the reversion to the mean process does not permit such returns to be below zero percent or in excess of 15 percent during the three-year reversion period.
Changes in assumptions can have a significant impact on the amount of VOBA reported for all products and their related amortization patterns. In the event actual experience differs from assumptions or assumptions are revised, the Company is required to record an increase or decrease in VOBA amortization expense (VOBA unlocking), which could be significant. In general, increases in the estimated general and separate account returns result in increased expected future profitability and may lower the rate of VOBA amortization, while increases in lapse/surrender and mortality assumptions reduce the expected future profitability of the underlying business and may increase the rate of VOBA amortization.
Management regularly reviews each investment in its fixed maturity and equity securities portfolios to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. A number of criteria are considered during this process including, but not limited to, the current fair value as compared to amortized cost or cost, as appropriate, of the security, the length of time the security’s fair value has been below amortized cost/cost, and by how much, specific credit issues and financial prospects related to the issuer, the Company’s intent to hold or dispose of the securities and current economic conditions. Other-than-temporary impairment losses result in a permanent reduction of the cost basis of the underlying investment.
In connection with acquisitions of operating entities, the Company recognizes the excess of the purchase price over the fair value of the net assets acquired as goodwill. In accordance with GAAP, goodwill is not amortized, but rather evaluated
The process of evaluating goodwill for impairment requires a number of judgments and assumptions to be made in determining the fair value of the reporting units. Some of the more significant judgments and assumptions include the method used to determine fair value, discount rates, expected levels of cash flows, revenues, earnings, and identification of comparable companies used to develop market based assumptions.
Total revenues increased $647.6 million, or 20%, to $3.94 billion in 2003 compared to $3.29 billion in 2002. Revenue growth was fueled by the addition of the Nationwide Provident, which added $620.6 million and $155.2 million of revenues in
Policy charges include asset fees, which are primarily earned on separate account values generated from the sale of individual and group variable annuities and investment life insurance products; cost of insurance charges earned on universal life insurance products; administrative fees, which include fees charged per contract on a variety of the Company’s products and premium loads on universal life insurance products; and surrender fees, which are charged as a percentage of premiums withdrawn during a specified period for annuity and certain life insurance contracts.
Net realized losses on investments, hedging instruments and hedged items totaled $85.1 million in 2003, compared to net realized losses of $88.3 million 2002 and $13.1 million 2001, respectively, and included other-than-temporary impairments of $170.4 million, $124.2 million and $80.7 million in 2003, 2002 and 2001, respectively. In third quarter 2003, the Company refined its mortgage loan valuation allowance process by incorporating more detailed information in the analysis. As a result, the valuation allowance was reduced by $16.5 million. Please refer to the table included under the - Corporate heading within this section of the document for a detailed summary of the components of net realized gains and losses on investments, hedging instruments and hedged items.
Interest credited to policyholder account values totaled $1.38 billion in 2003 compared to $1.28 billion in 2002 and $1.25 billion in 2001 and principally relates to fixed annuities, both individual and institutional, funding agreements backing the Company’s medium-term note program and certain life insurance products. The increase in interest credited reflects an increase in account values for these products as a result of strong fixed annuity production, increased allocations of variable annuity deposits to the guaranteed fixed option and the addition of Nationwide Provident fixed business, partially offset by lower crediting rates in the Individual Annuity and Institutional Products segments, on products where crediting rates have not already reached guaranteed floors.
Other benefits and claims include policyholder benefits in excess of policyholder account values for universal life and individual deferred annuities and net claims and provisions for future policy benefits for traditional life insurance products and immediate annuities. Significant increases in other benefits and claims for 2003 compared to 2002 and 2002 compared to 2001 reflects additional life insurance benefits related to Nationwide Provident, growth in life insurance in-force, an increase in the provision for future policy benefits for immediate annuities due to growth in new premium in 2003 compared to 2002 and 2002 compared to 2001, and an increase in GMDB costs due to a higher level of claims.
products and variable life insurance products and increasing future lapses and costs related to GMDB on individual variable annuity contracts. These adjustments were primarily driven by the sustained downturn in the equity markets.
Excluding accelerated DAC amortization of $347.1 million in 2002. Amortization of DAC increased $68.5 million to $399.5 million in 2003 compared to $331.0 million in 2002, primarily due to the addition of Nationwide Provident and growth in individual annuity segment.
The increase in interest expense on debt reflects additional interest expense from the issuance of $300.0 million of senior notes in June 2002 and $200.0 million of senior notes in February 2003, and increased usage of commercial paper in 2003.
On June 28, 2002 NFS completed a transaction with Nationwide Corp. to exchange all of the shares of common stock of Gartmore Global Investments, Inc. (GGI), a majority owned subsidiary, that NFS held for shares of NFS common stock held by Nationwide Corp. GGI comprised NFS’ asset management operations. NFS also exchanged all of the shares of common stock of Nationwide Securities, Inc. (NSI), an indirect wholly owned broker/dealer subsidiary, for shares of NFS’ common stock held by Nationwide Corp.
As a result of these transactions, the Company is no longer engaged in asset management operations and the results of GGI and NSI have been reported as discontinued operations. Also, the Company no longer reports an Asset Management segment and structured products transactions previously reported in the Asset Management segment are now reported in the Institutional Products segment. All periods presented have been revised to reflect these changes.
Income from discontinued operations, net of tax, in 2002 was $3.4 million compared to a loss of $4.4 million in 2001.
contribute to asset and earnings growth, they do not produce steady production flow that lends itself to meaningful comparisons and are therefore excluded from sales.
The Company’s flagship products are marketed under The BEST of AMERICA brand, and include individual variable and group annuities, group private sector pension plans sold through Nationwide Trust Company, and variable life insurance. The BEST of AMERICA products allow customers to choose from investment options managed by premier mutual fund managers. The Company has developed private label variable and fixed annuity products in conjunction with other financial services providers that allow those providers to sell products to their own customer bases under their own brand name.
Sales by product and segment for each of the last three years were as follows:
The Company sells its products through a diverse distribution network. Unaffiliated entities that sell the Company’s products to their own customer base include independent broker/dealers, wirehouse and regional firms, financial institutions, pension plan administrators, life insurance specialists and representatives of certain CPA firms. Representatives of the Company who market products directly to a customer base include NRS, Nationwide Provident producers, The 401(k) Company and TBG Financial. The Company also distributes products through the agency distribution force of its ultimate parent, NMIC.
Sales by distribution channel for each of the last three years are summarized as follows:
Sales through the independent broker/dealer channel in 2003 were flat compared a year ago. Total sales through this channel were down 5% in 2002 reflects primarily lower demand for variable annuities and variable life insurance in light of depressed equity markets, partially offset by growth in sales of private sector pension plans.
Sales through financial institutions declined 10% in 2003, as a result of efforts focused on pricing discipline and planned reductions in fixed annuity sales, which more than offset growth in variable annuity sales. Sales in 2002 grew 17% driven mainly by increased fixed annuity and pension sales, partially offset by lower production of variable annuities.
Sales through wirehouse and regional firms decreased 10% in 2003 to $2.00 billion compared to $2.20 billion in 2002 due to lower individual annuity sales, partially offset by increased private sector pension plan sales. Sales through this channel decreased 10% in 2002 to $2.20 billion compared to $2.45 billion in 2001, primarily reflecting lower variable annuity sales from the Waddell & Reed Financial, Inc. relationship, partially offset by growth from other firms.
Sales through pension plan administrators declined 23% and 27% in 2003 and 2002, respectively. As the Company’s private sector pension business model continues to evolve, direct production through this channel is not expected to grow, as more new business opportunities are being created in conjunction or partnership with the independent broker/dealers, wirehouse and regional firms and financial institutions relationships.
Sales generated by Nationwide agents declined 7% in 2003 due to lower fixed annuity sales resulting from an intentional slow down in sales and commission reductions.
Sales generated by The 401(k) Company grew 44% in 2003 as a result of deferrals on several new cases added in 2002 and at the beginning of 2003.
Sales through TBG Financial increased by 10% in 2003 compared to a year ago primarily due to the sale of a single large case, while 2002 sales fell 37% short of 2001. This decline was driven by the unfavorable environment for COLI and executive deferred compensation programs.
Asset fees of $376.6 million in 2003 were down 1% from $378.6 million in 2002, which was down 10% from the $421.9 million reported in 2001. Asset fees are calculated and assessed daily as a percentage of separate account values. The fluctuations in asset fees are primarily due to changes in the market value of the investment options underlying the account values, which have followed the general trends of the equity markets. Average separate account values decreased 3% in 2003 to $29.17 billion following a 10% decrease in 2002.
Amortization of DAC and VOBA decreased by $295.5 million to $239.5 million in 2003, compared to $535.0 million in 2002. Excluding the $328.3 million of accelerated DAC amortization in 2002, amortization of DAC and VOBA increased 16% to $239.5 million in 2003 reflecting higher gross profits following a 6% decrease in 2002, reflecting lower gross profits.
Although interest spread income of $227.4 million was higher than 2002, interest spread margins compressed during 2003 to 165 basis points compared to 191 basis points in 2002. A one year enhanced crediting rate special offered in the fourth quarter 2002 coupled with new crediting rates at or near contractual minimum rates and a jump in prepayments of higher yielding investments created pressure on interest spread on average general account values in 2003. Included in 2003 were 5 basis points, or $8.2 million of prepayment income on mortgage loans and bonds compared to 7 basis points, or $6.8 million, in 2002 and 8 basis points, or $5.7 million, in 2001, respectively. The current interest rate environment has limited the ability to adjust crediting rates to the extent of declines in investment yields due to the interest rate floors contained in annuity contracts.
guaranteed minimum accumulation benefits (see note 7 of the consolidated financial statements included in the F pages of this report).
Individual Annuity segment sales, which exclude internal replacements, during 2003 were $6.71 billion, down 8% from $7.33 billion a year ago. A sharp drop-off in fixed annuities, the result of actions described above, which were intended to reduce the level of new individual fixed annuity business, drove segment sales lower compared to 2002. Fixed annuity sales were $1.96 billion down 27% compared to $2.71 billion in 2002. Fixed annuity sales were up 33% to $2.71 billion in 2002 from 2001. Variable annuity sales were $4.75 billion in 2003, up 3% compared to $4.62 million in 2002. Sales of variable annuities were down 17% in 2002 compared to 2001. In 2002, the sustained weakness in the equity markets reduced demand for variable products and drove consumer interest in fixed products. According to the Variable Annuity Research & Data Service (VARDS), the Company was ranked 9th in total variable annuity sales in the U.S. in 2003.
The Institutional Products segment is comprised of the Company’s private and public sector group retirement plans, medium-term note program and structured products initiatives. The private sector includes the 401(k) business generated through fixed and variable annuities, Nationwide Trust Company and The 401(k) Company. The public sector includes the IRC Section 457 business in the form of fixed and variable annuities as well as administration-only business.
Pre-tax operating earnings totaled $244.8 million in 2003, up 18% compared to 2002 pre-tax operating earnings of $207.0 million, including $12.0 million accelerated DAC amortization in third quarter 2002, which was down 1% from 2001. Increased interest spread income in 2003, driven primarily by prepayment income and growth in average general account values, and other income were partially offset by higher operating expenses and lower policy charges. Pre-tax operating earnings were essentially flat in 2002 compared to 2001 as growth in interest spread income and other income was offset by lower policy charges and higher operating expenses.
Asset fees declined 3% to $146.9 million in 2003 compared to $151.5 million in 2002 and totaled $176.8 million in 2001. The declines were driven by a 4% decrease in average separate account assets in 2003 following a decrease of 16% in 2002 as a result of experience in the equity markets and a shift in product mix from annuities to administration-only products.
Administrative fees declined by $7.1 million or 45% in 2003 compared to 2002, primarily due $3.6 million of fees related to a terminated case in the first quarter of 2002.
Other income, which includes fees for administration-only cases and Nationwide Trust Company products and structured products initiatives, increased 54% in 2003 compared to a year ago due to growth in private sector pension plans sold through Nationwide Trust Company, which now account for 21% of private sector pension plan account values compared to 13% a year ago, and growth in public sector administrative services-only agreements which now account for 60% of public sector pension plan account values compared to 49% a year ago. The growth in 2003 also reflects $21.8 million in fees from structured products transactions compared to $7.9 million in 2002 and $3.5 million in 2001.
Interest spread improved slightly to 198 basis points in 2003 compared to 196 basis points in 2002. Included in 2003 were 19 basis points, or $27.4 million, of prepayment income on mortgage loans and bonds compared to 9 basis points, or $11.4 million in 2002 and 13 basis points, or $14.4 million in 2001, respectively.
Other operating expenses in 2003 increased 15% to $302.3 million, compared to a 9% increase to $262.8 million in 2002. The 2003 increase reflects increased costs related to an initiative aimed at expanding the sales and service capabilities in the Company’s private sector pension business, an increase in participants in public sector pension plans, the addition of Nationwide Provident and increased employee benefit, pension and insurance costs. The increase in 2002 reflects the growth in the number of cases being administered and an increase in employee benefit costs.
Account values ended 2003 at $68.83 billion, up $19.03 billion from $49.80 billion at the end of 2002, which were down $618.9 million compared to $50.42 billion at the end of 2001. The 2003 increase reflects the rebounding equity markets and the March 2003 addition of the $4.94 billion State of New York and September 2003 addition of the $227.5 million State of New Mexico public sector cases. In 2002, the impact of market depreciation resulting from depressed equity markets in both 2001 and 2002 was partially offset by the addition of the California Savings Plus Program in 2001 which added $4.77 billion in administration-only account values, the acquisition of Nationwide Provident in 2002 which added $1.53 billion in account values, and new issues of medium-term notes in both years. Net flows, which consists of deposits less withdrawals, were $2.40 billion in 2003, compared to $1.43 billion and $1.76 billion in 2002 and 2001, respectively. The 2003 increase in net flows was driven primarily by sales growth as described below.
Institutional Products segment sales during 2003 reached $8.40 billion compared to $7.42 billion in 2002 and $7.00 billion in 2001. Private sector pension sales in 2003 totaled $5.22 billion, an increase of 8% from 2002 compared to an increase of 11% from 2001. The sales exceeded prior year primarily due to the addition of Nationwide Provident.
Public sector pension sales in 2003 totaled $3.18 billion, 23% higher compared to $2.58 billion in 2002 and totaled $2.62 billion in 2001, a decline of 2%. The increased sales in 2003 reflect increased rollover activity from existing participants’ previous employer sponsored plans into existing accounts, as recent pension reform legislation implemented has expanded the portability of public plan assets and the addition of deposits into the newly acquired State of New York and State of New Mexico defined contribution plans.
The decreases in pre-tax operating income to average account values, which reached 0.37% in 2003, compared to 0.40% in 2002 and 0.42% in 2001, are primarily driven by changes in the mix of products including growth in administration-only products which generally provide lower margins than group annuity contracts. The decrease also reflects more private sector pension business in the form of Nationwide Trust Company, FSB, products, which results in selling and other acquisition costs being recognized more quickly than with annuity products.
The Life Insurance segment consists of investment life products, including individual variable life and COLI, traditional life insurance products and universal life insurance. Effective May 31, 2002, the Company increased its ownership in TBG Financial, a leading COLI producer, to 63%. The results of TBG Financial are included in the consolidated results of the Company from that date forward. Also included in this segment, beginning October 1, 2002, are Nationwide Provident life insurance products. Life insurance products provide a death benefit and generally also allow the customer to build cash value on a tax-advantaged basis.
The following table summarizes selected financial data for the Company’s Life Insurance segment for the years indicated.
Life benefits and policyholder dividends increased 37% to $720.2 million in 2003 following a 22% increase in 2002. The growth reflects the growth in insurance in-force, higher mortality experience and the addition of Nationwide Provident business.
Total Life Insurance segment sales in 2003 increased 12% to $1.72 billion compared to $1.54 billion in 2002. Variable life sales in 2003 improved 19% from the prior year as Nationwide Provident variable life sales accounted for $264.2 million, or 38%, of total variable life sales during 2003. Individual variable life production continues to be adversely impacted by consumer preference for fixed products. COLI sales in 2003 declined 17% from the prior year due to the current unfavorable environment for COLI and executive deferred compensation programs.
Strong fixed life growth and improved variable life sales were partially offset by decreased COLI sales in 2003. Growth attributable to Nationwide Provident was substantially offset as individual variable life sales continue to be adversely impacted by the sluggish equity markets, concern over the potential for adverse tax legislation and consumer preference for fixed products. According to the December 31, 2003 Tillinghast-Towers Perrin Value Variable Life Survey, the Company was ranked 4th in total variable life sales in 2003 (including Nationwide Provident sales for the full year of 2003), compared to 3rd in 2002 and 6th in 2001. In 2002, our efforts to expand sales to new channels drove sales through the wirehouse and regional firms and financial institutions up 37% and 30%, respectively, from 2001. COLI sales were negatively impacted throughout 2002 by the sluggish economy, depressed equity markets, unfavorable press regarding COLI and executive deferred compensation plans, and proposed legislation which could adversely impact the tax benefits of COLI. First year premiums for fixed life were up from a year ago due to increased universal life and term life sales. Total life insurance sales of $1.54 billion in 2002 were essentially flat compared to 2001. Individual variable universal life sales were adversely impacted by the phase out of the estate tax, uncertainty surrounding the taxation of split dollar plans and the volatile stock market. Sales of new COLI cases in 2002 were down given the depressed economic conditions where corporations were not forming new executive benefit plans and existing plans were being funded at lower levels.
The increase in operating revenues in 2003 reflects $22.9 million of fee income primarily from acquisitions of certain non-insurance subsidiaries in the fourth quarter of 2002 and an increase in net investment income primarily attributable to income earned on the proceeds from the $200.0 million senior note offering completed in February 2003 and the $300.0 million senior note offering completed in June 2002, partially offset by lower yields on investments. The increase in operating revenues in 2002 reflects an increase in net investment income primarily attributable to income earned on the proceeds from the $300.0 million senior note offerings completed in November 2001 and June 2002 and $7.6 million of revenue from Nationwide Provident’s non-insurance subsidiaries, partially offset by lower yields on investments.
The additional interest expense in 2003 and 2002 reflects the senior note offerings mentioned above and increased utilization of commercial paper borrowings.
In addition to these operating revenues and expenses, the Company also reports net realized gains and losses on investments, hedging instruments and hedged items in the Corporate segment. Net realized losses on investments, hedging instruments and hedged items totaled $85.1 million in 2003, compared to net realized losses of $88.3 million in 2002 and $13.1 million in 2001, respectively, and included other-than-temporary impairments of $170.4 million, $124.2 million and $80.7 million in 2003, 2002 and 2001, respectively. Included in 2003 realized losses are $13.0 million of other-than-temporary impairments related to Parmalat, leaving $5.0 million of gross exposure. Also, in third quarter 2003, the Company refined its mortgage loan valuation allowance process by incorporating more detailed information in the analysis. As a result, the valuation allowance was reduced by $16.5 million. The table below provides a detailed summary of the components of net realized gains and losses on investments, hedging instruments and hedged items.
An analysis of net realized losses on investments, hedging instruments and hedged items from continuing operations, by source follows for the years ended December 31:
In the normal course of business, the Company has entered into a number of related party transactions. Descriptions of these transactions are provided in Note 19 to the consolidated financial statements included in the F pages to this report and are hereby incorporated by reference.
Long-term debt is comprised of three separate issuances of $300.0 million principal of senior notes and a single issuance of $200.0 million principal of senior notes, none of which is subject to any sinking fund payments, and a variable rate note payable. Additionally, the Company has reclassified its capital and preferred securities of subsidiary trusts into long-term debt for all prior periods presented. Consistent with their classification as debt, the Company recognizes distributions on the capital and preferred securities as interest expense in the consolidated statements of earnings. In connection with the adoption of FIN 46R, the Company has deconsolidated the trusts established in connection with the issuance of mandatorily redeemable capital and preferred securities effective December 31, 2003. As required by FIN 46R, prior periods were not restated. As a result, at December 31, 2003, the Company reports as a component of long-term debt the junior subordinated debentures payable by NFS to the trusts. Previously, the junior subordinated debentures were eliminated in consolidation. Because the Company’s implementation of FIN 46R did not result in restating prior periods, the related trust preferred securities are still in the totals of long-term debt for 2002 and 2001.
The $300.0 million 8.00% senior notes are redeemable in whole or in part, at the option of NFS, at any time on or after March 1, 2007 at scheduled redemption premiums through March 1, 2016, and, thereafter, at 100% of the principal amount thereof plus, in each case, accrued and unpaid interest. The $200.0 million 6.25% senior notes are not redeemable prior to their maturity date. The $300.0 million 5.90% and $300.0 million 5.625% senior notes are redeemable in whole or in part, at the option of NFS, at any time or from time to time at a redemption price equal to the greater of: (i) 100% of the aggregate principal amount of the notes to be redeemed; or (ii) the sum of the present value of the remaining scheduled payments of principal and interest on the notes, discounted to the redemption date on a semi-annual basis at the treasury rate plus 20 basis points, together in each case with accrued interest payments to the redemption date. The Company made interest payments of $66.4 million in 2003, $42.6 million in 2002 and $24.0 million in 2001 on the senior notes.
The variable rate note payable is tied to 1-year U.S. libor rates with annual resets and had an interest rate of 4.96% as of December 31, 2003. During 2003, total interest paid on the variable rate note payable was $0.1 million.
The capital and preferred securities of subsidiary trusts, which are no longer consolidated effective December 31, 2003, as noted above, include $100.0 million of capital securities that are due March 1, 2037 and pay a distribution rate of 7.899% and $200.0 million of preferred securities of subsidiary trusts that are due October 31, 2028 and pay a distribution rate of 7.10%. The related capital and preferred securities are fully and unconditionally guaranteed by NFS. Junior subordinated debentures with an interest rate of 7.899% are the sole assets of Nationwide Financial Services Capital Trust (NFSCT) and are redeemable by NFS in whole at any time or in part from time to time at par plus an applicable make-whole premium. The capital securities have a liquidation value of $1,000 per security and must be redeemed by NFSCT when the 7.899% junior subordinated debentures mature or are redeemed by NFS. Junior subordinated debentures with an interest rate of 7.10% are the sole assets of Nationwide Financial Services Capital Trust II (NFSCTII) and became redeemable, in whole or in part, on or after October 19, 2003 at a redemption price equal to the principal amount to be redeemed plus any accrued and unpaid interest. The preferred securities have a liquidation value of $25 per security and must be redeemed by NFSCTII when the 7.10% junior subordinated debentures mature or are redeemed by NFS. There are no sinking fund requirements related to the capital and preferred securities of subsidiary trusts.
The Company has an available financing capacity of $1.30 billion under a shelf registration statement dated February 4, 2003. Under the shelf registration statement, the Company can issue unsecured senior or subordinated debt securities, preferred stock, Class A common stock, stock purchase contracts or stock purchase units. The Company may also, in conjunction with owned trusts, may issue trust preferred securities guaranteed by NFS.
For group annuity products ($25.96 billion of reserves as of December 31, 2003), the surrender charge amounts and periods can vary significantly, depending on the terms of each contract and the compensation structure for the producer. Generally, surrender charge percentages for group products are less than individual products because the Company incurs lower expenses at contract origination for group products. In addition, over ninety percent of the general account group annuity reserves are subject to a market value adjustment at withdrawal.
The following table summarizes the Company’s contractual obligations and commitments due in each period presented.
Purchase commitments for limited partnerships are primarily related to investments in low income housing tax-credit partnerships. The ultimate call date of these commitments may extend beyond 2004, but have been reflected in the 2004 column due to the call feature.
Under the medium-term note program, NLIC issues funding agreements, which are insurance obligations, to an unrelated third-party trust to secure notes issued to investors by the trust. The funding agreements are recorded as a component of future policy benefits and claims on the Company’s consolidated balance sheets. Because the Company is not the primary beneficiary of, and has no ownership interest in, or control over, the third-party trust that issues the notes, the Company does not include the trust in its consolidated financial statements and therefore, such notes are not reflected in the consolidated financial statements of the Company. As the notes issued by the trust have a secured interest in the funding agreements issued by NLIC, Moody’s, Inc. and S&P, assign the same ratings to the notes as the insurance financial strength ratings of NLIC. As described in the Liquidity and Capital Resources caption of this section, non-consolidated subsidiary trusts of the Company have issued capital and preferred securities that are fully and unconditionally guaranteed by NFS and are backed by junior subordinated debentures of NFS.
As of December 31, 2003, NFS had received $976.6 million of cash collateral on securities lending and invested the proceeds in short-term investments, which are reflected on the balance sheet, and a corresponding liability is established to reflect the return of the collateral. Also, NFS has received $544.5 million of cash for derivative collateral, which has been invested in short-term investments and a corresponding liability has been recorded in other liabilities. The Company also held $163.0 million and $25.9 million of securities as off-balance sheet collateral on derivative transactions as of December 31, 2003 and 2002, respectively.
The Company’s assets are divided between separate account and general account assets. As of December 31, 2003, $60.94 billion (55%) of the Company’s total assets were held in separate accounts and $50.09 billion (45%) were held in the Company’s general account, including $43.14 billion of general account investments.
Separate account assets consist primarily of deposits from the Company’s variable annuity and variable life insurance business. Most separate account assets are invested in various mutual funds. All of the investment performance in the Company’s separate account assets is passed through to the Company’s customers. In addition to the information presented herein, see note 3 to the consolidated financial statements included in the F pages of this report for further information regarding the Company’s investments.
The following table summarizes amortized cost, gross unrealized gains and losses and estimated fair value of the Company’s fixed maturity securities by category as of each December 31.
The average duration and average maturity of the Company’s general account fixed maturity securities as of December 31, 2003 were approximately 4.0 and 5.4 years, respectively, compared to 3.7 years and 5.7 years, respectively, at December 31, 2002. The market value of the Company’s general account investments may fluctuate significantly in response to changes in interest rates. In addition, the Company may also be likely to experience realized investment losses to the extent its liquidity needs require the disposition of general account fixed maturity securities in unfavorable interest rate environments.
Of the Company’s general account fixed maturity securities, 93.4% were in the highest two NAIC Designations as of December 31, 2003.
NAIC Designations are assigned no less frequently than annually. Some NAIC designations for securities shown have been assigned by management to securities not yet assigned designation by the NAIC in a manner approximating equivalent public rating categories.
As of December 31, 2003 the fair value of the Company’s general account mortgage-backed security (MBS) investments is comprised of residential MBS investments and totaled $4.43 billion (14.4%) of the carrying value of the general account fixed maturity securities available-for-sale.
The Company believes that MBS investments add diversification, liquidity, credit quality and additional yield to its general account portfolio. The Company’s objective for its MBS portfolio is to provide reasonable cash flow stability and increased yield. The MBS portfolio include collateralized mortgage obligations (CMOs), Real Estate Mortgage Investment Conduits (REMICs) and mortgage-backed pass-through securities. The Company’s general account MBS investments generally do not include interest-only securities or principal-only securities or other MBSs, which may exhibit extreme market volatility.
The following table sets forth the distribution by investment type of the Company’s general account ABS portfolio as of each December 31.
As of December 31, 2003, none of the Company’s mortgage loans were classified as delinquent, compared to 0.11% a year ago. Foreclosed and restructured loans totaled 0.13% and 0.11%, respectively of the Company’s mortgage loans as of December 31, 2003 compared to 0.36% and 0.27% as of December 31 2002, respectively.