Management's discussion and analysis 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 others, the following possibilities: (i) the potential impact on the Company's reported net income that could result from the adoption of certain accounting standards issued by the Financial Accounting Standards Board; (ii) tax law changes impacting the tax treatment of life insurance and investment products; (iii) 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; (iv) adverse state and federal legislation and regulation, including limitations on premium levels, increases in minimum capital and reserves, and other financial viability requirements; (v) failure to expand distribution channels in order to obtain new customers or failure to retain existing customers; (vi) 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; (vii) changes in interest rates and the capital markets causing a reduction of investment income and/or asset fees, reduction in the value of the Company's investment portfolio or a reduction in the demand for the Company's products; (viii) general economic and business conditions which are less favorable than expected; (ix) unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations; and (x) inaccuracies in assumptions regarding future persistency, mortality, morbidity and interest rates used in calculating reserve amounts.
Policy charges include asset fees, which are primarily earned from separate account assets generated from sales of individual and group variable annuities and investment life insurance products; cost of insurance charges earned on universal life insurance products; administration 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 of annuity and certain life insurance contracts.
Policy charges for each of the last three years were as follows:
The growth in asset fees reflects increases in total average separate account assets of $11.99 billion (21%) in 2000 and $13.26 billion (30%) in 1999. Net flows into variable annuity and investment life insurance products as well as market appreciation, as measured on a daily average basis, in each of the last three years have resulted in the increase in average separate account balances.
Other income includes fees earned by the Company's broker/dealers and in 1999 and 1998, fees for investment management services, as well as commissions and other income for marketing, distribution and administration services.
Amortization of deferred policy acquisition costs (DAC) increased $79.5 million in 2000 and $58.1 million in 1999 principally due to the Individual Annuity segment as a result of growth in the number of policies in-force in each of the last two years coupled with increased surrender activity during 2000. Amortization of DAC increased in the Life Insurance segment as a result of growth in policies in-force.
See note 2(j) to the consolidated financial statements for a discussion of recently issued accounting pronouncements.
The Company sells its products through a broad distribution network. Unaffiliated entities that sell the Company's products to their own customer base include independent broker/dealers, brokerage firms, financial institutions, pension plan administrators, life insurance specialists and Nationwide agents. Representatives of the Company who market products directly to a customer base identified by the Company include Nationwide Retirement Solutions.
The competitive environment for individual annuity sales through the independent broker/dealer channel has become very challenging; however, total sales through this channel (including retirement plans and life insurance) were up 16% in 2000 reflecting the strength of the Company's multiple product strategy, appointment of new distributors, introduction of new products and features and a broad distribution network. Sales through financial institutions grew 18% during 2000 and 21% during 1999 driven mainly by the appointment of new distributors in the bank channel and increased fixed annuity sales.
Pre-tax operating earnings reached $281.7 million in 2000, up 9% compared to 1999 earnings of $259.2 million, which were up 12% from 1998. Improved segment results are primarily due to growth in asset fees partially offset by increased DAC amortization.
Asset fees were $478.5 million in 2000 up 15% from $415.0 million in 1999 and totaled $337.8 million in 1998. Asset fees are calculated daily and charged as a percentage of separate account reserves. Average separate account assets have increased substantially in the past three years as a result of net market appreciation and net flows of $675.2 million, $1.28 billion and $3.08 billion in 2000, 1999 and 1998, respectively. While separate account assets reflect market depreciation in 2000, there was substantial market appreciation in the first half of the year, which contributed to the growth in average separate account assets.
The Company is able to mitigate the effects of changes in investment yields by periodically resetting the rates credited on fixed features of individual annuity contracts. As of December 31, 2000, individual fixed annuity policy reserves and fixed option of variable annuity reserves of $2.42 billion and $2.50 billion, respectively, are in contracts that adjust the crediting rate periodically with portions resetting in each calendar quarter. The Company also has $398.7 million of fixed option of variable annuity policy reserves related to private label annuities that call for the crediting rate to be reset annually on each January 1 and $1.52 billion of individual fixed annuity policy reserves that are in payout status where the Company has guaranteed periodic, typically monthly, payments.
Changes in the Company's products, including the introduction of new products with reduced policy charges have slightly decreased the ratio of asset fees to average separate account assets within the segment. This ratio was 1.26% in 2000 compared to 1.29% and 1.30% in 1999 and 1998, respectively.
Individual Annuity sales, which exclude internal replacements, during 2000 were $7.23 billion compared to sales of $6.37 billion in 1999 and $6.14 billion in 1998. Sales growth in 2000 was driven by The BEST of AMERICA variable annuities and reflects the successful introduction of the Extra Value rider, which accounted for $2.65 billion of sales. In addition, sales of deferred fixed annuities increased 61% to $534.8 million driven by additional bank distribution.
Institutional Products segment earnings growth in 2000 and 1999 was driven by higher asset fees from 24% and 32% increases in average separate account assets in 2000 and 1999, respectively. Net investment income increased $56.2 million in 2000 to $827.4 million, following a decline in 1999 of $13.5 million to $771.2 million. The change in net investment income was driven by higher average general account assets in each year and an increase in average investment yields in 2000 and a decrease in average investment yields in 1999. The increase in interest credited in 2000 is primarily the result of a 4% increase in average general account reserves and an increase in the average crediting rate of 26 basis points. The decrease in interest credited in 1999 is primarily the result of a 44 basis point decrease in the average interest-crediting rate reflecting lower market rates, offset by a 5% increase in average general account reserves. Higher operating expenses in 2000 reflect the significant technology investments made as part of the new business model in the public sector business.
The following table depicts the interest spread on average general account reserves in the Institutional Products segment for each of the last three years.
Changes in the Company's products, including the introduction of new institutional products with reduced policy charges, and the mix of business have slightly decreased the ratio of asset fees to average separate account assets within the segment. This ratio was 0.79% in 2000 compared to 0.83% and 0.86% in 1999 and 1998, respectively.
The Company has recently experienced decreases in pre-tax operating income to average account balances, which reached 0.59% in 2000, compared to 0.65% in 1999 and to 0.66% in 1998. The decreases were primarily driven by a change in the mix of products, including new products with reduced policy charges and the growth in separate account products.
Life Insurance segment earnings in 2000 increased 27% to $152.9 million, up from $120.8 million a year ago and $88.8 million in 1998. Continued strong sales and reserve growth from both individual and corporate investment life insurance products contributed to the sharp earnings increases.
Traditional/Universal life pre-tax earnings slightly increased to $67.6 million in 2000 compared to $67.4 million in 1999 and were $59.2 million in 1998. The 1998 results reflect additional expenses related to the installation of a new policy administration system.
Total life insurance sales, excluding all BOLI and Nationwide employee and agent benefit plan sales increased 40% to $1.53 billion in 2000 compared to $1.10 billion during 1999 and $653.2 million in 1998. Sales in 2000 include record levels of production for individual investment life insurance and COLI, reflecting the Company's efforts to sell through multiple channels and growing producer and consumer acceptance of these product offerings.
The Corporate segment includes net investment income not allocated to the three product segments, unallocated expenses and interest expense on short-term borrowings. 1999 and 1998 results also include investment management activities associated with Nationwide mutual funds. During 1999, these investment management activities were assigned to an affiliate. In addition to these operating revenues and expenses, the Company also reports net realized gains and losses on investments in the Corporate segment.