During 2016, National Western created a new operating entity, Braker P III, LLC ("BP III"), to own and manage the operations of an approximately 196,400 square foot commercial office building in Austin, Texas, which BP III acquired. The purchase price of the property was $49.3 million, exclusive of closing costs and fees. The Company relocated its principal office to this facility during the fourth quarter of 2017, and currently occupy approximately 78,000 square feet. At December 31, 2018, all of the remaining space is leased by BP III to other third party tenants.
The Westcap Corporation, a wholly owned subsidiary of National Western, owns the Company’s former office location in Austin, Texas and two buildings adjacent to it. During 2018, the two adjacent buildings were sold for in excess of $2.9 million. The remaining building of approximately 72,000 square feet is currently available for sale. The Company’s affiliate, Regent Care Building, LP, owns an approximately 63,000 square foot building in Reno, Nevada, which is leased and utilized by another of the Company’s affiliates, Regent Care Operations, LP, for use in its nursing home operations. The Company’s subsidiary, Regent Care San Marcos A-3 LP, owns an approximately 79,000 square foot building in San Marcos, Texas, which is also used in 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 homes have been eliminated for consolidated reporting purposes.
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 the 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, as a matter of policy, the Company 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 the financial condition and results of operations (“MD&A”) of National Western Life Group, Inc. for the three years ended December 31, 2018 follows. Where appropriate, discussion specific to the insurance operations of National Western Life Insurance Company is denoted by "National Western" or "company". This discussion should be read in conjunction with the Company’s Consolidated Financial Statements and related notes beginning on page 85 of this report.
The Company monitors these factors continually as key business indicators. The discussion that follows in this Item 7 includes these indicators and presents information useful to an overall understanding of the Company’s business performance in 2018, incorporating required disclosures in accordance with the rules and regulations of the SEC.
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 DPAC, and are included in interest credited to contract holders’ funds. Deferred sales inducements are also periodically reviewed for recoverability. For more information about accounting for deferred sales inducements see Note 1, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.
Share-Based Payments. Liability awards under a share-based payment arrangement have been measured based on the awards’ fair value at the reporting date. The Black-Scholes valuation method is used to estimate the fair value of the options. This fair value calculation of the options includes assumptions relative to the following:
Cost of insurance charges were $105.9 million in 2018 compared to $107.5 million in 2017 and $106.2 million in 2016. Cost of insurance charges typically trend with the size of the universal life insurance block in force and the amount of new business issued during the period. The volume of universal life insurance in force during 2018 decreased to $15.6 billion from $16.5 billion during 2017. Cost of insurance charges in 2017 showed an increase over the previous year due to the company increasing its cost of insurance charges during 2016 in accordance with its policy provisions on certain blocks of international life insurance policies. These increases were in effect for the entirety of 2017 and helped to mitigate the decline in insurance in force from 2016. Administrative charges were $23.7 million, $27.4 million, and $27.8 million for the years ended December 31, 2018, 2017 and 2016, respectively, and correlate with new universal life insurance business sales by the number of policies placed, the amount of premiums received and the volume of insurance issued. National Western's decision in May 2018 to cease accepting international policy applications from residents of other countries significantly decreased the level of universal life insurance sales.
Surrender charges assessed against policyholder account balances upon withdrawal were $37.1 million in 2018 compared to $42.1 million in 2017 and $44.8 million in 2016. While the Company earns surrender charge income that is assessed upon policy terminations, the Company’s overall profitability is enhanced when policies remain in force and additional contract revenues are realized and the Company continues to make an interest rate spread equivalent to the difference it earns on its investment and the amounts that it credits to policyholders. Policy lapse rates in 2018 for domestic life insurance and annuities segments were somewhat higher than those experienced in 2017 while the international life segment exhibited lower lapse rates. A spike in surrender charge income recognized occurred in 2016 reflecting a higher international life insurance lapse rate, most noticeably in the countries from which the Company ceased accepting applications from residents in the fourth quarter of 2015. Surrender charge income recognized is also dependent upon the duration of policies at the time of surrender (i.e. later duration policy surrenders have lower surrender charges assessed and earlier policy surrenders have a higher surrender charge assessed).
Traditional life premiums - Traditional life premiums have been relatively level over the past three years. Traditional life insurance premiums for products such as whole life and term life are recognized as revenues over the premium-paying period. A sizable portion of traditional life business resides in the International Life insurance segment which ceased accepting new applications in the second quarter of 2018. The Company’s overall life insurance sales focus has been primarily centered around universal life products. Universal life products, especially the Company’s equity-index universal life products, which offer the opportunity for consumers to acquire life insurance protection and receive credited interest linked in part to an outside market index such as the S&P 500 Index®, have been more popular product offerings in the Company’s markets representing 95% of new life insurance sales in 2018.
Effective January 1, 2018, new accounting guidance requires that changes in fair values of equity securities be include in the Consolidated Statements of Earnings. For the year ended December 31, 2018, an unrealized (loss) of ($1.8) million is included in net investment income (in the Debt and equities line item in the above table) reflecting the change in fair value during the period. The carrying value of the Company’s portfolio of equity securities was $17.5 million at December 31, 2018.
The Company’s new mortgage loan activity has been relatively low for a number of years given the low level of rates and the higher level of risk associated with commercial properties in this economic environment. Due to a concerted effort, the volume of new mortgage loan originations during 2017 and 2016 increased from prior year levels, however, aggressive interest rates offered by competitors served to hold down new loan originations in 2018. Mortgage loan investment income in 2018 and 2017 benefited from incremental contributions from loan prepayment fees and profit participation receipts during the year. Policy loan and other invested asset balances outstanding have remained relatively stable over the past few years. As noted above, the company maintained elevated short-term investment balances during the latter part of 2018 in anticipation of closing the acquisition of target companies in early 2019.
The decline in average invested asset yield, excluding derivatives, from 2016 to 2017 and to 2018 is due to the Company continuing to obtain low yields on newly invested cash inflows as higher yielding assets mature or are called. The pattern in average invested asset yield, including derivatives, incorporates increases and decreases in the fair value of index options purchased by the company to support its fixed-index products. Fair values of the purchased call options recorded net gains in 2017 and 2016 while recording a loss in 2018 corresponding to the movement in the S&P 500 Index® during these periods (the primary index the Company's fixed-index products employ). Refer to the derivatives discussion following this section for a more detailed explanation.
Derivative gain (loss) - Index options are derivative financial instruments used to hedge the equity return component of the Company’s fixed-index products. Derivative gain or loss includes the amounts realized from the sale or expiration of the options. Since the index options do not meet the requirements for hedge accounting under GAAP, they are marked to fair value on each reporting date and the resulting unrealized gain or loss is reflected as a component of net investment income.
The financial statement investment spread, the difference between investment income and interest credited to contractholders, is subject to variations from option performance during any given period. For example, many of the company's equity-index annuity products provide for the collection of asset management fees. These asset management fees are assessed when returns on expiring options are positive, and they are collected prior to passing any additional returns above the assessed management fees to the policy contractholders. During periods of positive returns, the collected asset management fees serve to increase the financial statement spread by increasing option realized gains reported as investment income in an amount greater than interest credited to policy contractholders which is reported as contract interest expense. Asset management fees collected in 2018, 2017, and 2016 were $24.3 million, $31.8 million, and $6.4 million, respectively.
Equity impairments (common stocks) represent a mark-to-market write-down on securities in which the market discount to book value was considered significant and had been maintained for several reporting periods. Prior to 2018, market value changes in equity security holdings were recorded through Other Comprehensive Income as a component of Stockholders' Equity. Effective January 1, 2018, the accounting guidance for equity securities was amended requiring that market value changes be recorded as a component of investment income in the Consolidated Statements of Earnings in the period of change. This guidance caused the impairment analysis of equity securities to be not applicable going forward. Equity securities represent 0.2% of invested assets and individual holdings have an average cost basis of approximately $84,000.
Life and other policy benefits - Life and other policy benefits include death claims of $44.9 million, $38.6 million and $31.3 million for 2018, 2017 and 2016, respectively. While death claim amounts are subject to variation from period to period, the Company’s mortality experience has generally been consistent with or better than its product pricing assumptions. Mortality exposure is managed through reinsurance treaties under which the Company's retained maximum net amount at risk on any one life is capped at $500,000.
Life and other policy benefits also includes policy liabilities held associated with the company's traditional life products, including riders such as the company guaranteed minimum withdrawal benefit rider ("WBR"), a popular rider to its equity-indexed annuity products. The increases in these liabilities were $7.3 million, $17.9 million, and $17.5 million in 2018, 2017, and 2016, respectively. In 2018, the company unlocked its policy benefit reserves associated with the WBR which resulted in a decrease to the policy benefit liability (and policy benefit expenses) during the period of $15.7 million. The primary unlocking adjustment included within this amount was an adjustment of the assumed rate of election by policyholders taking withdrawal payments to a rate consistent with actual experience (which was lower than that previously assumed). In 2016, the company also recorded a prospective unlocking adjustment of WBR, the effect of which was to decrease WBR reserves by $3.1 million which decreased life and other policy benefits by a like amount.
Amortization of deferred policy acquisition costs - Life insurance companies are required to defer certain expenses that vary with, and are primarily related to, the cost of acquiring new business. The majority of these acquisition expenses consist of commissions paid to agents, underwriting costs, and certain marketing expenses. Recognition of these deferred policy acquisition costs (“DPAC”) as an expense in the Consolidated Financial Statements occurs 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 universal life and annuity contract 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 profits pattern is to be "unlocked" and reset based upon the actual experience. DPAC balances are also adjusted each period to reflect current policy lapse or termination rates, expense levels and credited rates on policies as compared to anticipated experience (“true-up”) with the adjustment reflected in current period amortization expense. In accordance with GAAP guidance, the Company must also write off deferred acquisition costs and unearned revenue liabilities upon internal replacement of certain contracts as well as annuitizations of deferred annuities.
The following table identifies the effects of unlocking adjustments on DPAC balances recorded through amortization expense separate from recurring amortization expense components for 2018, 2017 and 2016.
During 2016, the Company unlocked its DPAC balance for: (1) favorable mortality in the Domestic life insurance segment resulting in reduced amortization expense by $8.2 million; (2) International life insurance favorable mortality, increased cost of insurance charges that had been implemented during the year, and higher lapse assumptions for policies associated with residents in "disengaged countries" (countries which the Company ceased accepting applications from residents in 2015) collectively decreasing DPAC amortization expense by $7.3 million; (3) updating surrender and annuitization rates on indexed, single tier, and two tier annuities which increased DPAC amortization expense by $3.7 million; and (4) updating DPAC future profit projections for universal life insurance riders which had not been previously included in software models which resulted in decreasing DPAC amortization expense by $2.1 million.
realized and unrealized gains/(losses) included in net investment income approximate the change in contract interest associated with the corresponding embedded derivative liability change). However, other aspects of the embedded derivatives can cause deviations to occur between the change in index option asset values included in net investment income and the change in the embedded derivative liability included in contract interest. As noted in the discussion of net investment income, the collection of asset management fees in a period can cause investment income to increase marginally higher than contract interest expense since these collected fees are deducted from indexed interest credited to policyholders. During the years ended December 31, 2018, 2017, and 2016, asset management fees collected were $24.3 million, $31.8 million, and $6.4 million, respectively.
Accounting rules require the embedded derivative liability to include a projection of asset management fees estimated to be collected in the succeeding fiscal year as an offset to projected policyholder interest credits. The projections are based upon the performance of options as of the year-end balance sheet dates. The change in this projection, plus or minus, is included in contract interest expense for the period being reported on. During the years ended December 31, 2018, 2017, and 2016, contract interest was increased/(decreased) by $17.6 million, $6.9 million, and $(15.9) million, respectively, for this occurrence. The increases to contract interest expense reflect lower estimated asset management fees to be collected while the decrease to contract interest expense represents an increase to the amount of asset management fees estimated to be collected. Refer to Note 15 Derivative Investments in the accompanying Notes to Consolidated Financial Statements for further information.
As previously discussed in the amortization of deferred policy acquisition costs section, in 2018 the company unlocked its life insurance DPAC balance for mortality experience and extended benefit policy reserves. While these changes had a relatively modest impact on the DPAC unlocking, they had a larger effect on the policy benefits liability balance. The impact of these unlocking adjustments upon policy benefit reserves was an increase of $14.2 million. This increase is included as a component of contract interest expense in 2018. Similarly, the company unlocked its excess benefit reserves (International life) and two tier annuity reserves in 2017 and 2016. The unlockings of these reserves increased contract interest expense by $13.7 million and $3.0 million in 2017 and 2016, respectively.
expenditures. The Company has progressively released into production components of system development over the past couple of years initiating amortization of these capitalized costs. Software costs, including amortization expense, for 2018, 2017, and 2016 were $11.3 million, $9.0 million, and $8.6 million, respectively. General insurance expenses also include payments and provisions made relating to potential or contingent legal liabilities. Expenses related to these items were $(1.8) million, $8.5 million, and $4.2 million in 2018, 2017, and 2016, respectively. The 2016 amount includes a $1.3 million payment (including interest and expenses) to insurance authorities in Brazil pertaining to administrative proceedings in that country and a $2.9 million provision for an annuity contract matter in Puerto Rico in litigation. The 2018 amount reflects settlement of the annuity contract matter in Puerto Rico for $1.0 million and the release of the excess provision recorded in 2016. The 2017 amount pertains to an $8.2 million loss contingency recorded by the Company at December 31, 2017 related to excess premiums on certain of its policies. Refer to the Legal Proceedings narrative in Part I, Item 3 of this Form 10-K for further discussion of litigation matters.
In 2013 the Company began deferring the premium load on its highest selling domestic product, single pay life insurance. Amounts deferred are amortized into revenues over future periods corresponding with the duration of the policies. Initially, the premium load amounts deferred exceeded the amounts amortized back into revenues. However, beginning in 2016 the cumulative amounts deferred reached a level such that the current year revenue amortization now exceeds the current period deferral resulting in net increasing revenue from this accounting method.
Life and policy benefits for a smaller block of business are subject to variation from period to period. Claim count activity during 2018 increased 19% compared to 2017 while the average net claim amount increased to $31,800 from $27,700. The low face amount per claim relative to the current issued amounts of insurance per policy reflects the older block of domestic life insurance policies sold which were final expense type products (i.e. purchased to cover funeral costs). The increase in the average net claim amount reflects claims from more recent policy sales (single premium wealth transfer products) which have much higher face amounts of insurance coverage per policy. GAAP reporting requires that claims be recorded after any cash value amounts that have been accumulated in the policies. While domestic claims increased in 2018 compared to 2017, the accumulated cash values on the claims incurred was substantially higher in 2018 (which reduces the net amount at risk on policies). The company's overall mortality experience for this segment has been better than pricing assumptions.
Contract interest expense includes the fluctuations that are the result of the effect upon the embedded derivative for the performance of the underlying equity indices associated with fixed-indexed universal life products. For liability purposes, the embedded option in the Company's policyholder obligations for this feature is bifurcated and reserved for separately. Accordingly, the impact for the embedded derivative component in the equity-index universal life product is reflected in the contract interest expense for approximately the same amounts as in net investment income for each respective period. As part of the 2018 unlockings discussed above, the company reduced its excess benefit reserve by $1.0 million which served to decrease contract interest expense by a like amount.
The Company's international life operations have been a steady contributor to the Company's overall earnings performance and represented a niche where the Company believed it had a competitive advantage historically. A stable population of distribution relationships developed over decades of operations had provided the Company with a persistent block of business.
Universal life revenues and operating earnings are generated from the amount of life insurance in force and new sales activity. Over the past three years, the volume of insurance in force for this segment has contracted from $17.9 billion at December 31, 2016 to $16.6 billion at December 31, 2017 and to $15.4 billion at December 31, 2018. The decline in volume of in force reflect the company's decision at the end of 2015 to disengage from certain countries. In addition, during 2018 the company made the decision to cease accepting international policy applications from residents from all remaining countries. Universal life insurance revenues are also generated with the issuance of new business based upon amounts per application and percentages of the face amount (volume) of insurance issued. During 2018, the number of international life policies decreased 48% from the prior year while the volume of insurance issued decreased approximately 50% from the level in 2017.
National Western’s most popular international products have been its fixed-index universal life products in which the policyholder can elect to have the interest rate credited to their policy account values linked in part to the performance of an outside equity index. These products issued were not generally available in the local markets sold. Included in the totals in the above table are collected premiums for fixed-index universal life products of approximately $57.8 million, $65.6 million and $74.9 million for the years ended 2018, 2017 and 2016, respectively. The declining trend in renewal premiums during these periods corresponds with the decline in policies in force due to reduced sales activity and increased termination activity as discussed above.
The company records true-up adjustments to DPAC balances each period to reflect current policy lapse or termination rates, expense levels, and credited rates on policies as compared to anticipated experience as well as unlocking adjustments as necessary. The following table identifies the effects of unlocking adjustments on international life insurance DPAC balances recorded through amortization expense separate from recurring amortization components for 2018, 2017 and 2016.
In 2018, the company unlocked DPAC balances associated with its International Life segment for extended death benefit reserves and the investment portfolio yield supporting universal life policy liabilities. The effect of the prospective unlocking was to decrease DPAC balances by $0.3 million (and increase amortization expense). In 2017, the company unlocked the DPAC balance for favorable mortality, lower than expected lapses from disengaged countries, the implementation of an interest crediting clawback on certain universal life policies, and the interest crediting rate spread on one of its equity-indexed universal life products which collectively decreased amortization expense by $27.7 million. During 2016, the Company unlocked the DPAC balance for: (1) favorable mortality, (2) higher cost of insurance charges which had been implemented, (3) increased lapse rates for disengaged countries, and (4) for future profit projections related to universal life insurance riders which had not been previously included in DPAC actuarial software models, the result of which collectively decreased amortization expense by $8.5 million.
Although not an unlocking, during the fourth quarter of 2018 the company successfully converted its reserve modeling for excess death benefit reserves on UL riders to its existing actuarial software platform. The implementation refined the company's estimate increasing these reserves and included an adjustment increasing the International Life DPAC balance (decreasing amortization expense). The amount of the amortization expense decrease was $3.6 million.
National Western's annuity operations are exclusively in the United States. A comparative analysis of results of operations for the Company's annuity segment is detailed below.
Fixed-index products are more attractive for consumers when interest rate levels remain low and equity markets produce positive returns. Since National Western does not offer variable products or mutual funds, fixed-index products provide an important alternative to the company's existing fixed interest rate annuity products. Fixed-index annuity deposits as a percentage of total annuity deposits were 93%, 95% and 94% for the years ended December 31, 2018, 2017 and 2016, respectively. The percentage of fixed-index products to total annuity sales reflects the low interest rate environment and the ongoing bull market in equities.
Consistent with the domestic and international life segments, the Company records true-up adjustments to DPAC balances each period to reflect current policy lapse or termination rates, expense levels and credited rates on policies as compared to anticipated experience as well as unlocking adjustments as necessary. The following table identifies the effects of unlocking adjustments on annuity DPAC balances recorded through amortization expense separate from recurring amortization expense components for 2018, 2017 and 2016.
In 2018, the company unlocked the DPAC balances associated with its Annuity segment for assumptions concerning mortality, the election rate of the company's withdrawal benefit rider, and for the investment portfolio yield supporting annuity contract accounts. The effect of the prospective unlocking was to increase DPAC balances by $2.2 million (and decrease amortization expense). In 2017, the company unlocked the DPAC balance associated with its annuity segment for surrender/annuitization assumptions and interest crediting rate spreads. The effect of the prospective unlocking was to increase amortization expense by $15.1 million. During 2016, the annuity DPAC balance was unlocked for surrender and annuitization rates. The effect of this prospective unlocking was to increase amortization expense by $3.7 million.
As previously noted, accounting rules require the embedded derivative liability to include a projection of asset management fees estimated to be collected in the succeeding fiscal year as an offset to projected policyholder interest credits. The projections are based upon the performance of options as of the year-end balance sheet dates. The change in this projection, plus or minus, is included in contract interest expense for the period being reported on. During the years ended December 31, 2018, 2017, and 2016, contract interest was increased/(decreased) by $17.6 million, $6.9 million, and $(15.9) million, respectively, for this occurrence. The increases to contract interest expense reflect lower estimated asset management fees to be collected while the decrease to contract interest expense represents an increase to the amount of asset management fees estimated to be collected. The Annuity segment contains the products which charge asset management fees.
Annuity contract interest includes true-up adjustments for the deferred sales inducement balance which are done each period similar to that done with respect to DPAC balances with the adjustment reflected in current period contract interest expense. To the extent required, the company may also record unlocking adjustments to deferred sales inducement balances in conjunction with DPAC balance unlockings. For the years ended December 31, 2018, 2017, and 2016 bonus interest amortization was increased/(decreased) by $(1.3) million, $4.3 million and $1.7 million, respectively, for unlocking adjustments. The unlocking in 2016, in addition to impacting the DPAC and deferred sales inducement balances, also increased the Company's benefit reserves by $12.2 million for the two-tiered deferred annuity block of business which in turn increased contract interest expense.
As noted in the Domestic Life insurance and International Life insurance segments, the Company's overall operating expenses are allocated based upon functional business activity and volumes. Although annuity sales activity decreased somewhat in 2018 relative to the Domestic and International Life segments, the segment maintained a high level of maintenance expenses for the in force block of business which kept operating expenses at a relatively level amount.
The Company's overall conservative investment philosophy is reflected in the allocation of its investments, which is detailed below as of December 31, 2018 and 2017. The Company emphasizes investment grade debt securities.
The Company’s investment portfolio decreased (2)% to $10.6 billion at December 31, 2018 compared to $10.8 billion at December 31, 2017 due primarily to the unrealized loss increases associated with investments reported at fair value (debt securities available for sale, index options and equity securities).
A portion of the Company’s debt securities are designated in the available for sale portfolio, which is reported at fair market value. Unrealized gains associated with this part of the portfolio were $76.6 million at December 31, 2017 but shifted to an unrealized loss position of $(62.6) million at December 31, 2018 incrementally lowering the total portfolio balance. The increase in the unrealized loss position of the portfolio is largely a consequence of market interest rate levels increasing during 2018.
Derivatives are call options purchased to hedge the interest crediting mechanism associated with the Company's fixed-index universal life and annuity policies. These options are reported on the Consolidated Balance Sheets at fair value in accordance with GAAP. The unrealized loss position of options held at December 31, 2018 was $(72.3) million which was $191.7 million lower than the unrealized gain position at December 31, 2017 of $119.4 million. The decrease is due to the lower equity index level at the end of 2018 relative to the market indice levels at the time outstanding options were purchased.
The Company maintains a diversified portfolio which consists mostly of corporate, mortgage-backed, and public utility fixed income securities. Investments in mortgage-backed securities primarily include U.S. government agency pass-through securities and collateralized mortgage obligations ("CMO"). The Company's investment guidelines prescribe limitations by type of security as a percent of the total investment portfolio and all holdings were within these threshold limits. As of December 31, the Company's debt securities portfolio consisted of the following for 2018 and 2017:
In addition to diversification, an important aspect of the Company's investment approach is managing the credit quality of its investments in debt securities. Thorough credit analysis is performed on potential corporate investments including examination of a company's credit and industry outlook, financial ratios and trends, and event risks. This emphasis is reflected in the high average credit rating of the Company's debt securities portfolio with 99.1% held in investment grade securities. In the table below, investments in debt securities are classified according to credit ratings by nationally recognized statistical rating organizations.
The Company's percentage of below investment grade securities compared to total invested assets at December 31, 2018 remained level with that of year-end 2017 as upgrades of several securities, primarily energy-related entities, maturities, and calls by several issuers in this category nearly offset new downgrades. The Company's holdings of below investment grade securities are relatively small and as a percentage of total invested assets low compared to industry averages.
The Company is required to classify its investments in debt securities into one of three categories: (a) trading securities; (b) securities available for sale; or (c) securities held to maturity. The Company purchases securities with the intent to hold to maturity and accordingly does not maintain a portfolio of trading securities. Of the remaining two categories, available for sale and held to maturity, the Company makes a determination on categorization based on various factors including the type and quality of the particular security and how it will be incorporated into the Company's overall asset/liability management strategy. As shown in the table below, at December 31, 2018, approximately 29.0% of the Company's total debt securities, based on fair values, were classified as securities available for sale. These holdings in available for sale provide flexibility to the Company to react to market opportunities and conditions and to practice active management within the portfolio to provide adequate liquidity to meet policyholder obligations and other cash needs.
The Company targets a minimum specified yield on mortgage loan investments determined by reference to currently available debt security instrument yields, plus a desired amount of incremental basis points. During the past several years, the low interest rate environment has resulted in fewer loan opportunities being available that meet the Company's required rate of return. Mortgage loans originated by the Company totaled $29.9 million and $59.4 million for the years 2018 and 2017, respectively.
The Company's direct investments in real estate are not a significant portion of its total investment portfolio as most of these investments were acquired through mortgage loan foreclosures. For the years ended December 31, 2018 and 2017, there were no real estate properties acquired through mortgage loan foreclosure. The Company also participates in several real estate joint ventures and limited partnerships that invest primarily in income-producing retail properties.
The Company held net investments in mortgage loans, after allowances for possible losses, totaling $203.2 million and $208.2 million at December 31, 2018 and 2017, respectively. The diversification of the portfolio by geographic region, property type, and loan-to-value ratio was as follows:
The Company does not recognize interest income on loans past due ninety days or more. The Company had no mortgage loans past due six months or more at December 31, 2018 and 2017. There was no interest income that was not recognized in 2018, 2017 and 2016.
The fair value of derivative instruments presented in the Company’s Consolidated Financial Statements totaling $14.7 million at December 31, 2018 and $194.7 million at December 31, 2017 pertain to notional policyholder account values of $2.6 billion and $3.2 billion at December 31, 2018 and 2017, respectively, electing interest credits based upon applicable market index performance.
The Company manages interest rate risk principally through ongoing cash flow testing as required for insurance regulatory purposes. Computer models are used to perform cash flow testing under various commonly used stress test interest rate scenarios to determine if existing assets would be sufficient to meet projected liability outflows. Sensitivity analysis allows the Company to measure the potential gain or loss in fair value of its interest-sensitive instruments and to protect its economic value and achieve a predictable spread between what is earned on invested assets and what is paid on liabilities. The Company seeks to minimize the impact of interest risk through surrender charges that are imposed to discourage policy surrenders. Interest rate changes can be anticipated in the computer models and the corresponding risk addressed by management actions affecting asset and liability instruments. However, potential changes in the values of financial instruments indicated by hypothetical interest rate changes will likely be different from actual changes experienced, and the differences could be significant.
The Company is exposed to credit risk through counterparties and within its investment portfolio. Credit risk relates to the uncertainty associated with an obligor’s continued ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. As previously discussed, the Company manages credit risk through established investment credit policies and guidelines which address the quality of creditors and counterparties, concentration limits, diversification practices and acceptable risk levels. These policies and guidelines are regularly reviewed and approved by senior management and National Western’s Board of Directors.
Cash flows from the Company's insurance operations have historically been sufficient to meet current needs. Cash flows from operating activities were $326.6 million, $276.1 million, and $309.1 million in 2018, 2017, and 2016, respectively. The Company also has significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows totaled $633.2 million, $779.0 million, and $595.0 million in 2018, 2017, and 2016, respectively. Cash flows from security maturities, redemptions, and prepayments coincide primarily with scheduled maturity dates of securities given the Company's buy and hold investment philosophy but may become amplified during periods of significant declines in interest rates due to prepayments and bond calls. Conversely, these cash flow items could experience reduced levels of activity if interest rates rise in the future. Net cash inflows/(outflows) from the Company's universal life and annuity product operations totaled $(440.6) million, $(163.3) million, and $(52.8) million in 2018, 2017, and 2016, respectively. The trend in net outflows reflects the declining annuity sales pattern during the period and in 2018 the higher incidence of annuity cash surrenders and withdrawals.
The Company has declared and paid an annual dividend on its common shares since 2005 although its practice remains to substantially reinvest earnings internally to finance the development of new business. Despite the fact the Company's market price of its Class A common shares has been trading at a discount to the book value per share for some time, there are no imminent plans for the Company to repurchase its shares as the Board of Directors has adopted a strategic policy of building a strong capital base to maintain its high financial strength ratings and having the ability to take competitive advantages and acquisitions as they arise. The capacity of National Western to pay dividends to NWLGI is limited by law in the state of Colorado to earned profits (statutory unassigned surplus). At December 31, 2018, the maximum amount legally available for distribution during 2019 without further regulatory approval is $30.7 million.
(1) Refer to Note (9) Commitments and Contingencies in the Notes to Consolidated Financial Statements relating to Company leases.
(2) Life claims payable include benefit and claim liabilities for which the Company believes the amount and timing of the payment is essentially fixed and determinable. Such amounts generally relate to incurred and reported death and critical illness claims including an estimate of claims incurred but not reported.