Pursuant to an arrangement between NMIC and certain of its subsidiaries, during 2007 the Company leased on average approximately 898,000 square feet of office space in the three-building home office complex and in other offices in central Ohio. In addition, the Company leases approximately 120,000 square feet of office space in Berwyn, Pennsylvania (of which approximately 90,000 square feet are subleased) and owns approximately 160,000 square feet of office space in Newark, Delaware (of which approximately 15,000 square feet are subleased to an affiliate). The Company believes that its present and planned facilities are adequate for the anticipated needs of the Company.
(i) change in Nationwide Corporation’s control of the Company through its beneficial ownership of 95.2% of the combined voting power of all the outstanding common stock and 66.3% of the economic interest in the Company;
(iii) the potential impact on the Company’s reported net income and related disclosures that could result from the adoption of certain accounting and/or financial reporting standards issued by the Financial Accounting Standards Board, the SEC or other standard-setting bodies;
(viii) failure to expand distribution channels in order to obtain new customers or failure to retain existing customers;
(xiii) competitive, regulatory or tax changes that affect the cost of, or demand for, the Company’s products;
(xv) settlement of tax liabilities for amounts that differ significantly from those recorded on the balance sheets;
The primary segment profitability measure that management uses is pre-tax operating earnings, which is calculated by adjusting income from continuing operations before federal income taxes and discontinued operations to exclude: (1) net realized investment gains and losses, except for operating items (periodic net amounts paid or received on interest rate swaps that do not qualify for hedge accounting treatment, trading portfolio realized gains and losses, trading portfolio valuation changes, and net realized gains and losses related to securitizations); and (2) the adjustment to amortization of DAC and VOBA related to net realized investment gains and losses.
Management makes decisions concerning the sale of invested assets based on a variety of market, business, tax and other factors. All realized gains and losses generated by these sales, charges related to other-than-temporary impairments of available-for-sale securities and other investments, and changes in valuation allowances on mortgage loans on real estate are reported in net realized investment gains and losses. Also included are changes in the fair values of derivatives qualifying as fair value hedges and the related changes in the fair values of hedged items; the ineffective, or excluded, portion of cash flow hedges; changes in the fair values of derivatives that do not qualify for hedge accounting treatment; and periodic net amounts paid or received on interest rate swaps that do not qualify for hedge accounting treatment.
During the year ended December 31, 2005, management decided to discontinue the following operations: (1) Cap Pro, a majority-owned subsidiary of NFS that provided broker/dealer, registered investment advisor and insurance agency services to producers of certain certified public accounting firms; (2) NFSB, a wholly-owned subsidiary of NFS that sold variable and fixed annuity products in offshore markets; and (3) TBG Lynch, a wholly-owned subsidiary of TBG Financial that distributed BOLI products.
The results of operations of TBG Financial and The 401(k) Company for 2007 and all prior years are reflected as discontinued. The results of operations of Cap Pro, NFSB and TBG Lynch for 2005 are reflected as discontinued. In addition, the sales tables and “Other Data” section of the Retirement Plans segment table in the subsequent portions of MD&A exclude amounts applicable to The 401(k) Company. However, the “Other Data” sections of the tables in the subsequent segment portions of MD&A include amounts applicable to the operations that were discontinued in 2005. See Note 2(n) to the audited consolidated financial statements included in the F pages of this report for additional information on discontinued operations.
Nationwide Bank and Nationwide Federal Credit Union (NFCU) entered into an Agreement and Plan of Merger, dated as of June 16, 2006, pursuant to which Nationwide Bank acquired 100% of the ownership interests in NFCU for $79.0 million in cash. The merger was effective January 1, 2007, with payment of merger consideration to the NFCU membership on January 8, 2007, on a pro rata basis according to the members’ deposit account balances as of March 31, 2006.
The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ significantly from those estimates.
Changes in assumptions can have a significant impact on the amount of DAC reported for investment and universal life insurance products and their related amortization patterns. In the event actual experience differs from assumptions or future assumptions are revised, the Company is required to record an increase or decrease in DAC amortization expense, which could be significant. In general, increases in the estimated long-term general and separate account returns result in increased expected future profitability and may lower the rate of DAC amortization, while increases in long-term lapse/surrender and mortality assumptions reduce the expected future profitability of the underlying business and may increase the rate of DAC amortization.
The decrease in net income compared to 2006 was impacted by several events. First, $114.2 million of tax reserves were released into earnings during the second quarter of 2006. Thus, the effective tax rates in 2007 and 2006 are not comparable. Second, 2007 results include the $45.5 million gain on the sale of The 401(k) Company, partially offset by a $23.3 million loss related to TBG Financial (both reported in discontinued operations as described previously). Lastly, the Company recorded higher income from continuing operations before federal income tax expense largely due to lower amortization of DAC and related adjustments as discussed previously and below, along with higher other income and asset fees. Partially offsetting these factors were net realized investment losses; higher other operating expenses; lower administrative fees; increased amortization of DAC and annuity benefits related to modifications of features in the Company’s L.INC product; and debt extinguishment costs.
Through June 2006, the Company’s federal income tax returns for tax years 2000-2002 were under IRS examination pursuant to a routine audit. In accordance with its regular practice, management established tax reserves representing its best estimate of additional amounts the Company could be required to pay if certain
positions it had taken were challenged and ultimately denied by the IRS with respect to these tax years. These reserves are reviewed regularly and are adjusted as events occur that management believes impacts the Company’s liability for additional taxes, such as lapsing of applicable statutes of limitations; conclusion of tax audits or substantial agreement on the deductibility/non-deductibility of uncertain items; additional exposure based on current calculations; identification of new issues; release of administrative guidance; or rendering of a court decision affecting a particular tax issue. A significant component of the Company’s tax reserve as of December 31, 2005 was related to the separate account dividends received reduction (DRD).