The Company leases 72,000 square feet of office space in Austin, Texas, for $477,600 per year plus taxes, insurance, maintenance, and other operating costs less the amortization of the deferred gain of $325,000 which arose from the sale and lease-back of the property in 1984. This lease expires in 2000.
National Western Life Insurance Company is a life insurance company, chartered in the State of Colorado in 1956, and doing business in forty-three states and the District of Columbia. It also accepts applications from and issues policies to residents of Central and South American countries. These policies are accepted and issued in the United States and accounted for approximately 22% of the Company's total premium revenues, universal life, and investment annuity contract deposits in 1994. The Company ranks among the top eight percent of all life insurance companies measured by statutory admitted assets. The primary products marketed by the Company are its universal life and single and flexible premium annuity products. Most of the Company's new business comes from the development of a market and the design and marketing of a specific product for that market.
In addition to the life insurance business, the Company has a brokerage operations segment. The Westcap Corporation, a wholly owned subsidiary of National Western Life Insurance Company, is primarily a dealer in municipal and corporate bonds and collateralized mortgage obligations and a secondary market dealer in obligations issued or guaranteed by the U.S. Government or its agencies.
Securities the Company purchases with the intent to hold to maturity are classified as securities held to maturity. Because the Company has strong cash flows and matches expected maturities of assets and liabilities, the Company has the ability to hold the securities, as it would be unlikely that forced sales of securities would be required prior to maturity to cover payments of liabilities. As a result, securities held to maturity are carried at amortized cost less declines in value that are other than temporary. However, certain situations may change the Company's intent to hold a particular security to maturity, the most notable of which is a deterioration in the issuer's creditworthiness. Accordingly, a security may be sold to avoid a further decline in realizable value when there has been a significant change in the credit risk of the issuer.
Securities purchased by the Company's brokerage subsidiary that are held for current resale are classified as trading securities. These securities are typically held for short periods of time, as the intent is to sell them, producing a trading profit. Trading securities are recorded in the Company's financial statements at fair value. Any trading profits or losses and unrealized gains or losses resulting from changes in the fair value of the securities are reflected as a component of income in the Company's financial statements.
As an integral part of its investment philosophy, the Company performs an ongoing process of monitoring the creditworthiness of issuers within the investment portfolio. In addition, review procedures are performed on securities that have had significant declines in fair value. The Company's objective in these circumstances is to determine if the decline in fair value is due to changing market expectations regarding inflation and general interest rates or other factors.
At December 31, 1994, securities held to maturity totaled $1.606 billion or 62.5% of total invested assets. The fair value of these securities was $1.488 billion which reflects gross unrealized losses of $118 million. The unrealized losses within this portfolio result from increases in market interest rates during 1994. These gross unrealized losses are partially offset by $941,000 of net unrealized gains at December 31, 1994, recorded as a separate component of stockholders' equity resulting from the transfer of securities from available for sale to held to maturity as described in the notes to the financial statements.
Securities available for sale totaled $354 million at December 31, 1994, or 13.8% of total invested assets. Equity securities, which are included in securities available for sale, continue to be a small component of the Company's total investment portfolio totaling only $26 million. Securities available for sale are reported in the accompanying financial statements at fair value with changes in values reported as a separate component of stockholders' equity. As described in the notes to the financial statements, on July 31, 1994, the Company transferred securities with fair values totaling $805 million from securities available for sale to securities held to maturity. The lower holdings of securities available for sale will significantly reduce the Company's exposure to equity volatility while still providing securities for liquidity and asset/liability management purposes. The transfer resulted in locking in a net unrealized gain totaling $1,380,000 as a separate component of stockholders' equity which is subsequently being amortized. The net unrealized loss of the remaining securities available for sale was $3,140,000 at December 31, 1994.
As market interest rates declined in 1992 and into 1993, the Company's portfolio experienced increased calls and principal prepayments. The increase in calls was primarily in the Company's utilities holdings. The Company responded with an active approach in managing future call risk by investing the call proceeds in a more diverse group of companies with increased call protection. As a result, the Company's utilities holdings as a percentage of the entire portfolio was reduced from 26.6% in 1992 to 14.6% in 1994.
In addition to managing prepayment, extension and call risks, the Company continues to concentrate on improving the credit quality of its investments in debt securities. Much attention is often placed on a company's holdings of below investment grade debt securities, as these securities generally have greater default risk than higher rated corporate debt. These issuers usually have high levels of indebtedness and are more sensitive to adverse industry or economic conditions than are investment grade issuers. The Company's small holdings of below investment grade debt securities, which are summarized as follows, have increased slightly from 1992 primarily due to several corporate issuers that had ratings downgraded.
The level of investments in debt securities which are in default as to principal or interest payments is indicative of the Company's minimal holdings of below investment grade debt securities. At December 31, 1994 and 1993, securities with principal balances totaling $2,415,000 and $3,151,000 were in default and on non-accrual status.
The Company's overall conservative investment philosophy is reflected in the allocation of investments of its insurance operations which is detailed below as of December 31, 1994 and 1993. The Company emphasizes debt securities with smaller holdings in mortgage loans and real estate than industry averages.
The Company continues to improve the quality of its mortgage loan portfolio through strict underwriting guidelines and diversification of underlying property types and geographic locations. In addition to all mortgage loans being secured by the property, the majority of loans originated since 1991 are amortized over the term of the lease on the property, which is guaranteed by the lessee, and are approved based on the credit strength of the lessee. This approach also enables the Company to choose the locale in which the property securing the loan is located. In addition, the Company's underwriting guidelines require a loan-to-value ratio of 75% or less.
The Company's direct investments in real estate are not a significant portion of its total investment portfolio, and the majority of real estate owned was acquired through mortgage loan foreclosures. However, the Company is also currently participating in several real estate joint ventures. The joint ventures invest primarily in income-producing retail properties. While not a significant portion of the Company's investment portfolio, the joint ventures have produced favorable returns to date. The Company has no current plans to significantly increase its investments in real estate in the foreseeable future.
The diversification of the mortgage loan portfolio by geographic region of the United States and by property type as of December 31, 1994 and 1993, was as follows:
As of December 31, 1994, the allowance for possible losses on mortgage loans was approximately $5,929,000. Additions to the allowance totaling $307,000 and $2,152,000 were recognized as realized losses on investments in the Company's 1994 and 1993 financial statements. Management believes that the allowance for possible losses is adequate. However, while management uses available information to recognize losses, future additions to the allowance may be necessary based on changes in economic conditions, particularly in the West South Central region which includes Texas, Louisiana, Oklahoma, and Arkansas.
In addition to the non-accrual loans, the Company had mortgage loan principal balances with restructured terms totaling approximately $13,123,000 and $14,257,000 at December 31, 1994 and 1993, respectively. For the years ended December 31, 1994 and 1993, the approximate reduction in interest income associated with restructured loans was as follows:
The Company owns real estate that was acquired through foreclosure and through direct investment totaling approximately $17,766,000 and $22,672,000 at December 31, 1994 and 1993, respectively. This small concentration of properties represents less than one percent of the Company's entire investment portfolio. The real estate holdings consist primarily of income-producing properties which are being operated by the Company. The Company recognized operating losses on these properties of approximately $62,000 for the year ended December 31, 1994 and operating income of approximately $607,000 for the year ended December 31, 1993. The Company does not anticipate significant changes in these operating results in the near future.
The Company monitors the conditions and market values of these properties on a regular basis. Realized losses recognized due to declines in values of properties totaled $318,000 and $1,208,000 for the years ended December 31, 1994 and 1993, respectively. The Company makes repairs and capital improvements to keep the properties in good condition and will continue this maintenance as needed. However, the amounts expended for this maintenance have not had a significant impact on the Company's liquidity and capital resources, and such maintenance is not foreseen to have a significant impact in the near future.
A summary of operating results, net of taxes, for the years ended December 31, 1994, 1993 and 1992 is provided below:
Actual universal life and investment annuity deposits collected for the years ended December 31, 1994, 1993 and 1992 are detailed below. Deposits collected on these non-traditional products are not reflected as revenues in the Company's statements of earnings, as they are recorded directly to policyholder liabilities upon receipt, in accordance with generally accepted accounting principles.
Net Investment Income: Net investment income increased 5.4% from $180.3 million in 1993 to $190.0 million in 1994. Net investment income was up primarily due to yield and amortization adjustments on mortgage-backed securities and increases in invested assets. The yield and amortization adjustments were made in accordance with Statement of Financial Accounting Standards No. 91, "Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases." The adjustments are made to reflect changes in mortgage-backed securities prepayment levels, caused by changes in market interest rates, which affect average lives, yields and amortization periods of the securities. The increase in invested assets for insurance operations is primarily due to increases in investment annuity deposits as previously described.
During 1992, net investment income increased 4.4% which was consistent with the growth in investments. However, net investment income declined from $184.1 million in 1992 to $180.3 million in 1993. This is reflective of both slower investment growth and the decline in the Company's investment portfolio yield due primarily to the overall drop in market interest rates. In 1993, both cash from operations and investment proceeds from increased principal prepayments and calls on debt securities were reinvested at lower yields due to market conditions, thereby producing lower investment income. Additionally, in 1993 and 1992 investment income was impacted due to reductions in the yields of the Company's remaining holdings of residual interests in collateralized mortgage obligations (CMO residuals). Holdings of principal exchange rate linked securities (PERLS) were also reduced substantially throughout 1992 which decreased yields. Although the reductions in holdings of the CMO residuals and PERLS did decrease portfolio yields, the exposure to exchange rate and prepayment risks was significantly reduced. Remaining holdings of these securities totaled approximately $16.9 million at December 31, 1994.
Also, as previously disclosed in the Company's annual reports on Form 10-K, the Company was a defendant in a lawsuit seeking recovery of certain values of life insurance policies pledged as collateral for debentures totaling $8,000,000. In early 1991, a court ruled that the collateral assignment was not enforceable. As a result, the Company recorded a loss of $8,000,000 in 1990, as the debentures were no longer deemed collateralized by the insurance policies and their market value was zero due to the insolvency of the issuer. The Company appealed the court ruling and also recorded a corresponding $8,000,000 liability for the potential payment of this claim. The Company had been accruing an additional liability for interest on this $8,000,000 balance. This lawsuit was settled in September, 1993, resulting in an $11,500,000 payment by the Company. The Company's total accrued liability for this claim exceeded the payment by approximately $670,000 which has been reflected as other income in 1993. The Company also received proceeds from a settlement totaling $955,000 for recovery of damages incurred related to this lawsuit. These settlement proceeds have been reflected as other income in 1994.
Realized Gains on Investments: The Company had realized gains of $1.6 million, $3.2 million and $15.7 million in 1994, 1993 and 1992, respectively. The decrease in 1994 and 1993 from the previous year is attributable to the prevailing strategy within the Company's investment philosophy which is the intent to hold debt securities to maturity. The gains in the three years are net of write-downs on real estate and mortgage loans totaling $625,000, $3,360,000, and $3,325,000. The gains also are net of write-downs for permanent impairments on securities held to maturity of $6,329,000 and $5,000,000 in 1993 and 1992, respectively. The write-downs in 1993 and 1992 for securities held to maturity relate primarily to holdings of PERLS and CMO residuals. The Company made substantial reductions in the holdings of these securities in 1993 and 1992, thereby reducing the exposure to potential future losses.
Universal Life and Investment Annuity Contract Interest: Interest expense has declined steadily as amounts totaled $129.1 million, $130.9 million and $135.8 million for 1994, 1993 and 1992, respectively. This decline is due to the lowering of credited interest rates on most universal life and investment annuity products throughout these years. Additional interest costs related to increasing business has not been significant as the policy liabilities have remained relatively constant over the past three years except for the recent increase in investment annuity deposits in the latter part of 1994. The Company closely monitors its credited interest rates taking into consideration such factors as profitability goals, policyholder benefits, product marketability, and economic market conditions. Rates are established or adjusted after careful consideration and evaluation of these factors against established objectives.
Other Insurance Operating Expenses: These expenses totaled $29.4 million, $29.0 million and $27.9 million for 1994, 1993 and 1992, respectively. Although these expenses are relatively comparable between years, there were several items of significance which are described as follows:
(a) Commission expenses on insurance product sales were approximately $2,500,000 higher in 1992 due to higher premium volumes.
Brokerage Net Earnings (Loss): 1994 net losses from the Company's wholly owned subsidiary, The Westcap Corporation, totaled $2,936,000 compared to net earnings of $21,832,000 and $26,728,000 in 1993 and 1992, respectively. As described in detail below, adverse bond market conditions were the major factor for lower production and the resulting loss in 1994 for the subsidiary.
The liquidity requirements of the Company are met primarily by funds provided from operations. Premium deposits and revenues, investment income, and investment maturities are the primary sources of funds, while investment purchases and policy benefits are the primary uses of funds. Primary sources of liquidity to meet unexpected cash needs are the Company's securities available for sale portfolio, net cash provided by operations and $60 million bank line of credit. The Company's brokerage subsidiary also uses revolving lines of credit to complement any funds generated from operations. These lines of credit are used primarily for clearing functions for all securities transactions with its customers.
The Company had no long-term debt during 1994 or 1993. There are no present material commitments for capital expenditures in 1995, and the Company does not anticipate incurring any such commitments in the remainder of 1995.
(a) Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost.
The Company adopted SFAS No. 115 effective January 1, 1994, resulting in an increase to stockholders' equity of $26,610,000 on that date. There was no effect on net earnings of the Company. The implementation of SFAS No. 115 and subsequent effects on stockholders' equity during 1994 is more fully described in the accompanying notes to consolidated financial statements.
In December, 1994, the NAIC adopted for statutory accounting practices Actuarial Guideline GGG for determining minimum reserves for annuity contracts with multiple benefit streams often referred to as two-tier annuities. The guideline will be effective December 31, 1995, and will apply to all contracts issued on or after January 1, 1981, and allowance is made for a three-year phase-in period. However, the Company's statutory reserving practices for two-tier annuities follow an agreement reached with its state of domicile, Colorado.
The Colorado Division of Insurance (the Division) issued a Notice in 1987 which defined the basis of reserving for two-tier annuities and utilized a single interest rate for all benefit streams. Based on the Colorado Notice and the uncertainty of the implementation of Actuarial Guideline GGG, the Company added $7,000,000 in 1992 and $6,000,000 in 1993 to its existing statutory annuity reserves. These additional reserves were agreed upon and approved by the Colorado Division of Insurance.
During 1993, the Division conducted an Association Financial Examination of the Company for the six-year period ended December 31, 1992. One of the results of the examination was an agreement between the Division and the Company concerning the permitted statutory reserving basis for two-tier annuities. The agreement includes a plan to meet a target reserve by December 31, 1996. The agreement states the acceptable difference between the target reserve and the statutory reserve held by the Company. The difference will meet the following schedule: