(ix) 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), a reduction in separate account assets or a reduction in the demand for the Company’s products; increased liabilities related to living benefits and death benefit guarantees;
(x) reduction in the value of the Company’s investment portfolio as a result of changes in interest rates, yields and liquidity in the market as well as geopolitical conditions and the impact of political, regulatory, judicial, economic or financial events, including terrorism, affecting the market generally and companies in the Company’s investment portfolio specifically; corresponding impact on the ultimate realizability of deferred tax assets;
(xiii) unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations;
(xv) deviations from assumptions regarding future persistency, mortality (including as a result of the outbreak of a pandemic illness), morbidity and interest rates used in calculating reserve amounts and in pricing the Company’s products;
(xvi) adverse litigation results and/or resolution of litigation and/or arbitration, investigation and/ or inquiry results that could result in monetary damages or impact the manner in which the Company conducts its operations;
The primary segment profitability measure that management uses is pre-tax operating earnings (loss), which is calculated by adjusting income (loss) from continuing operations before federal income tax expense (benefit) 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, net realized gains and losses related to hedges on guaranteed minimum death benefit (GMDB) contracts and securitizations); (2) other-than-temporary impairment losses; (3) the adjustment to amortization of DAC and VOBA related to net realized investment gains and losses; and (4) net loss attributable to noncontrolling interest.
The Company earns revenues and generates cash primarily from policy charges, life insurance premiums and net investment income. Policy charges include asset fees, which are earned primarily from separate account values generated from the sale of individual and group variable annuities and investment life insurance products; cost of insurance charges earned on all life insurance products except traditional, which are assessed on the amount of insurance in force in excess of the related policyholder account value; 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 investment income includes earnings on investments supporting fixed annuities, the medium-term note (MTN) program and certain life insurance products, and earnings on invested assets not allocated to product segments, all net of related investment expenses. Other income includes asset fees, administrative fees, commissions and other income earned by subsidiaries of the Company that provide administrative, marketing, distribution and retail asset management services.
The Company’s primary expenses include interest credited to policyholder accounts, life insurance and annuity benefits, amortization of DAC and general business operating expenses. Interest credited principally relates to individual and group fixed annuities, funding agreements backing the MTN program and certain life insurance products. Life insurance and annuity benefits include policyholder benefits in excess of policyholder accounts for universal life and individual deferred annuities and net claims and provisions for future policy benefits for traditional life insurance products and immediate annuities.
During 2007, the Company committed to a plan of sale of its interest in TBG Insurance Services Corporation d/b/a TBG Financial (TBG Financial). Based on management’s determination that the carrying value of this business exceeded its estimated fair value (less estimated cost to sell), the Company recorded a $23.1 million loss, net of taxes. During 2008, the Company completed the sale of its interest in TBG Financial for $41.3 million in cash and potential additional consideration in the form of an earnout provision, resulting in the Company recording an additional loss of $13.2 million, net of taxes.
The Company categorizes financial assets and liabilities recorded at fair value in the consolidated balance sheets as Level 1, Level 2 or Level 3 depending on the observability of inputs used to measure fair value.
For fixed maturity and marketable equity securities for which active market quotations are available, the Company generally uses independent pricing services to assist in determining the fair value measurement. For certain fixed maturity securities not priced by independent services (generally investment grade private placement securities without quoted market prices), an internally developed pricing model or “corporate pricing matrix” is most often used. The corporate pricing matrix is developed by obtaining private spreads versus the U.S. Treasury yield for corporate securities with varying weighted average lives and bond ratings. The weighted average life and bond rating of a particular fixed maturity security to be priced using the corporate matrix are important inputs into the model and are used to determine a corresponding spread that is added to the U.S. Treasury yield to create an estimated market yield for that bond. The estimated market yield and other relevant factors are then used to estimate the fair value of the particular fixed maturity security. The Company also utilizes broker quotes to assist in pricing securities or to validate modeled prices.
Recent market conditions have led to illiquidity in certain markets for financial instruments, causing the Company to consider such markets inactive. Examples of the criterion used by the Company to determine that a market is inactive include, but are not limited to, few recent transactions, price quotations are not based on current information, price quotations vary substantially either over time or among market makers, indexes previously highly correlated have become uncorrelated, significant increase in implied liquidity risk premiums, wide bid-ask spreads, significant decline or absence of a market for new issuances and minimal public information.
Certain residential mortgage-backed securities backed by sub-prime and Alt-A collateral, which are included in Level 3 financial assets, utilize internal pricing models to assist in determining the estimated fair values. As of December 31, 2008, these investments were priced solely with the assistance of independent pricing services. As a result of low levels of activity in these markets during 2009, management believes that prices were no longer representative of the investments’ fair value, which is the price that would be received upon the sale of the investment in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date. The Company believes that a weighting of internal pricing models and independent pricing services represents a better estimate of the investments’ fair value.
In addition to weighting external prices in developing the internal values, the Company further calibrates those values to market indications through obtaining pricing from two independent pricing services (the market approach). The Company calibrates the prices obtained from the independent pricing services and the price developed internally by utilizing the median value to determine the estimated fair value.
Broker quotes are generally considered unobservable inputs as only one broker quote is ordinarily obtained, the investment is not traded on an exchange, the pricing is not available to other entities and the transaction volume in the same or similar investments has decreased such that generally only one quotation is available. As the brokers often do not provide the necessary transparency into their quotes and methodologies, the Company periodically performs reviews and tests to ensure that quotes are a reasonable estimate of the investments’ fair value and are appropriately categorized in the fair value hierarchy.
The Company periodically evaluates the risks within the derivative portfolios due to credit exposure. When evaluating this risk, the Company considers several factors which include, but are not limited to, the counterparty risk associated with derivative receivables, the Company’s own credit as it relates to derivative payables, the collateral thresholds associated with each counterparty, and changes in relevant market data in order to gain insight into the probability of default by the counterparty. In addition, the effect that the Company’s exposure to credit risk could have on the effectiveness of the Company’s hedging relationships is considered. As of December 31, 2009, the impact of the exposure to credit risk on both the fair value measurement of derivative assets and liabilities and the effectiveness of the Company’s hedging relationships was immaterial.
The Company’s most critical estimates include, but are not limited to, those used to determine the following: the balance, recoverability and amortization of DAC; whether an available-for-sale security is other-than-temporarily impaired; valuation allowances for mortgage loans on real estate; derivative instruments; the liability for future policy benefits and claims; and federal income tax provision. Although some variability is inherent in these estimates, recorded amounts reflect management’s best estimates based on facts and circumstances as of the balance sheet date. Management believes the amounts provided are appropriate.
For investment and universal life insurance products, the Company amortizes DAC with interest over the lives of the policies in relation to the present value of estimated gross profits from projected interest margins, asset fees, cost of insurance charges, administrative fees, surrender charges, and net realized investment gains and losses less policy benefits and policy maintenance expenses. The Company adjusts the DAC asset related to investment and universal life insurance products to reflect the impact of unrealized gains and losses on fixed maturity securities available-for-sale, as described in Note 2(c) to the audited consolidated financial statements included in the F pages of this report.
The assumptions used in the estimation of future gross profits are based on the Company’s current best estimates of future events and are reviewed as part of an annual process during the second quarter. During the annual process, the Company performs a comprehensive study of assumptions, including mortality and persistency studies, maintenance expense studies, and an evaluation of projected general and separate account investment returns. The most significant assumptions that are involved in the estimation of future gross profits include future net separate account investment performance, surrender/lapse rates, interest margins and mortality. Currently, the Company’s long-term assumption for net separate account investment performance is approximately 7% growth per year and varies by product. The Company reviews this assumption, like others, as part of its annual process. If this assumption were unlocked, the date of the unlocking could become the anchor date used in the reversion to the mean process (defined below). Variances from the long-term assumption are expected since the majority of the investments in the underlying separate accounts are in equity securities, which strongly correlate in the aggregate with the Standard & Poor’s (S&P) 500 Index. The Company bases its reversion to the mean process on actual net separate account investment performance from the anchor date to the valuation date. The Company then assumes different performance levels over the next three years such that the separate account mean return measured from the anchor date to the end of the life of the product equals the long-term assumption. The assumed net separate account investment performance used in the DAC models is intended to reflect what is anticipated. However, based on historical returns of the S&P 500 Index, and as part of its pre-set parameters, the Company’s reversion to the mean process generally limits net separate account investment performance to 0-15% during the three-year reversion period.
During the second quarter of 2009, the Company conducted its annual comprehensive review of model assumptions used to project DAC and other related balances, including sales inducement assets, VOBA and unearned revenue reserves. The review covered all assumptions including mortality, lapses, expenses and general and separate account returns. As a result of this review, certain assumptions were unlocked (DAC unlock). The unlocked assumptions primarily related to lower expected investment spreads and separate account returns across all segments.
During the fourth quarter of 2008, the Company’s recorded balance of individual variable annuity DAC fell outside the Company’s preset parameters, which primarily was driven by continued unfavorable market performance compared to assumed net separate account returns. Management made a determination that it was not reasonably possible to get back within the preset parameters during the remaining prescribed period. Accordingly, the Company recalculated DAC using revised best estimate assumptions, which resulted in a decrease in DAC and an increase in DAC amortization and other related balances of $243.1 million pre-tax in the Individual Investments segment. The Company used the reversion to the mean process with the anchor date that was reset during the second quarter 2007 unlocking as described below. The Company evaluated the assumed separate account performance level over the next three years and determined that the assumptions inherent in the reversion period were reasonable. The annual net separate account growth rate for the mean reversion period is 15%, the maximum rate under the Company’s parameters.
During the third quarter of 2008, the Company’s recorded balance of individual variable annuity DAC fell outside the Company’s preset parameters for the prescribed period, which primarily was driven by unfavorable market performance compared to the assumed net separate account returns. Accordingly, the Company recalculated DAC using revised best estimate assumptions, which resulted in a decrease in DAC and an increase in DAC amortization and other related balances totaling $177.2 million pre-tax in the Individual Investments segment.
During the second quarter of 2007, the Company conducted its annual comprehensive review of model assumptions used to project DAC and other related balances, including sales inducement assets, VOBA, unearned revenue reserves, and guaranteed minimum death and income benefit reserves. This review included all assumptions, including expected separate account investment returns during the three-year reversion period, lapse rates, mortality and expenses. The Company determined as part of this annual review that the overall separate account returns were expected to exceed previous estimates due to favorable financial market trends. Additionally, while the Company estimated that the overall profitability of its variable products had improved, it expected the long-term net growth in separate account investment performance to moderate.
Additionally, debt securities that become other-than-temporarily impaired (where the Company does not intend to sell the security and it is not more likely than not that it will be required to sell the security prior to recovery of the security’s amortized cost) are bifurcated with the credit portion of the impairment loss being recognized in earnings and the non-credit loss portion of the impairment being recognized in a separate component of other comprehensive income, net of applicable taxes and other offsets.
When evaluating whether a residential mortgage-backed security, commercial mortgage-backed security, collateralized debt obligation and other asset-backed securities are other-than-temporarily impaired, the Company examines characteristics of the underlying collateral, such as delinquency, prepayment and default rates, the quality of the underlying borrower, the type of collateral in the pool, the vintage year of the collateral, subordination levels within the structure of the collateral pool, the quality of any credit guarantors, the Company’s intent to sell the security and whether it is more likely than not it will be required to sell the security before the recovery of its amortized cost basis.
See Note 2(c) and Note 6 of the audited consolidated financial statements included in the F pages of this report, for additional information regarding the Company’s valuation of investments, investment income, realized gains and losses and other-than-temporary impairment evaluations.
Changes in the valuation allowance are recorded in net realized investment gains and losses, while loan-specific reserves are included in other-than-temporary impairment losses.
The Company recorded net income for the year ended December 31, 2009 compared to a loss in the prior year, primarily due to net realized investment gains, lower other than-temporary impairment losses and lower amortization of DAC. In addition, higher interest spread income, lower other operating expenses and higher premiums contributed to the overall increase, partially offset by lower asset fees and lower other income. Lastly, the Company recorded federal income tax expense for 2009 compared to a tax benefit in 2008 primarily due to the aforementioned increases in net income.
Higher interest spread income for Nationwide Bank and the Retirement Plans segment of $37.2 million and $31.6 million, respectively, and lower losses from hedge fund and private equity investments of $80.4 million drove the increase in interest spread income during 2009. The overall increase was partially offset by lower MTN interest spread income of $41.9 million.
Lower other operating expenses primarily were driven by expense savings initiatives and a decline in retail asset management operating expenses attributable to a decrease in average customer funds managed and administered during 2009. Additionally, the Company exited its NFN professional consulting group sales channel in 2008, which resulted in a pre-tax charge of $24.7 million during 2008.
Higher amortization of DAC was due to several factors. First, the DAC unlocks in 2007 lowered amortization of DAC by $235.8 million in 2007. Next, the DAC unlocks in 2008 increased amortization of DAC by $434.2 million in 2008. However, the Company modified the features of its L.inc product within the Individual Investments segment during 2007. This modification required the Company to extinguish existing DAC and other balances related to L.inc, resulting in a $124.0 million increase in amortization of DAC and increased annuity benefits of $11.0 million in 2007. In addition, net realized losses on embedded derivatives in annuity products offering living benefits decreased amortization of DAC by $93.1 million in 2008. Finally, lower gross profits in the current year and a lower rate of DAC amortization due to the impact of 2007 unlocking further offset the increases described above by approximately $141.4 million.
The Company regularly monitors and reports a sales production metric as a measure of the volume of new and renewal business generated in a period.
Life insurance premiums determined on a GAAP basis are significantly different than statutory premiums and deposits. Life insurance premiums determined on a GAAP basis are recognized as revenue when due, as calculated on an accrual basis in proportion to the service provided and performance rendered under the contract. In addition, many life insurance and annuity products involve an initial deposit or a series of deposits from customers. These deposits are accounted for as such on a GAAP basis and therefore are not reflected in the GAAP income statement. On a statutory basis, life insurance premiums collected (cash basis) and deposits received (cash basis) are aggregated and reported as statutory premiums and annuity consideration revenues.
As calculated and analyzed by management, statutory premiums and deposits on individual and group annuities and life insurance products calculated in accordance with accounting practices prescribed or permitted by regulatory authorities and deposits on administration-only group retirement plans and the advisory services program are adjusted as described below to arrive at new and renewal production premiums and deposits.
The Company’s flagship products are marketed under the Nationwide DestinationSM brand and include individual variable and group annuities and group private sector retirement plans sold through Nationwide Trust Company, FSB, a division of Nationwide Bank (NTC). The Nationwide Destination product series are designed to appeal to a wide array of customer and financial advisor needs. The Company has also 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 names.
See Part I, Item 1 - Business - Overview for a description of the Company’s distribution network.
See Part II, Item 7 - MD&A - Business Segments for an analysis of new and renewal production premiums and deposits by product and segment.
Lower amortization of DAC was driven by DAC unlocks in 2009, which lowered amortization of DAC by $191.9 million in 2009. Additionally, DAC unlocks in 2008, which increased amortization in the prior year by $429.1 million, and lower variable annuity gross profits in 2009 contributed to the overall decline in amortization. Refer to Part II, Item 7 - MD&A - Critical Accounting Policies and Recently Issued Accounting Standards - Deferred Policy Acquisition Costs for Investment and Universal Life Insurance Products for a description of the current and prior year DAC unlocks.
A 44% increase in sales of income products in the current year generated higher premiums as customer demand shifted toward fixed income products.
The decline in asset fees primarily was due to lower average separate account values (down 18%) driven by volatility in the equity markets.
The Individual Investments segment recorded a pre-tax operating loss for 2008 compared to pre-tax operating earnings in 2007 primarily due to higher amortization of DAC. In addition, higher benefits and claims, lower asset fees and interest spread income partially were offset by an increase in other income.
Other income increased primarily due to gains of $109.4 million on derivatives associated with the Company’s economic hedging program for GMDB contracts.
Higher amortization of DAC primarily was due to the DAC unlock in the second quarter of 2007, which lowered amortization of DAC by $10.5 million in 2007. In addition, the DAC unlock in the second quarter of 2008 increased amortization of DAC by $2.3 million in 2008.
The decrease in other operating expenses primarily was due to lower employee incentives and benefits.
The decrease in pre-tax operating earnings was driven by higher benefits and claims, higher amortization of DAC and VOBA, lower asset fees, partially offset by higher cost of insurance charges and lower other operating expenses.
Pre-tax operating earnings declined due to higher benefits, amortization of DAC, other operating expenses and policyholder dividends, partially offset by higher policy charges, lower amortization of VOBA and other intangible assets, and higher interest spread income.
Other operating expenses increased due to the Company’s announced plans to exit its NFN professional consulting group sales channel in 2008 and selling arrangement changes for the NFN independent agency force. As a result, the Individual Protection segment recorded a pre-tax charge of $24.7 million during the fourth quarter of 2008 related to intangibles assets and exit costs. Lower agency marketing costs of $6.3 million, premium taxes of $5.3 million and employee incentives of $3.5 million partially offset the overall increase.
The decrease in new and renewal production premiums and deposits primarily was due to lower renewals of variable life products, partially offset by an increase in universal life sales primarily driven by the ULtimate product.
Excluding 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, net realized gains and losses related to hedges on GMDB contracts and securitizations).
Lower other operating expenses primarily were driven by a $32.0 million decline in retail asset management operating expenses attributable to lower average customer funds managed and administered during 2009 resulting from volatile market conditions. Additionally, other income for the retail asset management business declined by $49.8 million during 2009.
Lower losses from hedge fund and private equity investments of $80.4 million drove the increase in interest spread income during the year ended December 31, 2009. Additionally, higher interest spread income for Nationwide Bank of $37.2 million further contributed to the increase. Nationwide Bank’s improved interest spread income primarily was due to higher volume in the investment portfolio driven by increased customer deposits during 2009 (up 39%). The overall increase was partially offset by lower MTN earnings of $41.9 million during 2009 primarily due to a decrease in MTN assets as a result of note maturities and repurchases of $1.56 billion.
Includes gains of $413.6 million and losses of $500.7 million on embedded derivatives associated with living benefit contracts for the years ended December 31, 2009 and 2008, respectively.
Includes losses of $171.8 million and gains of $109.4 million on derivatives associated with death benefit contracts for the year ended December 31, 2009 and 2008, respectively.
The Company recorded a pre-tax operating loss in 2008 compared to earnings in 2007 primarily due to lower interest spread income and other income, partially offset by the aforementioned debt extinguishment costs recorded in the second quarter of 2007.
The decrease in interest spread income primarily was driven by lower income from hedge fund and private equity investments of $94.5 million. Lower income from mortgage loan prepayments and bond call premiums of $11.6 million, reduced earnings from the MTN program of $9.0 million primarily due to lower prepayment income, and approximately a 10% decline in average asset levels further contributed to the shortfall.
On June 4, 2007, NFS redeemed all of its outstanding 8.00% senior notes due March 1, 2027 at a price of $317.4 million. This amount represented aggregate principal of $300.0 million, an $11.2 million premium due as a result of early redemption (3.728% of the principal amount) and $6.2 million of accrued interest through the redemption date. These senior notes were originally issued in March 1997 and, in accordance with their terms, became subject to optional redemption by NFS on or after March 1, 2007. As a result of this transaction, NFS incurred a $10.2 million charge ($6.6 million, net of taxes) during the quarter ended June 30, 2007. This charge includes the redemption premium described above and the accelerated amortization of both unamortized debt issuance costs and the unamortized discount on the original issuance, partially offset by a deferred gain on previous hedging transactions. These amounts (excluding the redemption premium) otherwise would have been recognized through 2027.
Other-than-temporary investment losses were driven by a $1.03 billion increase in impairment charges compared to the prior year due to challenging conditions in the credit markets.
Declines in the creditworthiness of the issuer of hybrid securities with both debt and equity-like features requires the use of the equity model in analyzing the security for other-than-temporary impairment. For the year ended December 31, 2008, the Company recognized $89.5 million in other-than-temporary impairments related to these securities compared to none for the year ended December 31, 2007.
The Company’s capital structure consists of long-term debt and shareholder’s equity. The following table summarizes the Company’s capital structure as of December 31:
For individual annuity products ($42.17 billion and $37.36 billion of reserves as of December 31, 2009 and 2008, respectively), surrender charges generally are calculated as a percentage of deposits and are assessed at declining rates during the first seven years after a deposit is made.
Given the Company’s historical cash flow from operating and investing activities and current financial results, management of the Company believes that cash flows from operating activities over the next year will provide sufficient liquidity for the operations of the Company and sufficient funds for interest payments.
NLIC has entered into an agreement with its custodial bank to borrow against the cash collateral that is posted in connection with its securities lending program. This is an uncommitted facility contingent on the liquidity of the securities lending program. The borrowing facility was established to fund commercial mortgage loans that were originated with the intent of sale through securitization. The maximum amount available under the agreement is $350.0 million. The borrowing rate on this program is equal to one-month U.S. London Interbank Offered Rate (LIBOR). On July 31, 2009, NLIC paid down the $99.7 million principal balance on the securities lending program facility. NLIC had no amounts outstanding under this agreement as of December 31, 2009 compared to $99.8 million as of December 31, 2008.
Nationwide Bank has the ability to borrow from a single financial institution under a $250.0 million line of credit agreement and $550.0 million repurchase-based advance agreement. The borrowings are collateralized by investments owned by Nationwide Bank and are included in the consolidated balance sheets. The available portion of the credit facilities is limited by the collateral value of loans or securities pledged. The subsidiary had $177.0 million and $46.0 million outstanding under the $550.0 million repurchase-based advance agreement as of December 31, 2009 and December 31, 2008, respectively, at a weighted average interest rate of 0.16% in 2009 and 1.94% in 2008. Nationwide Bank had no amounts outstanding under the $250.0 million line of credit agreement at December 31, 2009 and 2008. As of December 31, 2009, the total additional collateralized borrowing capacity under these agreements was $337.0 million.
The Company also has a wholly-owned subsidiary with a five-year letter of credit issuance agreement with a single financial institution to provide up to $50.0 million in letters of credit. The agreement was effective September 30, 2006 and is guaranteed by NFS. The subsidiary had issued $50.0 million in letters of credit from this facility as of both December 31, 2009 and 2008.
On May 18, 2007, NFS issued $400.0 million principal of 6.75% fixed-to-floating rate junior subordinated notes. These notes bear interest at a fixed rate of 6.75% for a 30-year period, after which the notes will bear interest at the rate of three-month U.S. LIBOR plus 2.33%. These notes are redeemable under one of three scenarios. First, these notes are redeemable, in whole or in part, at any time on or after May 15, 2037 at their principal amount plus accrued and unpaid interest to the date of redemption, provided that in the event of a redemption in part, the principal amount outstanding after such redemption is at least $50.0 million. Next, these notes are redeemable, in whole or in part, prior to May 15, 2037, in cases not involving certain tax or rating agency events, at their principal amount plus accrued and unpaid interest to the date of redemption or, if greater, the “make-whole price,” provided that in the event of redemption in part the principal amount outstanding after such redemption is at least $50.0 million. “Make-whole price” means the sum of the present values of the outstanding principal (discounted from May 15, 2037) and remaining scheduled payments of interest that would have been payable to and including May 15, 2037 (discounted from their respective interest payment dates) on the notes to be redeemed (not including any portion of such payments of interest accrued to the redemption date) to the redemption date on a semiannual basis at a prevailing U.S. Treasury rate plus 30 basis points, plus accrued and unpaid interest on the principal amount being redeemed to the redemption date. Lastly, these notes are redeemable in whole, but not in part, prior to May 15, 2037, within 90 days after the occurrence of certain tax or rating agency events, at their principal amount plus accrued and unpaid interest to the date of redemption or, if greater, the “special event make-whole price.” “Special event make-whole price” means the sum of the present values of the outstanding principal (discounted from May 15, 2037) and remaining scheduled payments of interest that would have been payable to and including May 15, 2037 (discounted from their respective interest payment dates) on the notes to be redeemed (not including any portion of such payments of interest accrued to the redemption date) to the redemption date on a semiannual basis at a prevailing U.S. Treasury rate plus 50 basis points, plus accrued and unpaid interest on the principal amount being redeemed to the redemption date. The final maturity date for the notes is May 15, 2067 extendable to 2087.
On March 11, 1997, Nationwide Financial Services Capital Trust I (Trust I) sold, in a public offering, $100.0 million principal of 7.899% capital securities, representing preferred undivided beneficial interests in the assets of Trust I. This sale generated net proceeds of $98.3 million. Concurrent with the sale of the capital securities, NFS sold to Trust I $103.1 million principal of its 7.899% junior subordinated debentures due March 1, 2037. The junior subordinated debentures are the sole assets of Trust I 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 related capital securities will mature or be called simultaneously with the junior subordinated debentures and have a liquidation value of $1,000 per capital security. The capital securities are fully and unconditionally guaranteed by NFS, and there are no related sinking fund requirements. Distributions on the capital securities are cumulative and payable semi-annually in arrears. On February 18, 2009, Trust I delisted the capital securities from the New York Stock Exchange.
In addition, Nationwide Bank has fixed rate borrowings from various financial institutions that totaled $220.0 million as of both December 31, 2009 and 2008, with interest rates ranging from 1.80% to 4.45%. These borrowings have maturity dates ranging from one to eighteen years, and all are secured by investments pledged by Nationwide Bank ($45.0 million will mature in 2010). Nationwide Bank made interest payments of $6.9 million in 2009, $4.7 million in 2008 and $0.1 million in 2007.
The following table summarizes the Company’s contractual obligations and commitments as of December 31, 2009 expected to be paid in the periods presented. Payment amounts reflect the Company’s estimate of undiscounted cash flows related to these obligations and commitments. Balance sheet amounts were determined in accordance with GAAP and may differ from the summation of undiscounted cash flows. The most significant difference relates to future policy benefits for life and health insurance, which include discounting.
No contractual provisions exist that could create, increase or accelerate those obligations presented. The amount presented includes contractual principal and interest based on rates in effect at December 31, 2009.
A significant portion of policy contract benefits and claims to be paid do not have stated contractual maturity dates and may not result in any ultimate payment obligation. Amounts reported represent estimated undiscounted cash flows out of the Company’s general account related to death, surrender, annuity and other benefit payments under policy contracts in force at December 31, 2009. Separate account payments are not reflected due to the matched nature of these obligations and because the contract owners bear the investment risk of such deposits. Estimated payment amounts were developed based on the Company’s historical experience and related contractual provisions. Significant assumptions incorporated in the reported amounts include future policy lapse rates (including the impact of customer decisions to make future premium payments to keep the related policies in force); coverage levels remaining unchanged from those provided under contracts in force at December 31, 2009; future interest crediting rates; and estimated timing of payments. Actual amounts will vary, potentially by a significant amount, from the amounts indicated due to deviations between assumptions and actual results and the addition of new business in future periods.
Contractual provisions exist which could adjust the amount and/or timing of those obligations reported. Key assumptions related to payments due by period include customer lapse and withdrawal rates (including timing of death), exchanges to and from the fixed and separate accounts of the variable annuities, claims experience with respect to variable annuity guarantees, and future interest crediting level. Assumptions for future interest crediting levels were made based on processes consistent with the Company’s past practices, which is at the discretion of the Company, subject to guaranteed minimum crediting rates in many cases and/or subject to contractually obligated increases for specified time periods. Many of the contracts with potentially accelerated payments are subject to surrender charges, which are generally calculated as a percentage of deposits made and are assessed at declining rates during the first seven years after a deposit is made. Amounts disclosed include an estimate of those accelerated payments, net of applicable surrender charges. See Note 2(l) to the audited consolidated financial statements included in the F pages of this report for a description of the Company’s method for establishing life and annuity reserves in accordance with GAAP. Health reserves are immaterial and are reflected in the less than one year column.
Certain assumptions have been made about mortality experience and retirement patterns in the amounts reported. Actual deaths and retirements may differ significantly from those projected, which could cause the timing of the obligations reported to vary significantly. In addition, contractual surrender provisions exist on an immaterial portion of these contracts that could accelerate those obligations presented. Amounts disclosed do not include an estimate of those accelerated payments. Most of the contracts with potentially accelerated payments are subject to surrender charges, which are generally calculated as a percentage of the commuted value of the remaining term certain benefit payments and are assessed at declining rates during the first seven policy years.