Braker P III, LLC ("BP III") was created in 2016 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 occupies approximately 78,000 square feet. At December 31, 2019, all of the remaining space is leased by BP III to other third party tenants.
Ozark National owns an approximately 63,000 square foot building located in Kansas City, Missouri which is utilized as commercial office space by Ozark, is leased and utilized as commercial office space by its affiliate NIS, and the remainder is leased by Ozark to a third party tenant. The intercompany lease costs related to NIS have been eliminated for consolidated reporting purposes. Additionally, Ozark owns two parcels of land located in Kansas City, Missouri. The first parcel contains 0.3 acres of land and an unused single-story parking garage. The second parcel contains 2.3 acres of land and operates as a surface parking lot contracted on a monthly basis to a parking lot operator.
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 2019, incorporating required disclosures in accordance with the rules and regulations of the Securities Exchange Commission ("SEC").
With regard to the credit market, industry analysts and observers generally agree that a sudden jump in interest rate levels, while presently a highly unlikely scenario, would be harmful to life insurers with interest-sensitive products as it could provide an impetus for abnormal levels of product surrenders and withdrawals at the same time fixed debt securities held by insurers declined in market value. However, the direction and at what pace interest rate movements may occur in the future is ultimately uncertain and subject to change. What impact, if any, such movements would have on the Company’s business, results of operations, cash flows or financial condition is indeterminate.
Deferred Sales Inducements ("DSI"). 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.
Value of Business Acquired ("VOBA"). VOBA is a purchase accounting convention for life insurance companies in business combinations based upon an actuarial determination of the difference between the fair value of policyholder liabilities acquired and the same policyholder liabilities measured in accordance with the acquiring company's accounting policies. The difference, referred to as VOBA, is an intangible asset subject to periodic amortization. Similar to DPAC and DSI, VOBA is subject to periodic analysis assessing recoverability.
Future Policy Benefits. Because of the long-term nature of insurance contracts, the Company is liable for policy benefit payments many years into the future. The liability for future policy benefits represents estimates of the present value of the Company’s expected benefit payments, net of the related present value of future net premium collections. For traditional life insurance contracts, this is determined by standard actuarial procedures, using assumptions as to mortality (life expectancy), morbidity (health expectancy), persistency, and interest rates, which are based on the Company’s experience with similar products. The assumptions used are those considered to be appropriate at the time the policies are issued. An additional provision is made on most products to allow for possible adverse deviation from the assumptions assumed. For universal life and annuity products, the Company’s liability is the amount of the contract’s account balance. Account balances are also subject to minimum liability calculations as a result of minimum guaranteed interest rates in the policies. While management and Company actuaries have used their best judgment in determining the assumptions and in calculating the liability for future policy benefits, there is no assurance that the estimate of the liabilities reflected in the financial statements represents the Company’s ultimate obligation. In addition, significantly different assumptions could result in materially different reported amounts. A discussion of the assumptions used to calculate the liability for future policy benefits is reported in Note (1), Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements.
The Company’s Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). In addition, the Company regularly evaluates operating performance using non-GAAP financial measures which exclude or segregate derivative and realized investment gains and losses from operating revenues. Similar measures are commonly used in the insurance industry in order to assess profitability and results from ongoing operations. The Company believes that the presentation of these non-GAAP financial measures enhances the understanding of the Company’s results of operations by highlighting the results from ongoing operations and the underlying profitability factors of the Company’s business. The Company excludes or segregates derivative and realized investment gains and losses because such items are often the result of events which may or may not be at the Company’s discretion and the fluctuating effects of these items could distort trends in the underlying profitability of the Company’s business. Therefore, in the following sections discussing consolidated operations and segment operations, appropriate reconciliations have been included to report information management considers useful in enhancing an understanding of the Company’s operations to reportable GAAP balances reflected in the Consolidated Financial Statements.
Cost of insurance charges were $102.0 million in 2019 compared to $105.9 million in 2018 and $107.5 million in 2017. 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 2019 decreased to $14.4 billion from $15.6 billion at year-end 2018 and $16.5 billion at year-end 2017. Administrative charges were $24.1 million, $23.7 million, and $27.4 million for the years ended December 31, 2019, 2018 and 2017, 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 $33.1 million in 2019 compared to $37.1 million in 2018 and $42.1 million in 2017. 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. While policy lapse rates in 2019 for the domestic life insurance and annuities segments were somewhat lower than those experienced in 2018, the international life segment exhibited a higher lapse rate. 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 in 2019 include the activity of Ozark National subsequent to their acquisition on January 31, 2019. Ozark National's principal product is a non-participating whole life insurance policy with premiums remitted primarily on a monthly basis. The product is sold in tandem with a mutual fund investment product offered through its broker-dealer affiliate, NIS. 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 National Western's traditional life business resided in the International Life insurance segment which ceased accepting new applications in the second quarter of 2018. However, National Western’s overall life insurance sales focus has historically been primarily centered around universal life products. The addition of Ozark National's business of repetitive paying permanent life insurance adds an important complement to National Western's life insurance sales. Included in the amount for the year ended December 31, 2019 is $69.0 million of life insurance renewal premium from Ozark National. Universal life products, especially National Western’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, have been more popular product offerings in the Company’s markets.
The Company's investable funds are derived from incremental cash flow from new business and investment income from its portfolio above its operational requirements to pay policy benefits, commissions, and expenses. The debt securities portfolio declined from $10.3 billion at December 31, 2017 to $10.2 billion at December 31, 2018, but increased to $10.5 billion at December 31, 2019 reflecting the addition of Ozark National's $722.9 million debt security portfolio. Investment yields on new bond purchases in 2018 exceeded the portfolio's weighted average yield for the first time since 2009. The portfolio weighted average yield was approximately 3.78% at December 31, 2019, while the yield on debt security purchases to fund insurance operations was 4.06% in 2019 and 4.20% in 2018. Ozark National's weighted average portfolio yield at December 31, 2019 was 3.59%. Although the yield on new purchases in 2018 and 2019 exceeded the portfolio weighted average yield, bond portfolio returns continued to be impacted by higher yielding debt securities maturing or being called by borrowers with the proceeds being reinvested into lower yielding securities.
NIS revenues of $8.2 million pertain to operations for the months of February through December of 2019. Revenues associated with BP III were $3.9 million, $3.2 million and $1.5 million in December 31, 2019, 2018 and 2017, respectively, reflecting additional tenant leases subsequently executed. Other revenues also includes the annual revaluation of the fair value of the life interest in the Libbie Shearn Moody Trust.
Derivative gain (loss) - Index options are derivative financial instruments used to hedge the equity return component of the National Western’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. As the options hedging the notional amount of policyholder contract obligations are purchased as close as possible to like amounts, the amount of the options returns tend to correlate closely with indexed interest credited.
Gains and losses from index options are substantially due to changes in equity market conditions. Index options are intended to act as hedges to match the returns on the product’s underlying reference index and the rise or decline in the index relative to the index level at the time of the option purchase which causes option values to likewise rise or decline. As income from index options fluctuates with the underlying index, the contract interest expense to policyholder accounts for the Company’s fixed-index products also fluctuates in a similar manner and direction. During 2019 and 2017, the reference indices increased and the Company recorded each year an overall gain from index options with a corresponding increase in contract interest expense in an amount relative to the gains recorded. In 2018, the reference indices decreased and an overall loss from index options was incurred and contract interest expense similarly declined.
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, 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 no longer applicable. Equity securities represent 0.2% of invested assets and individual holdings have an average cost basis of approximately $92,000.
Life and other policy benefits - Life and other policy benefits include death claims of $65.8 million, $44.9 million and $38.6 million for 2019, 2018 and 2017, respectively. Of the amount included in the year ended December 31, 2019, $36.5 million was associated with National Western business and $29.3 million pertained to Ozark National. Death claim amounts are subject to variation from period to period. In 2019, the number of National Western life insurance claims decreased 5% from 2018 and the average dollar amount per net claim declined 7% to $48,400. National Western’s mortality experience has generally been consistent with or better than its product pricing assumptions. The average net claim for Ozark National during the 2019 period was $15,300 reflecting the average face amount of insurance inforce of $34,100 at December 31, 2019 . 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. Ozark National's retained maximum net amount at risk is capped at $200,000 under its reinsurance treaties with limited exceptions related to the conversion of child protection and guaranteed insurability riders.
The following table identifies the effects of unlocking adjustments on DPAC balances recorded through amortization expense separate from recurring amortization expense components for 2019, 2018 and 2017.
In 2018, the Company unlocked its DPAC balances associated with its Life and Annuity segments for: (1) mortality, extended death benefit reserves, and the investment yield supporting universal life policy liabilities on its Life segment which collectively increased amortization expense by $1.2 million; and (2) mortality, the election rate of the Company's withdrawal benefit rider, and the investment yield supporting annuity contract accounts which collectively decreased amortization expense by $2.2 million for the Annuity segment.
Similar to deferred policy acquisition costs, the Company defers sales inducements in the form of first year credited interest bonuses on annuity products that are directly related to the production of new business. These bonus interest charges are deferred and amortized using the same methodology and assumptions used to amortize other capitalized acquisition costs and the amortization is included in contract interest. In addition, deferred sales inducement balances ("DSI") are also reviewed periodically to ascertain whether actual experience has deviated significantly from that assumed (unlock) and are adjusted to reflect current policy lapse or termination rates, expense levels and credited rates on policies compared to anticipated experience (true-up). These adjustments, plus or minus, are included in contract interest expense. As part of the DPAC balance unlockings for the Annuity segment previously discussed for 2019, 2018, and 2017, the Company also unlocked its DSI balance. The effect of the prospective unlocking was to decrease the DSI balance by $0.6 million in 2019 and $4.3 million in 2017 (and increase contract interest expense), and to increase the DSI balance by $1.3 million in 2018 thereby decreasing contract interest expense.
In the year ended December 31, 2019, general insurance expenses include a $3.3 million broker fee paid in connection with the acquisition of Ozark National and NIS which closed during the first quarter. GAAP precludes this fee from being part of the purchase price for acquiring these businesses. Also included in 2019 are general insurance expenses of Ozark National in the amount of $4.2 million.
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 2019, 2018, and 2017 were $12.7 million, $11.3 million, and $9.0 million, respectively. General insurance expenses also include payments and provisions made relating to potential or contingent legal liabilities. Expenses related to these items were $0.0 million, $(1.8) million, and $8.5 million in 2019, 2018, and 2017, respectively. The 2018 amount reflects settlement of an annuity contract matter in Puerto Rico for $1.0 million and the release of the excess provision of $1.9 million recorded previously. 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.
Real estate expenses pertain to the commercial building operated by Braker P III. The building was acquired at year-end 2016 and National Western relocated to this facility during the fourth quarter of 2017. The increased level of operating expenses beginning in 2018 reflects National Western's occupancy as well as other third party tenants added during 2018 and 2019.
Taxes, licenses and fees include premium taxes and licensing fees paid to state insurance departments, guaranty fund assessments, the company portion of social security and Medicare taxes, real estate taxes, state income taxes, and other state and municipal taxes. State income taxes are generally determined by apportioning federal taxable income based upon premium generated from a particular state as a percentage of total premiums. Federal taxable income is derived primarily from statutory financial results. National Western state income tax expense was $3.4 million, $0.8 million, and $2.5 million in 2019, 2018, and 2017, respectively. Premium tax expenses for the years ended December 31, 2019, 2018, and 2017 were $5.5 million, $3.4 million, and $4.0 million, respectively. The 2017 taxes, licenses and fees expense also includes withholding tax liabilities for international policy distributions not previously withheld on. Ozark National taxes, licenses and fees included in 2019 amounts were $2.2 million.
A summary of segment earnings from continuing operations for the years ended December 31, 2019, 2018 and 2017 is provided below. The segment earnings exclude realized gains and losses on investments, net of taxes.
The Company’s domestic life insurance in force, in terms of policy counts, has been declining for some time. The pace of new policies issued has lagged the number of policies terminating from death or surrender causing a declining level of insurance in force from which contract revenue is received. Consequently, the number of domestic life insurance policies in force has declined from 50,200 at December 31, 2017 to 49,000 at December 31, 2018 and to 47,900 at December 31, 2019. Policy lapse rates in 2019 decreased to 6.2% from 6.5% in 2018.
During the past several years, sales have been substantially weighted toward single premium policies which do not have much in the way of recurring premium payments. These products are targeting wealth transfer strategies involving the movement of accumulated wealth in alternative investment vehicles, including annuities, into life insurance products. As a result, renewal premium levels have not been exhibiting a corresponding level of increase.
In the Consolidated Operations discussion of amortization of deferred acquisition costs it was noted that interest earned on DPAC balances serves to offset (decrease) amortization expense and that the interest rate used is the crediting rate experience during the period. The increase in the core amortization expense in 2019 relative to 2018 reflects lower interest earned on universal life DPAC balances due to the lower crediting rates resulting from declines in index option returns.
Contract interest also includes certain policy reserve balance changes which are also subject to unlocking adjustments in conjunction with DPAC. As part of the 2019 and 2018 unlockings discussed above, the Company increased its excess benefit reserve balance by $0.3 million in 2019 (increasing contract interest expense) and reduced its excess benefit reserve by $1.0 million in 2018 which served to decrease contract interest expense by a like amount.
A third component of international universal life revenues include surrender charges assessed upon surrender of contracts by policyholders. In 2015, termination activity levels increased in conjunction with the Company's decision to cease accepting applications from residents in Brazil and certain other countries resulting in additional surrender charge fee revenues. This activity continued into 2016 and 2017 but subsided in 2018. While the termination rate edged up in 2019, the resulting additional surrender charge fee revenue was less due to lower surrender charge fees assessed later in the contract term according to the policy contract provisions. The following table illustrates National Western's recent international life termination experience.
As noted previously, premiums collected on universal life products are not reflected as revenues in the Company's Consolidated Statements of Earnings in accordance with GAAP. Actual international universal life premiums collected are detailed below.
As previously noted, net investment income and contract interest include period-to-period changes in fair values pertaining to call options purchased to hedge the interest crediting feature on the fixed-index universal life products. With the growth in the fixed-index universal life block of business, the period-to-period changes in fair values of the underlying options have had an increasingly greater impact on net investment income and universal life contract interest. A detail of net investment income for international life insurance operations is provided below.
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 2019, 2018 and 2017.
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 increased DPAC balances and decreased amortization expense by $27.7 million.
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 the purchased call options are reported in net investment income for each respective period. Amounts realized on purchase call options generally approximate the amounts credited to policyholders.
Similar to the Domestic Life segment, operating expenses are allocated to lines of business based upon a functional cost analysis of the business activity giving rise to incurred expenses. As discussed in the Domestic Life segment, a greater proportion of the Company's overall operating expenses were allocated toward the Domestic Life segment and away from the International Life and Annuity segments due to decreased activity in the latter two segments. In 2017, the potential and contingent legal liability provisions discussed in the Consolidated Operations section pertained to and were allocated to the International Life segment.
Premiums and contract charges primarily consist of surrender charge income recognized on terminated policies. The amount of the surrender charge income recognized is determined by the volume of surrendered contracts as well as the duration of each contract at the time of surrender given the pattern of declining surrender charge rates over time that is common to most annuity contracts. The Company's lapse rate for annuity contracts during 2019 was 7.4%, a slight decrease from a rate of 7.5% in 2018 but significantly greater than the 6.0% rate experienced in 2017. Annuity contracts with fixed interest rates are more prone to terminate during periods of increases in secular interest rate levels and as contracts approach the end of their surrender charge period.
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. The larger unlocking adjustment in 2017 served to lessen the subsequent unlocking adjustments in 2018 and 2019.
As noted in the discussion in the Consolidated Operations section, collection of asset management fees on positive returns of expiring options are subtracted from contract interest credited to policyholders. This offset serves to lessen the increase in contract interest expense relative to the option gains reported in the Company's net investment income. Asset management fees collected during 2019, 2018, and 2017 were $15.9 million, $24.3 million, and $31.8 million, respectively.
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, 2019, 2018, and 2017 bonus interest amortization was increased/(decreased) by $0.6 million, $(1.3) million and $4.3 million, respectively, for unlocking adjustments.
Life and policy benefits for the Annuity segment include death claims and benefits associated with the Company's withdrawal benefit rider (WBR). As part of the unlockings performed in 2019 and 2018, the Company unlocked its policy benefits reserves associated with the assumption regarding policyholder utilization of the WBR provisions attached to annuity contracts. The assumptions were updated for actual utilization experience versus that which was previously assumed. The effect of this prospective unlocking was to increase policy reserves by $0.7 million (and increase policy benefits expense) in 2019 and to decrease policy reserves by $15.7 million (and decrease life and policy benefits expense) in 2018. The adjustment in 2018 was the first instance of unlocking for WBR utilization and the adjustment reflects an overly conservative utilization assumption that was previously in place.
Effective January 31, 2019, Ozark National and NIS were acquired and their results included in the Consolidated Financial Statements of the Company. Ozark National and NIS have been combined into a separate segment "Acquired Businesses" given their inter-related marketing and sales approach which consists of a coordinated sale of a non-participating whole life insurance product (Ozark National) and a mutual fund investment product (NIS). An analysis of results of operations for the Company's acquired businesses segment is detailed below.
The average face value of Ozark National's policies in force at December 31, 2019 was approximately $34,100. Consequently, life and policy benefits for smaller face amounts are subject to variation from quarter to quarter. Incurred death claims for the eleven months of operations were $29.3 million representing an average net claim of $15,300. Ozark National's maximum retention on any single insured life is $200,000 with limited exceptions related to the conversation of child protection and guaranteed insurability riders. The balance of life and policy benefits during the year ended December 31, 2019 consists of increases in insurance reserves and payments of other policy benefits.
As part of the purchase accounting required with the acquisition of Ozark National effective January 31, 2019, the Company recorded an intangible asset of $145.8 million referred to as the value of business acquired ("VOBA"). VOBA represents the difference between the acquired assets and liabilities of Ozark National measured in accordance with the Company's accounting policies and the fair value of these same assets and liabilities. The VOBA balance sheet amount is amortized following a methodology similar to that used for amortizing deferred policy acquisition costs.
Subsequent to its acquisition effective January 31, 2019, Ozark National began deferring policy acquisition costs and amortizing these deferrals similar to the methodology employed by National Western. The following table identifies the amortization expense of Ozark National's DPAC and VOBA for the eleven months subsequent to their acquisition.
The majority of the Company’s investable cash flows are directed toward the purchase of long-term debt securities. The Company’s investment policy calls for investing in debt securities that are investment grade, meet quality and yield objectives, and provide adequate liquidity for obligations to policyholders. Debt securities with intermediate maturities are targeted by the Company as they more closely match the intermediate nature of the Company’s policy liabilities and provide an appropriate strategy for managing cash flows. During 2019, the Company purchased a higher level of longer maturity debt securities to match the increased duration of its growing life insurance policy liabilities. The Company holds minimal levels of U.S. Treasury securities due to their low yields and deposits most of these holdings with various state insurance departments in order to meet security deposit on hand requirements in these jurisdictions.
In addition to diversification, an important aspect of the Company's investment approach is managing the credit quality of its investment 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 99.2% 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.
Investments in debt securities that are below investment grade are the result of subsequent downgrades of the securities. These holdings are further summarized below.
The Company's percentage of below investment grade securities compared to total invested assets at December 31, 2019 decreased compared to year-end 2018 primarily due to net upgrades of several credit issuers and disposals of securities through maturities or sales. The Company's holdings of below investment grade securities are relatively small and as a percentage of total invested assets are low compared to industry averages.
Holdings in below investment grade securities by category as of December 31, 2019 are summarized below, including their comparable fair value as of December 31, 2018 for those debt securities rated below investment grade at December 31, 2019. The Company continually monitors developments in these industries for issues that may affect security valuation.
Generally accepted accounting principles require that investments in debt securities be written down to fair value when declines in value are judged to be other-than-temporary. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price methodology). Refer to Note (4) Fair Values of Financial Instruments of the accompanying Consolidated Financial Statements for further discussion.
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, along with a competitive marketplace, resulted in fewer loan opportunities being available that met the Company's required rate of return. Mortgage loans originated by the Company totaled $121.4 million and $29.9 million for the years 2019 and 2018, respectively. The increased level of originations in 2019 reflect the Company's efforts in more actively pursuing and underwriting mortgage loan credits. Principal repayments on mortgage loans in 2019 and 2018 were $47.8 million and $35.2 million, respectively.
The Company recognized no impairment losses for the years ended December 31, 2019, 2018 and 2017, respectively. The current mortgage loan valuation allowance represents a general valuation allowance established for the Company's mortgage loan portfolio based upon the Company's loss experience over more than ten years and is not specifically identified to individual loans.
The Company had no mortgage loans past due six months or more at December 31, 2019 and 2018. There was no interest income that was not recognized in 2019, 2018 and 2017.
The Company’s design of its fixed-index products incorporates a budget for the purchase of over-the-counter call options to fund the index credits due to policyholders. Management monitors current prices of these call options and manages component features of the fixed-index products in accordance with the terms of the policy contracts in order to control the cost of purchases. These terms permit the Company to change caps, participation rates, and asset fees, subject to guaranteed minimums, thus managing the cost of the call options quoted by counterparties. In addition, the Company's product terms allow for the Company to withdraw from offering a particular index option at any time effective on the next policy anniversary date.
The fair value of derivative instruments presented in the Company’s Consolidated Financial Statements totaling $157.6 million at December 31, 2019 and $14.7 million at December 31, 2018 pertain to notional policyholder account values of $2.2 billion and $2.6 billion at December 31, 2019 and 2018, respectively, electing interest credits based upon applicable market index performance.
The Company has the ability to adjust interest rates, participation rates, and asset management fees and caps, as applicable, in response to changes in investment portfolio yields for a substantial portion of its business in force. The ability to adjust these rates is subject to competitive forces in the market for the Company’s products. Surrender rates could increase and new sales could be negatively affected if crediting rates are not competitive with the rates on competing products offered by other insurance companies and financial service entities. The Company designs its interest sensitive and annuity products with features encouraging persistency, such as surrender and withdrawal penalty provisions. Typically, surrender charge rates gradually decrease each year the contract is in force.
The Company seeks to minimize the impact of interest rate risk through surrender charges that are imposed to discourage policy surrenders and to offset unamortized deferred policy acquisition costs. Certain products, such as supplementary contracts with life contingencies, are not subject to surrender or discretionary withdrawal. The Company may also include a market value adjustment (“MVA”) feature on its annuity products which could increase or decrease the amount paid to contract holders upon surrender of their contract as a means to further mitigate interest rate risk.
The following table profiles the Company’s insurance liabilities at December 31, 2019 for annuities, deposit-type contracts and supplementary contracts with life contingencies by surrender and discretionary withdrawal characteristics.
The above described scenarios produce estimated changes in cash flows as well as cash flow reinvestment projections. Estimated cash flows in the Company's model assume cash flow reinvestments, which are representative of the Company's current investment strategy. Calls and prepayments include scheduled maturities and those expected to occur which would benefit the security issuers. Assumed policy surrenders consider differences and relationships between credited interest rates and market interest rates as well as surrender charges on individual policies. The impact to earnings also includes the expected effects on amortization of deferred policy acquisition costs. The model considers only annuity and supplemental contracts in force at December 31, 2019, and does not consider new product sales or the possible impact of interest rate changes on sales.
A primary liquidity concern for life insurers is the risk of an extraordinary level of early policyholder withdrawals, particularly with respect to annuity products which can move more rapidly with interest rate changes. The Company includes provisions within its annuity and universal life insurance policies, such as surrender and market value adjustments, that help limit and discourage early withdrawals.
The above contractual withdrawals, as well as the level of surrenders experienced, were generally consistent with the Company's assumptions in asset-liability management, and the associated cash outflows did not have an adverse impact on overall liquidity. The amount shown for traditional life in 2019 includes Ozark National cash outflows subsequent to their acquisition on January 31, 2019. Individual life insurance policies are less susceptible to withdrawal than annuity reserves and deposit liabilities because policyholders may need to undergo a new underwriting process in order to obtain a new insurance policy elsewhere. Annuity dollar outflows are generally more sensitive to economic conditions and interest rate levels. In addition, the maturation of policies within the annuity block of business (i.e. moving into durations having no surrender charges or minimal surrender charges), has been gradual as evidenced by the previous table depicting withdrawal characteristics of the in force reserves. During 2018, interest rate levels marginally increased coinciding with policy decisions of the Federal Reserve and this upward movement in rates did prompt a higher incidence of annuity dollar outflows. Cash flow projections and tests under various market interest rate scenarios and assumptions are performed to assist in evaluating liquidity needs and adequacy. The Company currently expects available liquidity sources and future cash flows to be more than adequate to meet the demand for funds.
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 for providing the ability to take advantage of potential acquisitions and other competitive situations 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, 2019, the maximum amount legally available for distribution during 2020 without further regulatory approval is $152.8 million.
It is Company practice to not enter into off-balance sheet arrangements or to issue guarantees to third parties, other than in the normal course of issuing insurance contracts. Commitments related to insurance products sold are reflected as liabilities for future policy benefits. Insurance contracts guarantee certain performances by National Western and Ozark National.
(1) Refer to Note (17) Commitments and Contingencies in the Notes to Consolidated Financial Statements relating to Company leases.
See Attachment A, Index to Consolidated Financial Statements, Notes and Schedules, in Part IV, Item 15. of this report.