Pursuant to an arrangement between NMIC and certain of its subsidiaries, during 2002 the Company leased on average approximately 902,000 square feet of office space in the three building home office complex and in other offices in Columbus, Ohio. Also, approximately 120,000 square feet and 150,000 square feet of office space is located in Berwyn, Pennsylvania and Newark, Delaware, respectively. The Company believes that its present facilities are adequate for the anticipated needs of the Company.
Management’s discussion and analysis of financial condition and results of operations (MD&A) of Nationwide Financial Services, Inc. and its subsidiaries (NFS or collectively, the Company) for the three years ended December 31, 2002 follows. This discussion should be read in conjunction with the Company’s consolidated financial statements and related notes beginning on page of this report.
Management’s discussion and analysis contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the results of operations and businesses of the Company. These forward-looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated or projected, forecast, estimated or budgeted in such forward-looking statements include, among others, the following possibilities: (i) change in Nationwide Corp.’s control of the Company through its beneficial ownership of approximately 94.4% of the combined voting power of all the outstanding common stock and approximately 63.0% of the economic interest in the Company; (ii) NFS’ primary reliance, as a holding company, on dividends from its subsidiaries to meet debt service obligations and the applicable regulatory restrictions on the ability of NFS’ subsidiaries to pay such dividends; (iii) the potential impact on the Company’s reported consolidated net income that could result from the adoption of certain accounting standards issued by the Financial Accounting Standards Board (FASB) or other standard-setting bodies; (iv) tax law changes impacting the tax treatment of life insurance and investment products; (v) repeal of the federal estate tax; (vi) heightened competition, including specifically the intensification of price competition, the entry of new competitors and the development of new products by new and existing competitors; (vii) adverse state and federal legislation and regulation, including limitations on premium levels, increases in minimum capital and reserves, and other financial viability requirements; (viii) failure to expand distribution channels in order to obtain new customers or failure to retain existing customers; (ix) inability to carry out marketing and sales plans, including, among others, development of new products and/or changes to certain existing products and acceptance of the new and/or revised products in the market; (x) changes in interest rates and the stock markets causing a reduction of investment income and/or asset fees, an acceleration of the amortization of deferred policy acquisition costs (DAC), reduction in the value of the Company’s investment portfolio or separate account assets, or a reduction in the demand for the Company’s products; (xi) general economic and business conditions which are less favorable than expected; (xii) competitive, regulatory or tax changes that affect the cost of, or demand for the Company’s products; (xiii) unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations; (xiv) deviations from assumptions regarding future persistency, mortality,
Interest spreads should be in a range 160 to 165 basis points in the individual annuity segment and 170 to 175 basis points in the institutional products segment.
For the full year 2003, should the equity markets and the related performance of our separate account assets achieve a return of 0 to 2 percent per quarter for the full year and interest spreads perform as noted above, net operating income per diluted share should be within a range of $2.75 to $2.95.
Toward the end of each quarter, the Company has a “quiet period” when it no longer publishes or updates its current outlook and Company representatives will not comment concerning the Company’s financial results or expectations. The quiet period will extend until the day when the Company’s next earnings release is published. Prior to the start of the next quiet period, April 7, 2003, investors can continue to rely on the earnings release and Web site as still being the Company’s current expectations on matters covered, unless the Company publishes a notice stating otherwise.
financial statements issued in accordance with accounting principles generally accepted in the United States of America (GAAP), it is included herein as this tentative guidance is related solely to the Company’s industry and could change the accounting for such arrangements in the future.
DEFERRED POLICY ACQUISITION COSTS FOR INVESTMENT PRODUCTS AND UNIVERSAL LIFE INSURANCE PRODUCTS
VOBA reflects the estimated fair value of the business in-force and represents the portion of the purchase price that is allocated to the value of the right to receive future cash flows from the life insurance and annuity contracts existing as of the closing date of the Nationwide Provident acquisition. The value assigned to VOBA is supported by an independent valuation study that was commissioned by the Company and executed by a team of qualified valuation experts, including actuarial consultants. The expected future cash flows used in determining such value were based on actuarially determined projections, by each major line of business, of future policy and contract charges, premiums, mortality and morbidity, separate
account performance, surrenders, changes in reserves, operating expenses, investment income and other factors. These projections took into account all known or expected factors at the valuation date, based on the judgment of management. The actual experience on purchased business may vary from projections due to differences in renewal premiums, investment spreads, investment gains or losses, mortality and morbidity costs, or other factors.
Interest received on non-accrual status mortgage loans on real estate is included in net investment income in the period received.
Significant changes in the factors the Company considers in determining the valuation allowance on mortgage loans on real estate could result in a significant change in the provision for valuation allowance reported in the consolidated financial statements.
Total operating revenues, which exclude net realized gains and losses on investments not related to securitizations, hedging instruments and hedged items increased $290.6 million, or 9%, to $3.38 billion in 2002 compared to $3.09 billion in 2001. Operating revenue growth was fueled by the completion of the Nationwide Provident acquisition, which added $158.2 million of operating revenues in the fourth quarter of 2002. In addition to Nationwide Provident, the growth in operating revenues in 2002 was primarily driven by an increase in net investment income as a result of continued growth in interest spread-based businesses, which offset lower policy charges due to depressed equity markets. Operating revenues in 2001 were up 0.3% from $3.08 billion reported in 2000, with growth in net investment income offsetting lower policy charges.
The declines in asset fees reflect decreases in total average separate account assets of $6.11 billion (10%) and $9.08 billion (13%) in 2002 and 2001, respectively. The decrease in average separate account values over the past two years was fueled by market depreciation on investment options underlying variable annuity and investment life insurance products as a result of the sharp declines in the equity markets.
Cost of insurance charges are assessed on the net amount at risk on universal life insurance policies. The net amount at risk is equal to a policy’s death benefit minus the related policyholder account value. The amount charged is based on the insured’s age and other underwriting factors. The increase in cost of insurance charges is due primarily to growth in the net amount at risk related to corporate and individual investment life insurance reflecting the addition of Nationwide Provident, new sales, favorable persistency on policies sold in prior periods, and equity market declines which lowered policyholder account values. The net amount at risk related to corporate and individual investment life insurance grew to $57.65 billion, including $21.50 billion for Nationwide Provident, at the end of 2002 compared to $32.93 billion and $28.28 billion at the end of 2001 and 2000, respectively.
Realized gains and losses on investments not related to securitizations, hedging instruments and hedged items are not considered by the Company to be recurring components of earnings. The Company makes decisions concerning the sale of invested assets based on a variety of market, business, tax and other factors. In addition, charges related to other-than-temporary impairments of available-for-sale
securities and other investments and valuation allowances on mortgage loans on real estate are included in this caption. Also included are changes in the fair value of derivatives qualifying as fair value hedges and the change in the fair value of the hedged items, the ineffective portion of cash flow hedges and changes in the fair value of free-standing derivatives, all of which are considered non-recurring components of earnings.
Losses from other-than-temporary impairments were $124.2 million in 2002, compared to $80.7 million in 2001 and $15.4 million in 2000. Included in the 2002 losses were $22.5 million related to WorldCom, Inc., and 2001 losses included $25.9 million related to fixed maturity securities issued by Enron and affiliated entities. Non-impairment related net realized gains on investments, hedging instruments and hedged items totaled $35.9 million in 2002 compared to $67.6 million of net gains in 2001 and net losses of $9.5 million in 2000, including gains of $23.2 million and $44.4 million in 2002 and 2001, respectively, related to the two-step sale of a real estate limited partnership to related parties, as described in note 19 to the consolidated financial statements included in the F pages of this report.
Other benefits and claims include policyholder benefits in excess of policyholder account balances for universal life and individual deferred annuities and net claims and provisions for future policy benefits for traditional life insurance products and immediate annuities. An increase in other benefits and claims in 2002 compared to a year ago reflects higher levels of GMDB claims from individual variable annuity products and additional life insurance benefits reflecting the addition of Nationwide Provident and growth in life insurance in-force. The growth in 2001 reflects additional life insurance claims primarily as a result of growth in life insurance in-force.
Policyholder dividends on participating policies reflect an increase in 2002 due to the addition of Nationwide Provident, which historically sold a significant amount of participating life insurance.
The substantial increase in DAC amortization in 2002 compared to a year ago reflects an acceleration of DAC amortization recorded in the third quarter of 2002. As part of the regular quarterly analysis of DAC, at the end of the third quarter of 2002, the Company determined that using actual experience to date and assumptions consistent with those used in the second quarter of 2002, its individual variable annuity DAC balance would be outside a pre-set parameter of acceptable results. The Company also determined that it was not reasonably possible that the DAC would return to an amount within the acceptable parameter within a prescribed period of time. Accordingly, the Company unlocked its DAC assumptions for individual variable annuities and reduced the DAC asset to the amount calculated using the revised assumptions. Because the Company unlocked the net separate account growth rate assumption for individual variable
annuities for the three-year reversion period, the Company unlocked that assumption for all investment products and variable universal life insurance products to be consistent across product lines.
Therefore, the Company recorded an acceleration of DAC amortization totaling $347.1 million, before tax, or $225.6 million, net of $121.5 million of tax benefit, which has been reported in the following segments in the amounts indicated, net of tax: Individual Annuity-$213.4 million, Institutional Products-$7.8 million and Life Insurance-$4.4 million. The acceleration of DAC amortization was the result of unlocking certain assumptions underlying the calculation of DAC for investment products and variable universal life insurance products. The most significant assumption changes were the resetting of the Company’s anchor date for reversion to the mean calculations to September 30, 2002, resetting the assumption for net separate account growth to 8 percent during the three-year reversion period for all investment products and variable life insurance products and increasing future lapses and costs related to GMDB on individual variable annuity contracts. These adjustments were primarily driven by the sustained downturn in the equity markets.
Federal income tax benefit was $7.3 million representing an effective tax rate of (5.5)% for 2002. Federal income tax expense in 2001 and 2000 was $143.9 million and $187.3 million, respectively, representing effective rates of 25.3% and 30.1%. The tax benefit of $121.5 million associated with the $347.1 million of accelerated DAC amortization in third quarter of 2002 was calculated at the U.S. federal corporate income tax rate of 35%. Excluding the accelerated DAC amortization and related tax benefit, the effective tax rate for 2002 was 23.8%, which is lower than 2001 due to an increase in tax credits from affordable housing partnership investments and the elimination of non-deductible goodwill amortization expense in 2002, partially offset by lower tax-exempt income. An increase in tax-exempt income and tax credits, including credits from affordable housing partnership investments, resulted in the decrease in 2001.
The Company analyzes operating performance using non-GAAP financial measures called pre-tax operating income and net operating income. The Company calculates pre-tax operating income by adjusting income from continuing operations before federal income taxes and cumulative effect of adoption of accounting principles to exclude net realized gains and losses on investments not related to securitizations, hedging instruments and hedged items. The Company calculates net operating income by adjusting net income to exclude net realized gains and losses on investments not related to securitizations, hedging instruments and hedged items, discontinued operations and cumulative effect of adoption of accounting principles, all net of tax. Pre-tax operating income, net operating income or similar measures are commonly used in the insurance industry as a measure of ongoing earnings performance.
Sales should not be viewed as a substitute for revenues determined in accordance with GAAP, and the Company’s definition of sales might differ from that used by other companies. Sales generate customer funds managed and administered, which ultimately drive revenues. Sales are primarily comprised of statutory premiums and deposits on individual and group annuities and life insurance products sold to a diverse customer base. Statutory premiums and deposits are calculated in accordance with accounting practices prescribed or permitted by regulatory authorities and then adjusted to arrive at sales. Sales also include deposits on administration-only group pension plans. Revenues are generated from both current and previous sales that are in-force during part of the reporting period and are reported as policy charges, life insurance premiums, net investment income and other revenues. Because revenues are generated primarily based on charges against the in-force or surrendering contracts based on a fraction of the value of the contract and sales relate primarily to the amount of premiums and deposits received in a period, the Company does not believe a reconciliation of these amounts would be meaningful.
The Company’s flagship products are marketed under The BEST of AMERICA® brand, and include individual variable and group annuities, group Private Sector pension plans sold through Nationwide Trust Company, FSB and variable life insurance. The BEST of AMERICA products allow customers to choose from investment options managed by premier mutual fund managers. 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 name.
Sales through financial institutions grew 17% in 2002, driven mainly by increased fixed annuity and pension sales, partially offset by lower production of variable annuities. Sales in 2001 grew 16% due primarily to the appointment of new distributors in the bank channel who sell fixed annuity products and a shift in customer preference in 2001 to fixed annuity products in light of the declining and volatile equity markets.
Sales through pension plan administrators dropped 27% and 3% in 2002 and 2001, respectively. As the Company’s Private Sector pension business model continues to evolve, direct production through this channel is not expected to grow, as more new business opportunities are being created in conjunction or partnership with the independent broker/dealers, wirehouse and regional firms and financial institutions relationships.
Asset fees were $378.6 million in 2002 down 10% from $421.9 million in 2001 and totaled $479.3 million in 2000. Asset fees are calculated daily and charged as a percentage of separate account values. The fluctuations in asset fees are primarily due to changes in the market value of the investment options underlying the account values, which have followed the general trends of the equity markets. Average separate account values decreased 10% in 2002 to $30.09 billion following a 12% decrease in 2001.
Surrender fees increased by $5.3 million to $61.2 million in 2002 compared to $55.9 million in 2001 and $75.4 million in 2000, primarily due to the competitive market place and sustained downturn in the equity markets. Lower surrender fees in 2001 were the result of the successful implementation of customer retention programs in the individual variable annuity business during the year. These programs were created as the heightened competitive environment in 2000 led to increased surrender activity and related fees.
The following table depicts the interest spread on average general account values in the Individual Annuity segment for each of the last three years.
Interest spreads on average general account values increased 4 basis points in 2002 compared to a year ago. The improvement was due to the Company’s ability to lower renewal crediting rates more quickly than investment portfolio rates have declined as a result of lower market interest rates. However, a one-year enhanced crediting rate special offered in the fourth quarter of 2002 coupled with new crediting rates at or near contractual minimum rates and a jump in prepayments of higher yielding investments will put pressure on interest spread on average general account values in 2003. A combination of a competitive environment, a sharp decline in interest rates and a by-product of the Company’s investment strategy contributed to the reduction in interest spreads in 2001 compared to 2000. As a strategic move to maintain market share, the Company did not lower crediting rates in the third quarter of 2001 as quickly as earned rates declined. In addition, throughout 2001, the Company had a significant increase in cash flows in the general account due to strong fixed annuity sales. As a result, at certain times throughout the year, cash positions were greater than targeted as the Company acquired appropriate long-term investments, putting pressure on spreads, especially given a declining interest rate environment. Declining interest rates in 2002 and 2001 resulted in a significant increase in mortgage loan and bond prepayment income, which added 7 and 8 basis points to the 2002 and 2001 interest spread, respectively, compared to 4 basis points in 2000.
Excluding the $328.3 million of accelerated DAC amortization in 2002, amortization of DAC and VOBA decreased 6% in 2002 following an 8% decrease in 2001, reflecting lower earnings in each year.
Operating expenses were $188.0 million in 2002, an increase of 32% over 2001. The increase reflects growth in the number of contracts in-force, an increase in employee benefit costs and projects focused on improving producer and customer support.
Account values ended 2002 at $40.90 billion, down $1.29 billion from the end of 2001 of $42.19 billion, which was down $1.51 billion from the end of 2000. The acquisition of Nationwide Provident added $1.58 billion of account values in 2002. Net flows, which consists of deposits less withdrawals, of $2.24 billion and $3.38 billion in 2002 and 2001, respectively, were offset by market depreciation of variable annuities of $4.85 billion and $4.52 billion in 2002 and 2001, respectively. The decrease in net flows is attributable to the decline in sales combined with an increase in variable annuity surrenders due to continued losses in the equity markets. Individual annuity sales, which exclude internal replacements, during 2002 were $7.33 billion, down 4% from $7.63 billion a year ago. The decline in sales is driven by sustained weakness in the equity markets, which had a negative impact on variable annuity demand. Variable annuity sales were $4.62 billion in 2002, down 17% compared to 2001. Sales of variable annuities were down 16% in 2001 compared to 2000. According to the Variable Annuity Research & Data Service (VARDS), the Company was ranked 8th in total variable annuity sales in 2002. Partially offsetting a decline in variable annuity sales was the strong appeal of fixed products to consumers, as fixed annuities sales reached a record $2.71 billion in 2002, a 33% increase from the $2.03 billion reported in 2001. Fixed annuity sales were up 207% in 2001 from 2000. The decline in the equity markets has fueled interest in fixed annuity sales across the industry. In addition, the Company has expanded the number of banks that sell the Company’s fixed products.
The Institutional Products segment is comprised of the Company’s Private and Public Sector group retirement plans, medium-term note program and structured products initiatives. The Private Sector includes the 401(k) business generated through fixed and variable annuities, Nationwide Trust Company, FSB and The 401(k) Company. The Public Sector includes the IRC Section 457 business in the form of fixed and variable annuities as well as administration-only business.
competitive environment in the public sector market and a shift in product mix to more administration-only cases have resulted in reduced revenues and earnings.
Asset fees declined 14% to $151.5 million in 2002 compared to $176.8 million in 2001 and totaled $220.2 million in 2000. The declines were driven by a 16% decrease in average separate account assets in 2002 following a decrease of 17% in 2001 as a result of sustained downturns in the equity markets and a shift in product mix from annuities to administration-only products. The 2001 decline in other policy charges was a result of additional administration fees in 2000 from case terminations.
Despite growth in average general account values in 2002, net investment income has decreased compared to 2001, reflecting lower market interest rates in 2002 and the floating rate nature of many of the investments in this segment.
The following table depicts the interest spread on average general account values in the Institutional Products segment for each of the last three years.
Excluding the $12.0 million of accelerated DAC amortization in 2002, amortization of DAC and VOBA decreased 13% in 2002, following a 3% decrease in 2001, reflecting lower revenue and earnings from group annuity contracts.
The decreases in pre-tax operating income to average account values, which reached 0.40% in 2002, compared to 0.42% in 2001 and 0.46% in 2000, are primarily driven by changes in the mix of products including growth in administration-only products which generally provide less revenue and earnings than group annuity contracts and lower revenues and earnings from existing public sector pension contracts due to the intensively competitive environment in the public sector market. The decrease also reflects more Private Sector pension business in the form of Nationwide Trust Company, FSB, products, which results in selling and other acquisition costs being recognized more quickly than with annuity products.
partially offset by an increase in operating expenses and lower earnings from the Company’s COLI business as a result of a slowdown in the COLI and deferred compensation markets due to the economic downturn, depressed equity markets and proposed legislation which would adversely impact the tax advantages of COLI. The 18% increase in 2001 compared to 2000 reflects increased revenues driven by growth in new sales and high persistency of both individual and corporate investment life insurance products.
Net investment income increased in both 2002 and 2001 reflecting the addition of Nationwide Provident in 2002 and growth from general account corporate-owned life insurance in 2001.
Benefits increased 22% to $527.2 million in 2002 following an 11% increase in 2001. The growth reflects the growth in insurance in-force and higher mortality experience and the addition of Nationwide Provident in 2002. In 2001, favorable mortality experience allowed the Company to renegotiate and lower certain reinsurance premiums.
Amortization of DAC and VOBA increased $24.6 million in 2002 following a $16.1 million increase in 2001. The increase in 2002 reflects the addition of Nationwide Provident and the $6.8 million of accelerated DAC amortization. The increase in 2001 reflects growth in investment life insurance earnings.
Operating expenses were $185.4 million in 2002, up 39% from 2001, primarily due to the addition of TBG Financial and Nationwide Provident, effective May 31 and October 1, respectively. Excluding these entities, operating expenses increased 6% in 2002, following a 2% decrease in 2001 compared to 2000. The increase in 2002 is attributable to growth in insurance in-force and higher employee benefit costs. Operating expenses for 2002 and 2001 also reflect the operational efficiencies and scale advantage being developed in the investment life operation. Technology and process improvement investments intended to streamline and improve the underwriting and policy-issue process made in 2000 drove these efficiencies.
Total life insurance sales in 2002 of $1.54 billion, which included $123.0 million related to Nationwide Provident, were flat compared to a year ago. Growth attributable to Nationwide Provident was substantially offset as individual variable life sales continue to be adversely impacted by the sluggish equity markets, concern over the potential for adverse tax legislation and consumer preference for fixed products. According to the December 31, 2002 Tillinghast-Towers Perrin Value Variable Life Survey, the Company was ranked 3rd in total variable life sales in 2002 (including Nationwide Provident sales for the full year of 2002), up from 6th in 2001 and 7th in 2000. Our efforts to expand sales to new channels are showing signs of success, with sales through the wirehouse and regional firms and financial institutions up 37% and 30%, respectively, from 2001. COLI sales were negatively impacted throughout 2002 by the sluggish economy, depressed equity markets, unfavorable press regarding COLI and executive deferred compensation plans, and proposed legislation which would adversely impact the tax benefits of COLI. First year premiums for fixed life were up from a year ago due to increased universal life and term life sales. Total life insurance sales of $1.54 billion in 2001 were essentially flat compared to $1.53 billion in 2000. Individual variable universal life sales were adversely impacted by the phase out of the estate tax, uncertainty surrounding the taxation of split dollar plans and the volatile stock market. Sales of new COLI cases in 2001 were down
given the depressed economic conditions where corporations are not forming new executive benefit plans and existing plans are being funded at lower levels.
Return on average allocated capital decreased to 10.3% in 2002 compared to 11.6% and 12.1% in 2001 and 2000, respectively. The decline in 2002 reflects losses at TBG Financial subsequent to its consolidation beginning May 31, 2002 and slightly lower returns on the Nationwide Provident business since its acquisition on October 1, 2002.
The additional interest expense in 2002 and 2001 reflects the senior note offerings mentioned above, offset by lower utilization of commercial paper borrowings.
In addition to these operating revenues and expenses, the Company also reports net realized gains and losses on investments not related to securitizations, hedging instruments and hedged items in the Corporate segment. Losses from other-than-temporary impairments were $124.2 million in 2002, compared to $80.7 million in 2001 and $15.4 million in 2000. Included in the 2002 losses were $22.5 million related to WorldCom, Inc., and 2001 losses included $25.9 million related to fixed maturity securities issued by Enron and affiliated entities. Non-impairment related net realized gains on investments, hedging instruments and hedged items totaled $35.9 million in 2002 compared to $67.6 million of net gains in 2001 and net losses of $9.5 million in 2000, including gains of $23.2 million and $44.4 million in 2002 and 2001, respectively, related to the two-step sale of a real estate partnership to related parties, as described in note 19 to the consolidated financial statements included in the F pages of this report.
During 2001, the Company entered into a transaction with NMIC, whereby it sold 78% of its interest in a limited partnership (representing 49% of the limited partnership) to NMIC for $158.9 million. As a result of this sale, the Company recorded a realized gain of $44.4 million and related tax expense of $15.5 million. During 2002, the Company entered into transactions with NMIC and Nationwide Indemnity Company (NIC), whereby it sold 100% of its remaining interest in the limited partnership (representing 15.11% of the limited partnership) to NMIC and NIC for a total of $54.5 million. As a result of this sale, the
In June 2002, NFS exchanged all of its shares of common stock of GGI and NSI for approximately 9.1 million shares of NFS Class B common stock held by Nationwide Corp. NFS’ interests in GGI and NSI were valued at approximately $362.8 million in these transactions. A special committee of independent directors of the NFS Board of Directors reviewed and recommended approval of the transaction by the full board of directors, which was obtained. As required by NFS’ Restated Certificate of Incorporation, the shares Nationwide Corp. exchanged were automatically converted from Class B common stock to Class A common stock upon return to NFS. NFS has retained these Class A shares in treasury for future issuance. The GGI and NSI transactions were between related parties and have therefore been recorded at carrying value of the underlying components of the transactions rather than fair value. As a result of these transactions, NFS recorded the NFS Class A shares received as treasury stock at Nationwide Corp.’s carrying value of these shares. NFS recorded the excess of Nationwide Corp.’s carrying value of NFS shares exchanged over the carrying value of GGI and NSI, net of transaction costs, $110.4 million, as a credit to additional paid-in-capital upon closing. These transactions are intended to qualify as tax-free exchanges. The results of the operations of GGI and NSI are reflected as discontinued operations for all periods presented.
GGI’s funds are offered as investment options in certain of the Company’s products. As of December 31, 2002, total GGI funds in the Company’s products were $12.21 billion. For the year ended December 31, 2002, GGI paid the Company $38.8 million for the distribution and servicing of these funds. In addition, effective June 28, 2002, the Company entered into a renewable three-year Marketing and Support Services Agreement with GGI. Under this agreement, beginning in third quarter 2002, the Company receives quarterly fees of $1.0 million in exchange for certain specified marketing and support of GGI product offerings.
On February 5, 2002, NFS purchased from existing shareholders the remaining 10% of shares of The 401(k) Companies, Inc. not owned by NFS for $3.9 million. The shareholders primarily consisted of management and employees of The 401(k) Companies, Inc. This transaction generated $2.9 million of goodwill in the Institutional Products segment.
In connection with the Nationwide Provident acquisition described in note 3 to the consolidated financial statements included in the F pages of this report, the Company has entered into an agreement to sell the value ascribed to the Market Street Fund to GGI at fair value. This transaction is expected to close in second quarter 2003. The Company has also entered into an agreement with GGI for GGI to serve as interim investment advisor to Market Street Fund until the sale. Net fees paid to GGI as interim investment advisor in 2002 were $0.2 million.
Through September 30, 2002, the Company filed a consolidated federal income tax return with NMIC, as described in note 2(k) to the financial statements included in the F pages of this report. Total payments to (from) NMIC were $47.3 million, $(48.7) million and $64.5 million for the years ended December 31, 2002, 2001 and 2000, respectively.
Pursuant to a cost sharing agreement among NMIC and certain of its direct and indirect subsidiaries, including the Company, NMIC provides certain operational and administrative services, such as investment management, advertising, personnel and general management services, to those subsidiaries. Expenses covered by such agreement are subject to allocation among NMIC and such subsidiaries. Measures used to allocate expenses among companies include individual employee estimates of time spent, special cost studies, salary expense, commission expense and other methods agreed to by the participating companies that are within industry guidelines and practices. In addition, Nationwide Services Company, LLC, a subsidiary of NMIC, provides computer, telephone, mail, employee benefits administration, and other services to NMIC and certain of its direct and indirect subsidiaries, including the Company, based on specified rates for units of service consumed. For the years ended December 31, 2002, 2001 and 2000, the Company made payments to NMIC and Nationwide Services Company totaling $146.1 million, $145.6 million and $156.6 million, respectively. The Company does not believe that expenses recognized under these agreements are materially different than expenses that would have been recognized had the Company operated on a stand-alone basis.
Under a marketing agreement with NMIC, NLIC makes payments to cover a portion of the agent marketing allowance that is paid to Nationwide agents. These costs cover product development and
promotion, sales literature, rent and similar items. Payments under this agreement totaled $24.9 million, $26.4 million and $31.4 million for the years ended December 31, 2002, 2001 and 2000, respectively.
The Company also participates in intercompany repurchase agreements with affiliates whereby the seller will transfer securities to the buyer at a stated value. Upon demand or after a stated period, the seller will repurchase the securities at the original sales price plus interest. As of December 31, 2002 and 2001, the Company had no borrowings from affiliated entities under such agreements. During 2002 and 2001, the most the Company had outstanding at any given time was $224.9 million and $368.5 million, respectively, and the Company incurred interest expense on intercompany repurchase agreements of $0.3 million and $0.2 million for 2002 and 2001, respectively. Transactions under the agreements during 2000 were not material. The Company believes that the terms of the repurchase agreements are materially consistent with what the Company could have obtained with unaffiliated parties.
date. The $300.0 million principal of 5.90% senior notes, due July 1, 2012, were issued in June 2002 and are redeemable in whole or in part, at the option of NFS, at any time or from time to time at a redemption price equal to the greater of: (i) 100% of the aggregate principal amount of the notes to be redeemed; or (ii) the sum of the present value of the remaining scheduled payments of principal and interest on the notes, discounted to the redemption date on a semi-annual basis at the treasury rate plus 20 basis points, together in each case with accrued interest payments to the redemption date. The Company made interest payments of $42.5 million in 2002 and $24.0 million in 2001 and 2000 on the senior notes.
The capital and preferred securities of subsidiary trusts include $100.0 million of capital securities that are due March 1, 2037 and pay a distribution rate of 7.899% and $200.0 million of preferred securities of subsidiary trusts that are due October 31, 2028 and pay a distribution rate of 7.10%. The 7.899% capital securities 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 7.10% preferred securities are redeemable, in whole or in part, on or after October 19, 2003 at a redemption price equal to the principal amount to be redeemed plus any accrued and unpaid interest. There are no sinking fund requirements related to the capital and preferred securities of subsidiary trusts.
On February 13, 2003, the Company sold $200 million par value of 5.625% senior notes, due February 13, 2015. These senior notes are redeemable in whole or in part, at the option of NFS, at any time or from time to time at a redemption price equal to the greater of: (i) 100% of the aggregate principal amount of the notes to be redeemed; or (ii) the sum of the present value of the remaining scheduled payments of principal and interest on the notes, discounted to the redemption date on a semi-annual basis at the treasury rate plus 20 basis points, together in each case with accrued interest payments to the redemption date.
The ability of NLICA to pay dividends to NFS is subject to regulation under Pennsylvania insurance law. Under Pennsylvania insurance law, unless the Pennsylvania Insurance Department either approves or fails
to disapprove payment within 30 days after being notified, NLICA may not pay any cash dividends or other non-stock distributions to NFS during any 12 month period if the total payments would exceed the same criteria as outlined two paragraphs above as it relates to NLIC’s limitations. Also, in connection with the acquisition of Nationwide Provident, the Pennsylvania Insurance Department ordered that no dividends could be paid out of NLICA for a period of three years without prior approval. The statutory capital and surplus of NLICA as of December 31, 2002 was $393.7 million, while statutory net loss for the year ended December 31, 2002 was $107.2 million.
In addition, one of the Company’s subsidiaries has available a $10 million revolving line of credit. The line is comprised of a 364-day $10 million agreement, which was entered into with a single financial institution. The line of credit is guaranteed by NFS. The Company had borrowed $2.7 million under this agreement as of December 31, 2002.
A primary liquidity concern with respect to annuity and life insurance products is the risk of early policyholder withdrawal. The Company mitigates this risk by offering variable products where the investment risk is transferred to the policyholder, charging surrender fees at the time of withdrawal for certain products, applying a market value adjustment to withdrawals for certain products in the Company’s general account, and monitoring and matching anticipated cash inflows and outflows.
Under the medium-term note program, NLIC issues funding agreements, which are insurance obligations, to an unrelated third-party trust to secure notes issued to investors by the trust. The funding agreements are recorded as a component of future policy benefits and claims on the Company’s consolidated balance sheets. Because the Company has no ownership interest in, or control over, the third-party trust that issues the notes, the Company does not include the trust in its consolidated financial statements and therefore, such notes are not reflected in the consolidated financial statements of the Company. As the notes issued by the trust have a secured interest in the funding agreement issued by the Company, Moody’s Investors Service, Inc. and Standard & Poor’s, a Division of The McGraw-Hill Companies, Inc., assign the same ratings to the notes as the insurance financial strength ratings of NLIC.
The Company’s assets are divided between separate account and general account assets. As of December 31, 2002, $50.35 billion (53%) of the Company’s total assets were held in separate accounts and $45.21 billion (47%) were held in the Company’s general account, including $39.13 billion of general account investments.
The following table summarizes the composition of the Company’s general account fixed maturity securities by category as of each December 31.
The Company believes that general account MBS investments add diversification, liquidity, credit quality and additional yield to its general account fixed maturity securities portfolio. The objective of the Company’s general account MBS investments is to provide reasonable cash flow stability and increased
yield. General account MBS investments include collateralized mortgage obligations (CMOs), Real Estate Mortgage Investment Conduits (REMICs) and mortgage-backed pass-through securities. The Company’s general account MBS investments do not include interest-only securities or principal-only securities or other MBSs, which may exhibit extreme market volatility.
The Company’s general account asset-backed security (ABS) investments include home equity/improvement ABSs and equipment lease ABSs, among others. As of December 31, 2002, ABSs were $3.89 billion (14%) of the carrying value of the general account fixed maturity securities available-for-sale.
The Company believes that general account ABS investments add diversification, liquidity, credit quality and additional yield to its general account fixed maturity securities portfolio. The objective of the Company’s general account ABS investments is to provide reasonable cash flow stability and increased yield. The Company’s general account ABS investments do not include interest-only securities or principal-only securities or other ABSs, which may exhibit extreme market volatility.