Pursuant to an arrangement between NMIC and certain of its subsidiaries, during 2000 the Company leased on average approximately 734,000 square feet of office space primarily in the four building home office complex in Columbus, Ohio. The Company believes that its present facilities are adequate for the anticipated needs of the Company.
Management's narrative analysis of the results of operations of NLIC and subsidiaries for the three years ended December 31, 2000 follows. This discussion should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this report.
In addition to net income, the Company reports net operating income, which excludes net realized investment gains and losses. Net operating income is commonly used in the insurance industry as a measure of on-going earnings performance.
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 individual investment life insurance reflecting expanded distribution and increased acceptance by producers and consumers. The net amount at risk related to individual investment life insurance grew to $24.69 billion at the end of 2000 compared to $19.76 billion and $14.95 billion at the end of 1999 and 1998, respectively.
The growth in administrative fees is attributable to a significant increase in premiums on individual investment life policies and certain corporate-owned life policies where the company collects a premium load. The substantial majority of the increase in surrender charges over the past two years is attributable to policyholder withdrawals in the Individual Annuity segment, and is driven by an overall increase in individual variable annuity policy reserves and a heightened competitive environment in the individual annuity marketplace.
Net investment income includes the investment income earned on investments supporting fixed annuities and certain life insurance products as well as the yield on the Company's general account invested assets which are not allocated to product segments, net of related investment expenses. General account assets supporting insurance products are closely correlated to the underlying reserves on these products. Net investment income grew from $1.48 billion and $1.52 billion in 1998 and 1999, respectively, to $1.65 billion in 2000 primarily due to increased invested assets to support growth in individual fixed annuity, institutional products and life insurance policy reserves. General account reserves supporting these products grew by $322.0 million and $2.09 billion in 2000 and 1999, respectively, and were $22.18 billion at December 31, 2000. The change in net investment income was also impacted by average yields on investments, which increased by 24 basis points in 2000 and declined by 24 basis points in 1999 following market interest rate trends.
Realized gains and losses on investments 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.
Interest credited to policyholder account balances totaled $1.18 billion in 2000 compared to $1.10 billion in 1999 and $1.07 billion in 1998 and principally relates to fixed annuities, both individual and institutional, and investment life insurance products. The growth in interest credited reflects the increase in policy reserves previously discussed and an overall increase in average crediting rates during 2000. The average crediting rate on fixed annuity policy reserves in the Individual Annuity and Institutional Products segments was 5.64% and 5.98% in 2000 compared to 5.72% and 5.72% in 1999 and 5.89% and 6.16% in 1998, respectively.
Operating expenses were $478.9 million in 2000, a 3% increase from 1999 operating expenses of $463.4 million. Operating expenses were $419.7 million in 1998. The increase reflects the growth in the number of annuity and life insurance contracts in-force and the related increase in administrative processing costs. 1999 and 1998 also include costs associated with investment management activities which were assigned to an affiliate in mid-1999.
Federal income tax expense was $207.7 million representing an effective tax rate of 30.4% for 2000. Federal income tax expense in 1999 and 1998 was $201.4 million and $190.4 million, respectively, representing effective rates of 33.2% and 34.2%. An increase in tax exempt income and investment tax credits resulted in the decrease in effective rates.
Sales are comprised of annuities, pension plans and life insurance products sold to a wide variety of customer bases. The 1999 and 1998 sales information has been restated to conform to the 2000 presentation, which better reflects multi-product sales across all distribution channels.
Sales are stated net of internal replacements, which in the Company's opinion provides a more meaningful disclosure of sales. In addition, sales exclude: funding agreements issued to secure notes issued to foreign investors through an unrelated third party trust under the Company's $2 billion medium-term note program; bank-owned life insurance (BOLI); large case pension plan acquisitions; and deposits into Nationwide employee and agent benefit plans. Although these products contribute to asset and earnings growth, they do not produce steady production flow that lends itself to meaningful comparisons and are therefore excluded from sales.
The increase in sales through life insurance specialists reflects $711.4 million of COLI sales in 2000 compared to $409.2 million in 1999. NLIC entered the COLI market in 1998 and has quickly become a market leader through a focus on mid-sized cases.
The Company's flagship products are marketed under The BEST of AMERICA(R) brand, and include individual and group variable annuities 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 which allow those providers to sell products to their own customer bases under their own brand name.
The Company has redefined its business segments in order to align this disclosure with the way management currently views its core operations. This updated view better reflects the different economics of the Company's various businesses and also aligns well with the current market focus. The Company has three product segments: Individual Annuity, Institutional Products and Life Insurance. In addition, the Company reports certain other revenues and expenses in a Corporate segment. All 1999 and 1998 amounts have been restated to reflect the new business segments.
The Individual Annuity segment consists of both variable and fixed annuity contracts. Individual annuity contracts provide the customer with tax-deferred accumulation of savings and flexible payout options including lump sum, systematic withdrawal or a stream of payments for life. In addition, variable annuity contracts provide the customer with access to a wide range of investment options and asset protection in the event of an untimely death, while fixed annuity contracts generate a return for the customer at a specified interest rate fixed for a prescribed period. The Company's individual annuity products consist of single premium deferred annuities, flexible premium deferred annuities and single premium immediate annuities.
During 1998 and 1999 the Company experienced an increase in mortgage loan and bond prepayment fees and such income accounted for approximately 4 basis points of the interest spread in 2000 compared to 7 basis points and 11 basis points in 1999 and 1998, respectively. Increases in interest rates in early 2000 generated higher net investment income and slowed prepayment activity.
Led by variable product deposits of $8.20 billion and withdrawals and surrenders of $5.98 billion, Individual Annuity segment deposits in 2000 of $8.87 billion offset by withdrawals and surrenders totaling $6.47 billion generated net flows of $2.40 billion compared to the $2.83 billion and $3.63 billion achieved in 1999 and 1998, respectively. Despite the competitive nature of the individual annuity market, the Company has demonstrated the ability to generate positive net flows by leveraging its broad distribution network and innovative product development resources. The Company successfully introduced new products, features and retention strategies during 2000.
The decrease in pre-tax operating income to average assets in 2000 and 1999 is primarily driven by the mix of products, which is demonstrated by average separate account assets accounting for 84.4%, 82.6% and 80.8% of total average account balances in 2000, 1999 and 1998, respectively. Higher sales of trail commission individual variable annuities and increased amortization of policy acquisition costs are also impacting margins.
The following table summarizes certain selected financial data for the Company's Institutional Products segment for the years indicated.
During 1998 and 1999 the Company experienced an increase in mortgage loan and bond prepayment fees and such income accounted for approximately 4 basis points of the interest spread in 2000 compared to 8 basis points and 22 basis points in 1999 and 1998, respectively. Increases in interest rates in early 2000 generated higher net investment income and slowed prepayment activity.
The Company is able to mitigate the effects of changes in investment yields by periodically resetting the rates credited on fixed features sold through group annuity contracts. Fixed annuity policy reserves in the Institutional Products segment as of December 31, 2000, included $7.03 billion in contracts where the guaranteed interest rate is reestablished each quarter and $545.9 million in contracts that adjust the crediting rate periodically with portions resetting in each calendar quarter. In this segment, the Company also has $809.4 million of fixed option of variable annuity policy reserves that call for the crediting rate to be reset annually on January 1. The remaining $1.63 billion of fixed annuity policy reserves relate to funding agreements issued in conjunction with the Company's medium-term note program where the crediting rate is either fixed for the term of the contract or variable, based on an underlying index.
Institutional Products sales during 2000 reached $6.13 billion compared to sales of $5.81 billion in 1999 and $4.94 billion in 1998. The growth in each year is primarily attributable to private sector plans. The independent broker/dealer, brokerage firms and financial institutions channels all reported sales growth in excess of 10 percent each year.
The Life Insurance segment consists of insurance products, including universal life insurance, COLI and BOLI products, which provide a death benefit and also allow the customer to build cash value on a tax-advantaged basis.
Driven primarily by increased policy charges, revenues from investment life products increased to $322.4 million in 2000 compared to $226.5 million in 1999 and $145.4 million in 1998. The revenue growth reflects significantly increased policy reserve levels as individual investment life reserves increased 14% in 2000 to $2.09 billion compared to $1.83 billion a year ago and $1.27 billion at the end of 1998. Corporate investment life reserves, which include both COLI and BOLI products, reached $2.55 billion, up from $1.50 billion and $903.6 million at the end of 1999 and 1998, respectively.
Pre-tax earnings from investment life products reached $85.3 million in 2000 compared to $53.4 million a year ago and $29.6 million in 1998. The strong revenue growth discussed previously more than offset increased operating expenses associated with the growth in business.
In addition to the operating revenues presented in the table above, the Company also reports net realized gains and losses on investments in the Corporate segment. The Company realized net investment (losses) gains of ($19.4) million, ($11.6) million and $28.4 million during 2000, 1999 and 1998, respectively. During 2000 the Company recognized a total of $19.4 million of realized losses on three fixed maturity security holdings.