The Company's principal executive offices are located in Columbus, Ohio. The Company leases its home office complex, consisting of approximately 465,000 square feet, from NMIC and its subsidiaries at One Nationwide Plaza, Two Nationwide Plaza and Three Nationwide Plaza, Columbus, Ohio. The Company believes that its present facilities are adequate for the anticipated needs of the Company.
The following table sets forth certain summary consolidated financial data. The consolidated income statement data set forth below for the years ended December 31, 1992 through 1996 and the consolidated balance sheet data as of December 31, 1992 through 1996 are derived from the consolidated financial statements of the Company. The summary consolidated financial data set forth below should be read in conjunction with the consolidated financial statements of the Company and notes thereto and the other financial information, including
Life Insurance Premiums. Life insurance premiums are earned primarily from traditional life insurance in the Life Insurance segment, but are also earned from the sale of life-contingent immediate annuities in the Fixed Annuities segment. Life insurance premiums from traditional life insurance policies are recognized as revenue when due from the policyholder. For life-contingent immediate annuities, net premium (i.e., the portion of the premium which covers benefits and expenses) is recognized as revenue when received. Any premium received in excess of the net premium is deferred and recognized as revenue over the expected benefit period. Traditional life insurance products accounted for 87.9%, 83.5% and 88.6% of the total life insurance premiums in 1996, 1995 and 1994, respectively. Life insurance premiums were $198.6 million for 1996, a 0.3% decrease from $199.1 million for 1995. The slight decrease in 1996 was due to an $8.7 million decrease in sales of life-contingent immediate annuities offset by an $8.3 million increase in traditional life insurance premiums. Life insurance premiums increased 12.7% in 1995 from $176.7 million in 1994. The 1995 increase in life insurance premiums resulted from an increase in traditional life insurance in-force in the Life Insurance segment and growth in the Fixed Annuities segment.
Other Income. Other income consists of investment management fees earned by a subsidiary of the Company from the management of Nationwide mutual funds. Net investment management fees earned on Nationwide mutual fund assets selected as investment options for variable annuity products and variable life insurance products are reported in the Variable Annuities segment and Life Insurance segment, respectively. The Company also sells its mutual fund products separately, and investment management fees from these assets are included in the Corporate and Other segment. Other income was $35.9 million in 1996, $20.7 million in 1995 and $11.3 million in 1994. The increase in other income in 1996 and 1995 resulted primarily from an increase in asset management fees earned on mutual fund assets.
Amortization of DAC. Amortization of deferred policy acquisition costs (DAC) results from the capitalization of commissions and other costs of acquiring new contracts and the amortization of these costs over the estimated life of the contract. Amortization of DAC was $133.4 million in 1996, a 61.3% increase over 1995. Amortization of DAC decreased 3.4% to $82.7 million in 1995 from $85.6 million in 1994. The increase in 1996 was primarily attributable to growth in all product segments while the decrease in 1995 resulted from a decrease in the amortization rate for variable and fixed individual annuities due to lower than anticipated lapse rates and strong separate account asset performance.
Operating Expenses. Operating expenses were $342.4 million in 1996, an 25.4% increase from 1995. Operating expenses increased 13.4% to $273.0 million in 1995 from $240.7 million in 1994. These increases were primarily due to the increasing number of individual and group annuity contracts in-force and the related increase in administrative processing costs. The Company has controlled its operating expenses by taking advantage of economies of scale and by increasing productivity through investments in technology. As a result, the ratio of operating expenses to total assets declined to 0.72% in 1996 and 0.71% in 1995 from 0.82% in 1994.
Federal Income Tax Expense. Federal income tax expense was $110.9 million, $99.8 million and $78.6 million, representing effective tax rates of 35.2%, 34.7% and 32.5% for 1996, 1995 and 1994, respectively. The increase in the 1996 effective tax rate is the result of greater benefits in 1995 and 1994 from charitable donations of appreciated securities.
Discontinued Operations. Discontinued operations include the results of (i) the three NLIC subsidiaries whose outstanding capital stock, on September 24, 1996, was declared as a dividend to Nationwide Corp. and (ii) all of NLIC's accident and health and group life business which was ceded to affiliates effective January 1, 1996. NLIC did not recognize any gain or loss on the disposal of these subsidiaries or discontinuance of the accident and health and group life insurance business. Income from discontinued operations was $11.3 million in 1996, a 54.3% decrease from $24.7 million in 1995. The decrease is attributable to losses incurred on group accident and health business, which are due to increases in the volume of claims and medical costs. Income from discontinued operations was $24.7 million in 1995, a 20.5% increase from $20.5 million in 1994. The increase is attributable to the income reported by ELICW, which NLIC acquired effective December 31, 1994.
Revenues. Revenues in the Variable Annuities segment consist of policy charges and other income. Policy charges consist of asset fees, which are generally a percentage of separate account assets deposited for the purchase of variable annuities; administration fees, which are generally a specific dollar amount per contract; and surrender fees, which are charged against assets withdrawn during a specified period (generally the first seven years) of variable annuity contracts. The separate account assets generated by the Variable Annuities segment do not contribute to net investment income of the Company because the customer receives the investment benefit and bears the investment risk of these assets. Other income includes net investment management fees earned on separate account assets held in mutual funds managed by a subsidiary of NLIC.
Revenues were $284.6 million in 1996, a 50.6% increase from 1995. Revenues increased 42.4% to $189.0 million in 1995 from $132.7 million in 1994. Revenues have increased primarily as a result of growth in separate account assets related to this segment and the corresponding growth in asset fees, which were $261.8 million, $172.8 million and $120.4 million in 1996, 1995 and 1994, respectively. Asset fees as a percentage of variable annuity separate account assets have remained relatively stable during the periods presented, reflecting minimal changes in the levels of asset fees charged on most variable annuity products.
Policy Reserves. Variable annuity policy reserves increased 44.9% from $16.76 billion as of December 31, 1995 to $24.28 billion as of December 31, 1996. Of this increase, $2.72 billion was due to market appreciation of separate account assets, while $6.50 billion of statutory premiums and deposits offset by $1.70 billion of withdrawals and policy charges resulted in the remainder of the increase. Variable annuity policy reserves increased 55.9% to $16.76 billion as of December 31, 1995 from $10.75 billion as of December 31, 1994, which was a 36.8% increase from $7.86 billion as of December 31, 1993. Market appreciation accounted for $2.93 billion of the increase in 1995 while market depreciation accounted for an $84.0 million decrease in 1994. Statutory premiums and deposits were $4.40 billion and $3.82 billion, while withdrawals and policy charges were $1.32 billion and $840.0 million, in 1995 and 1994, respectively.
Income from Continuing Operations Before Federal Income Tax Expense. Income from continuing operations before federal income tax expense was $135.4 million in 1996, a 1.2% decrease from 1995. Income from continuing operations before federal income tax expense decreased 1.4% to $137.0 million in 1995 from $139.0 million in 1994. Narrowing spreads, offset by asset growth, caused 1996 and 1995 earnings to decline from 1994.
Policy Reserves. Fixed annuity policy reserves increased 5.7% to $13.51 billion as of December 31, 1996, from $12.78 billion as of December 31, 1995. Statutory premiums and deposits of $1.60 billion and interest credited of $805.0 million were offset by $1.68 billion of withdrawals, annuity benefits and policy charges. Policy reserves increased 13.6% to $12.78 billion as of December 31, 1995 from $11.25 billion as of December 31, 1994. Statutory premiums and deposits were $1.86 billion and $1.31 billion, while interest credited was $775.7 million and $680.9 million in 1995 and 1994, respectively. Withdrawals and policy charges were $1.10 billion and $895.0 million in 1995 and 1994, respectively.
Income from Continuing Operations Before Federal Income Tax Expense. Income from continuing operations before federal income tax expense excluding realized gains and losses was $22.9 million, $33.9 million and $41.8 million in 1996, 1995 and 1994, respectively. The decrease in 1996 from 1995 is due to a decrease in net investment income and higher operating expenses. The change from 1994 to 1995 is primarily attributed to the change in revenues discussed above.
The Company has existing arrangements with NMIC and other affiliates that address the sharing of federal income taxes, the leasing of office space and the sharing of certain operational and administrative services. These arrangements have been in effect for all periods for which financial data is presented herein. See Item 13 - Certain Relationships and Related Transactions-Existing Arrangements with the Enterprise. The Company does not believe that expenses recognized under the intercompany arrangements are materially different from expenses that would have been recognized had the Company operated on a stand-alone basis.
NMIC and its U.S. subsidiaries, including the Company, file a consolidated federal income tax return. The members of the consolidated group currently have a tax sharing arrangement which provides for each member to bear essentially the same federal income tax liability as if separate tax returns were filed. For the years ended December 31, 1996, 1995 and 1994, the Company made federal income tax payments under the tax sharing arrangement of $115.8 million, $51.8 million and $83.2 million, respectively. See Item 13 - Certain Relationships and Related Transactions-Existing Arrangements with the Enterprise-Federal Income Taxes.
State insurance laws generally restrict the ability of insurance companies to pay cash dividends in excess of certain prescribed limitations without prior approval. The ability of NLIC to pay dividends is subject to restrictions set forth in the insurance laws and regulations of Ohio, its domiciliary state. The Ohio insurance laws require life insurance companies to seek prior regulatory approval to pay a dividend or distribution of cash or other property if the fair market value thereof, together with that of other dividends or distributions made in the preceding 12 months, exceeds the greater of (i) 10% of policyholders' surplus as of the prior December 31 or (ii) the net income of the insurer for the 12-month period ending as of the prior December 31. The Ohio insurance laws also require insurers to seek prior regulatory approval for any dividend paid from other than earned surplus. The payment of dividends by NLIC may also be subject to restrictions set forth in the insurance laws of New York that limit the amount of statutory profits on NLIC's participating policies (measured before dividends to policyholders) that can inure to the benefit of NLIC and its stockholder. NLIC currently does not expect such regulatory requirements to impair its ability to pay operating expenses and dividends in the future. However, NLIC can give no assurance that dividends will be declared or paid.
NLIC's statutory capital and surplus was $1.00 billion as of December 31, 1996. NLIC paid a dividend of $850.0 million on February 24, 1997. NFS contributed amounts totaling $836.8 million to NLIC on March 10, 1997 and March 11, 1997. NLIC believes that after such dividend and such contribution from NFS, NLIC has adequate statutory capital and surplus to satisfy all regulatory requirements and to support its growth over the following year.
NLIC's principal sources of liquidity to meet unexpected cash outflows are its portfolio of liquid assets and its net operating cash flow.
The short- and long-term liquidity requirements of the Company are monitored regularly to match cash inflows with cash requirements. The Company periodically reviews its short- and long-term projected sources and uses of funds and the asset/liability, investment and cash flow assumptions underlying these projections. Adjustments are made periodically with respect to the Company's investment policies to reflect changes in the Company's short- and long-term cash needs and changing business and economic conditions.
On August 12, 1996, NLIC and NMIC entered into a Credit Facility (Credit Facility) which provides for a $600.0 million loan over a five-year term on a fully revolving basis with a group of banks led by Morgan Guaranty Trust Company of New York. The Credit Facility provides for several and not joint liability with respect to any amount drawn by either NLIC or NMIC. To date, neither NLIC nor NMIC has drawn down any amount under the Credit Facility. The Credit Facility provides for several borrowing options including interest at a spread over LIBOR, money market auction, CD or base rate. The Credit Facility also provides covenants, including, but not limited to, restrictions on decreases in the statutory surplus of NMIC below $2.75 billion, mergers and sales of assets if a default has occurred and is continuing, transactions with affiliates (which must be on an arm's-length basis on terms at least as favorable to NLIC or NMIC as could have been obtained from a third party who was not affiliated with NLIC or NMIC) and restrictions on the creation, assumption or suffering to exist of liens. In addition, the Credit Facility provides for customary representations, warranties and events of default. Pursuant to the terms of the Credit Facility, NLIC may not declare or pay a dividend if it is, or if the payment thereof would cause it to be, in default under such facility. Events of default under the Credit Facility include, among others, the failure of NMIC and its affiliates to maintain beneficial ownership of more than 50% of the combined voting power of NLIC's outstanding voting stock and the failure of NLIC to maintain statutory surplus in excess of $875.0 million. Amounts borrowed under the Credit Facility may be used for, among other things, general corporate purposes.
The Company's assets are divided between separate account and general account assets. As of December 31, 1996, $26.9 billion (or 56.3%) of the Company's total assets were held in separate accounts and $20.9 billion (or 43.7%) were held in the Company's general account, including $18.3 billion of general account investments. Separate account assets consist primarily of deposits from the Company's variable annuity business. Most separate account assets are invested in various mutual fund options available within the variable annuity products sold by the Company. All of the investment risk in the Company's separate account assets is borne by the Company's customers, with the exception of $280.2 million of policy reserves as of December 31, 1996 ($205.7 million as of December 31, 1995) for which the Company bears the investment risk. General account assets consist mainly of investments generated by premiums on life insurance products and deposits in the Company's Fixed Annuities segment. The Company generates profits on these products in part, based on the spread between the yield on general account invested assets and crediting rates on these products.
The Company's general account investment policies emphasize high quality, diversification across asset classes and individual risks, and a buy and hold strategy. The Company's general account assets are invested primarily in fixed maturity securities and commercial mortgage loans. The Company has a general policy of diversifying investments within asset categories. Additionally, the Company's investment policy provides that fixed maturity investments are limited to purchases of investment grade securities or unrated securities which, in the opinion of the Company, should qualify for such rating. The Company monitors its exposure to individual borrowers, credit risks, industries or property types and geographic locations. The Company's investments are subject to suitability and diversification requirements under applicable insurance laws. The Investment Committee of the Board of Directors of the Company, which is comprised of the Chairman and five outside directors, meets ten times a year. Such committee approves investment policy and strategy, approves all mortgage loans and large private placements and reviews and ratifies all other investments. In relation to the life insurers reporting to the American Council of Life Insurance (ACLI), the Company's general account investment portfolio has achieved (i) higher net investment yields, (ii) lower bond default rates and (iii) lower mortgage delinquency rates, in each case in each of the three years ended December 31, 1996.
As of December 31, 1996, general account fixed maturity securities were $12.3 billion (or 67.2%) of the carrying value of consolidated general account invested assets. As of such date, public and private fixed maturity securities constituted $8.4 billion (or 68.3%) and $3.9 billion (or 31.7%), respectively, of total general account fixed maturity securities. The Company's general account fixed maturity securities portfolio consists primarily of investment grade corporate fixed maturity securities, high-quality mortgage-backed securities and U.S. government and agency obligations.
Below investment grade fixed maturity securities in the Company's general account as of December 31, 1996 included the securities of 23 issuers representing approximately 1.8% of the carrying value of total fixed maturity securities. The Company's investment policy provides that fixed maturity investments are limited to purchases of investment grade securities or unrated securities which, in the opinion of the Company, should qualify for such rating. All of the below grade fixed maturity securities held in the Company's general account as of December 31, 1996 were investment grade securities when purchased by the Company.
The Company maintains significant general account investments in mortgage-backed securities (MBSs). The Company's general account MBS investments include residential MBSs and commercial MBSs. As of December 31, 1996, MBSs were $3.67 billion (or 29.8%) of the carrying value of the general account fixed maturity securities, all of which were guaranteed by the U.S. government or an agency of the U.S. government.
The following table sets forth the distribution by investment type of the Company's general account MBS portfolio as of December 31, 1996.
Pursuant to the Company's investment policies, the Company does not invest in derivative securities other than MBSs.
See notes 5 and 9 to the consolidated financial statements for an analysis of activity in the valuation allowance account for mortgage loans and a summary of mortgage loans by region and property type.
The Company aggressively seeks to manage and resolve its troubled commercial mortgage loans. Commercial mortgage loans are placed into default immediately following the Company failing to receive payment when due. With respect to a delinquent mortgage loan, the Company seeks to enforce the assignment of rents clause in order to gain control of the rental income from the property shortly following the default in payment. The foreclosure process with respect to a delinquent mortgage loan is generally initiated by the Company prior to the second mortgage payment becoming delinquent. Over the last five years, the Company has recovered approximately 74% of the unpaid principal of all of its mortgage loans in default.
The following table sets forth the delinquency, foreclosure and restructured commercial mortgage loan experience for the Company and for the life insurers reporting to the ACLI for the periods indicated.
Many of the Company's assets and liabilities are monetary in nature and sensitive to the interest rate environment which can be affected by inflation. The Company is exposed to the risk of a reduction in interest spread or profit margins when interest rates fluctuate. Bond calls, mortgage prepayments, contract surrenders and withdrawals of annuities and life insurance policies are influenced by the interest rate environment. In general, the fair value of the Company's fixed maturities portfolio increases or decreases inversely with fluctuations in interest rates. For example, if interest rates rise, the Company's fixed maturity investments will generally decrease in value. Additionally, the Company's net investment income may be affected by the interest rate changes. If interest rates decline, net investment income will decrease if high-yielding fixed maturity investments mature or are sold and the proceeds therefrom are reinvested in securities yielding a lower rate. Management attempts to mitigate the negative impact if interest rate changes through asset/liability management, product design, management of crediting rates, relatively high surrender charges and management of mortality charges and dividend scales with respect to its in-force life insurance policies, but there can be no assurance that such attempts will be completely successful. Extreme changes in the interest rate environment could cause net interest margins to fluctuate from historical levels.