During 2016, National Western created a new operating entity, Braker P III, LLC ("BP III"), to own and manage the operations of a 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, occupying approximately 78,100 square feet. Nearly 89,000 square feet is currently leased by BP III to other third party tenants with the remaining 29,300 square feet actively being marketed.
The Westcap Corporation, a wholly owned subsidiary of National Western, owns the Company’s former office location in Austin, Texas and two buildings adjacent to it, totaling approximately 93,000 square feet which are currently available for sale. The Company’s affiliate, Regent Care Building, LP, owns a 65,000 square foot building in Reno, Nevada, which is leased and utilized by another of the Company’s affiliates, Regent Care Operations, LP, for use in its nursing home operations. The Company’s subsidiary, Regent Care San Marcos A-3 LP, owns a 74,000 square foot building in San Marcos, Texas, which is also used in nursing home operations. Lease costs and related operating expenses for facilities of the Company’s subsidiaries are currently not significant in relation to the Company’s Consolidated Financial Statements. The intercompany lease costs related to The Westcap Corporation and the nursing homes have been eliminated for consolidated reporting purposes.
(1) See Note 1 Summary of Significant Accounting Policies to the Consolidated Financial Statement for reorganization effective October 1, 2015.
National Western provides life insurance products on a global basis for the savings and protection needs of policyholders and annuity contracts for the asset accumulation and retirement needs of contract holders, both domestic and international residents. The company accepts funds from policyholders or contract holders and establishes a liability representing future obligations to pay the policy or contract holders and their beneficiaries. To ensure the company will be able to pay these future commitments, the funds received as premium payments and deposits are invested in high quality investments, primarily fixed income securities.
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. Currently, the consensus view of the Federal Reserve's course of action is predicated on the thesis that the U.S. economy is in a position to absorb a series of interest rate hikes without impeding ongoing economic growth. A progression of carefully measured increases in interest rate levels would be beneficial to financial service institutions, including life insurance companies. After the rate increase in December 2017, the current interest rate path is for another three interest rate hikes in 2018. It is uncertain what direction and at what pace interest rate movements may occur in the future and what impact, if any, such movements would have on the Company’s business, results of operations, cash flows or financial condition.
The U.S. life insurance sector today is faced with an interest rate, economic and regulatory environment making strategic long-term planning decisions more challenging and vulnerable to inaccurate assessments. In an environment such as this, the need for a strong capital position that can cushion against unexpected bumps is critical for stability and ongoing business activity. The Company's operating strategy continues to be focused on maintaining capital levels substantially above regulatory and rating agency requirements. Our business model is predicated upon steady growth in invested assets while managing the block of business within profitability objectives. A key premise of our financial management is maintaining a high quality investment portfolio, well matched in terms of duration with policyholder obligations, that continues to outperform the industry with respect to adverse impairment experience. This discipline enables the Company to sustain resources more than adequate to fund future growth and absorb abnormal periods of cash outflows.
Accounting policies discussed below are those considered critical to an understanding of the Company’s financial statements.
Impairment of Investment Securities. The Company’s accounting policy requires that a decline in the value of a security below its amortized cost basis be evaluated to determine if the decline is other-than-temporary. The primary factors considered in evaluating whether a decline in value for fixed income and equity securities is other-than-temporary include: (a) the length of time and the extent to which the fair value has been less than cost, (b) the reasons for the decline in value (credit event, interest rate related, credit spread widening), (c) the overall financial condition as well as the near-term prospects of the issuer, (d) whether the debtor is current on contractually obligated principal and interest payments, and (e) that the Company does not intend or be required to sell the investment prior to recovery. In addition, certain securitized financial assets with contractual cash flows are evaluated periodically by the Company to update the estimated cash flows over the life of the security. If the Company determines that the fair value of the securitized financial asset is less than its carrying amount and there has been a decrease in the present value of the estimated cash flows since the previous purchase or prior impairment, then an other-than-temporary impairment charge is recognized. The Company would recognize impairment of securities due to changing interest rates or market dislocations only if the Company intended to sell the securities prior to recovery. When a security is deemed to be impaired, a charge is recorded equal to the difference between the fair value and amortized cost basis of the security. In compliance with GAAP guidance the estimated credit versus the non-credit components are bifurcated, and the non-credit component is reclassified as unrealized losses in other comprehensive income. Once an impairment charge has been recorded, the fair value of the impaired investment becomes its new cost basis and the Company continues to review the other-than-temporarily impaired security for appropriate valuation on an ongoing basis. However, the new cost basis of an impaired security is not adjusted for subsequent increases in estimated fair value.
The Company annually reviews its pension benefit plans' assumptions which include the discount rate, the expected long-term rate of return on plan assets, and the compensation increase rate. The assumed discount rate is set based on the rates of return on high quality long-term fixed income investments currently available and expected to be available during the period to maturity of the pension benefits. The assumed long-term rate of return on plan assets is generally set at the rate expected to be earned based on the long-term investment policy of the plans, the various classes of the invested funds, input of the plan’s investment advisors and consulting actuary, and the plan’s historic rate of return. The compensation rate increase assumption is generally set at a rate consistent with current and expected long-term compensation and salary policy, including inflation. These assumptions involve uncertainties and judgment, and therefore actual performance may not be reflective of the assumptions.
Universal life and annuity contract revenues - Revenues for universal life and annuity contract charges decreased slightly in 2017 compared to 2016 largely due to lower surrender charge revenue from terminated policies as shown below. Revenues for universal life and annuity products consist of policy charges for the cost of insurance, administration charges, and surrender charges assessed against policyholder account balances, less reinsurance premiums as depicted in the following table.
Cost of insurance charges were $107.5 million in 2017 compared to $106.02 million in 2016 and $105.2 million in 2015. 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. At December 31, 2017, the volume of universal life insurance in force decreased to $16.2 billion from $17.4 billion as of the end of 2016. However, during 2016 the Company increased its cost of insurance charges in accordance with its policy provisions on certain blocks of international life insurance policies which were in effect for the entirety of 2017 and helped to mitigate the decline in insurance in force. Administrative charges were $27.4 million, $27.8 million, and $28.6 million for the years ended December 31, 2017, 2016 and 2015, 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.
Surrender charges assessed against policyholder account balances upon withdrawal were $42.1 million in 2017 compared to $44.8 million in 2016 and $41.3 million in 2015. 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. Policy lapse rates in 2017 for domestic life insurance and annuities segments were improved from those experienced in 2016 while the international life segment continued to exhibit higher lapse rates. The spike in surrender charge income recognized in 2016 over 2015 reflects a higher international life insurance lapse rate, most noticeably in the countries from which the Company ceased accepting applications from residents in the fourth quarter of 2015. 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).
The growth in domestic life insurance sales the past several years has been driven principally by the sale of single premium life insurance products. In 2013, the Company began deferring the premium load associated with these products and spreading it over future income periods. The amounts shown above as "Other charges" represent the net of current year deferrals of premium loads against previously capitalized amounts being amortized into revenue. During 2016, the amount of amortization of deferred premium loads overtook current period deferrals due to slightly lower sales compared to those in 2017 and 2015.
The Company’s new mortgage loan activity has been relatively low in recent years given the low level of rates and the higher level of risk associated with commercial properties in this economic environment. Due to a concerted effort, the volume of new mortgage loan originations during 2017 and 2016 increased from prior year levels. Mortgage loan investment income in 2017 and 2015 were at slightly higher levels due to incremental contributions from loan prepayment fees and profit participation receipts during the year. Policy loan, short-term investments, and other invested asset balances outstanding have remained relatively stable over the past few years.
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 2017 and 2016, 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 2015, 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. Equity securities represent 0.1% of invested assets and individual holdings have an average cost basis of approximately $43,000.
Life and other policy benefits - Life and other policy benefits include death claims of $38.6 million, $31.3 million and $38.2 million for 2017, 2016 and 2015, respectively. While death claim amounts are subject to variation from period to period, the Company’s mortality experience has generally been consistent with or better than its product pricing assumptions. 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.
As the DPAC balance is an asset on the Company's Consolidated Balance Sheets, GAAP provides for an earned interest return on the unamortized balance each period. The earned interest serves to increase the DPAC balance and reduce other amortization component expense. The rate at which the DPAC balance earns interest is the average credited interest rate on the company's universal life and annuity policies in force, including credited interest on equity-indexed policies. The amount of earned interest on DPAC balances recorded was $33.5 million, $10.5 million, and $20.5 million in 2017, 2016, and 2015, respectively, decreasing other amortization component expense.
Universal life and annuity contract interest - The Company closely monitors credited interest rates on interest sensitive policies, taking into consideration such factors as profitability goals, policyholder benefits, product marketability, and economic market conditions. As long-term interest rates change, the Company's credited interest rates are often adjusted accordingly, taking into consideration the factors described above. The difference between yields earned on investments over policy credited rates is often referred to as the "interest spread".
realized and unrealized gains/(losses) included in net investment income approximate the change in contract interest associated with the corresponding embedded derivative liability change). However, other aspects of the embedded derivatives can cause deviations to occur between the change in index option asset values included in net investment income and the change in the embedded derivative liability included in contract interest. As noted in the discussion of net investment income, the collection of asset management fees in a period can cause investment income to increase marginally higher than contract interest expense. In addition, accounting rules require the embedded derivative liability to include a projection of asset management fees estimated to be collected in the next fiscal year. The change in this projection, plus or minus, is included in contract interest expense for the period being reported on. During the years ended December 31, 2017, 2016, and 2015, contract interest was increased/(decreased) by $6.9 million, ($15.9 million), and $2.0 million, respectively, for this occurrence. Refer to Note 15 Derivative Investments in the accompanying Notes to Consolidated Financial Statements for further information.
annuitizations, and amortization of deferred sales inducement balances. These items are offset by policy charges assessed for policies having the withdrawal benefit rider. As changes in these items collectively impact contract interest expense, financial statement interest spread is also affected. For the years ended December 31, 2017, 2016, and 2015 the changes in these items increased contract interest expense by $38.1 million, $46.9 million, and $42.8 million, respectively.
As part of the DPAC balance unlockings previously discussed for 2017, 2016, and 2015, the Company unlocked its deferred sales inducement balance. The effect of the prospective unlocking was to decrease the deferred sales inducement balance by $4.3 million, $1.7 million, and $1.8 million, in 2017, 2016, and 2015, respectively, and thereby increasing contract interest expense by a related amount for each period.
Nursing home expenses reflect the operations of the Company's two facilities in Reno, Nevada and San Marcos, Texas. The lower expense level in 2017 compared to the prior two years corresponds with decreased revenues from lower census figures and the resultant cost containment measures undertaken to manage profitability.
Real estate expenses shown for 2017 pertain to the commercial building operated by Braker P III. The building was acquired at year-end 2016.
Universal life insurance revenues are also generated with the issuance of new business based upon amounts per application and percentages of the face amount (volume) of insurance issued. The number of domestic policies issued during 2017 was 14% higher than in 2016 and the volume of insurance issued was 17% more than that in 2016.
In 2013 the Company began deferring the premium load on its highest selling domestic product, single pay life insurance. Amounts deferred are amortized into revenues over future periods corresponding with the duration of the policies. Initially, the premium load amounts deferred exceeded the amounts amortized back into revenues. However, in 2016 the cumulative amounts deferred reached a level such that the current year revenue amortization exceeds the current period deferral resulting in net increasing revenue from this accounting method.
As noted previously in the discussion of results from Consolidated Operations, 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 with the adjustment reflected in current period amortization expense. To the extent required, the Company may also record unlocking adjustments to DPAC balances. The following table identifies the effects of unlocking adjustments on domestic life insurance DPAC balances recorded through amortization expense separate from recurring amortization expense components for 2017, 2016 and 2015.
As noted in the Consolidated Operations discussion, the Company unlocked the interest crediting rate spread on certain equity-indexed universal life products during 2017 which increased amortization expense by $0.8 million. During 2016 for Company unlocked its DPAC balance for favorable mortality and for future profit projections related to universal life insurance riders which had not been previously included in DPAC actuarial software models. These unlockings decreased DPAC amortization expense.
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 Consolidated Operations section, the Company's overall operating expense levels increased in 2017 from the prior year, which resulted in operating expenses for this segment being higher.
The Company's international life operations have been a significant factor in the Company's overall earnings performance and represents a niche where the Company believes it has had a competitive advantage historically. A stable population of distribution relationships has been developed over decades of operations providing the Company with a consistent foundation for development of the block of business.
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 2017, 2016 and 2015.
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 decreased amortization expense by $27.7 million. During 2016, the Company unlocked the DPAC balance for: (1) favorable mortality, (2) higher cost of insurance charges which had been implemented, (3) increased lapse rates for disengaged countries, and (4) for future profit projections related to universal life insurance riders which had not been previously included in DPAC actuarial software models, the result of which collectively decreased amortization expense by $8.5 million. In 2015, the Company unlocked the DPAC balance for favorable mortality experience on one of its international universal life products. The effect of the prospective unlocking was to decrease amortization expense.
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 Consolidated Operations section, the Company's overall operating expense levels increased in 2017 from the prior year, which resulted in operating expenses for this segment being higher. In addition, the potential and contingent legal liability provisions discussed in the Consolidated Operations section were primarily 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 2017 was 6.0%, a decrease from a rate of 6.5% in 2016 and marginally lower than the 6.2% rate experienced in 2015.
Deposits collected on annuity contracts are not reflected as revenues in the Company's Consolidated Statements of Earnings in accordance with GAAP. Actual annuity deposits collected are detailed below.
As previously described, derivatives are call options purchased to hedge the equity return component of National Western's fixed-index annuity products with any gains or losses from the sale or expiration of the options, as well as period-to-period changes in fair values, reflected in net investment income. Since the embedded derivative option in the policies is bifurcated when determining the contract reserve liability, the impact of the market value change of index options on asset values generally aligns closely with the movement of the embedded derivative liability such that the net effect upon pretax earnings is negligible (i.e. net realized and unrealized gains/(losses) included in net investment income approximate the change in contract interest associated with the corresponding embedded derivative liability change). See further discussion below regarding contract interest activity.
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. During 2016, the annuity DPAC balance was unlocked for surrender and annuitization rates. The effect of this prospective unlocking was to increase amortization expense by $3.7 million. The Company also unlocked in 2015 for future expense assumptions pertaining to product development override costs (trailer commissions) which it is obligated to pay certain contracted National Marketing Organizations. The effect of the prospective unlocking was to increase amortization expense by $5.3 million.
The fluctuation in reported contract interest amounts for fixed-index annuities is driven by sales levels, the level of the business in force and the effect of positive or negative market returns of option values on projected interest credits. As noted above in the net investment income discussion, the amounts shown for contract interest for fixed-index annuities generally align with the derivative gains/(losses) included in net investment income as the impact of the market value change of index options on asset values aligns closely with the movement of the embedded derivative liability held for these products. As noted in the discussion in the Consolidated Operations section, positive returns on expiring options during 2017 led to an increase in collected asset management fees by National Western which are subtracted from contract interest credited to policyholders and lessens the increase in contract interest relative to the option gains reported in the Company's net investment income. Asset management fees collected during 2017, 2016, and 2015 were $31.8 million, $6.4 million, and $10.6 million, respectively.
As previously noted, accounting rules require the embedded derivative liability to include a projection of asset management fees to be collected over the next fiscal year. The change in this projection, plus or minus, is included in contract interest. During the years ended December 31, 2017, 2016, and 2015, for all of the Company's equity-indexed business, contract interest was increased/(decreased) by $6.9 million, ($15.9) million, and $2.0 million, respectively, for this occurrence. The annuity segment holds approximately two-thirds of the options outstanding at December 31, 2017.
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, 2017, 2016, and 2015 bonus interest amortization was increased by $4.3 million, $1.7 million and $1.8 million, respectively, for unlocking adjustments.
Similar to the Domestic Life insurance and International Life insurance segments, the Company's overall increase in operating expenses has been allocated to the Annuity segment based upon functional business activity and volumes. As annuity sales and transaction activity decreased somewhat in 2017 relative to the Domestic and International Life segments, the Annuity segment bore less of the overall increase in Company operating expenses.
The Company's primary business encompasses its domestic and international life insurance operations and its annuity operations. However, the Company also has small real estate, nursing home, and other investment operations through its wholly owned subsidiaries. Nursing home operations generated $1.4 million, $0.3 million and $1.3 million of pre-tax earnings in 2017, 2016, and 2015, respectively. The 2017 results also include the operations of BP III which commenced operations at the beginning of the year. BP III incurred a pre-tax loss of $(1.5) million for the year.
The remaining pre-tax earnings in Other Operations of $26.8 million, $23.0 million, and $29.8 million for the years ended December 31, 2017, 2016, and 2015, respectively, represent investment income from real estate, municipal bonds, and common and preferred equities held in subsidiary company portfolios principally for tax-advantage purposes. Included in these amounts are semi-annual distributions from a life interest in the Libby Shearn Moody Trust which is an asset held in NWLSM, Inc. Pretax distributions from this trust were $6.1 million, $6.0 million, and $7.0 million in 2017, 2016, and 2015, respectively. In addition to pretax distributions, these amounts also include additional revenue recorded for annually revaluing the actuarial life interest in the Libbie Shearn Moody Trust.
The Company’s investment portfolio increased 2% to $10.8 billion at December 31, 2017 compared to $10.6 billion at December 31, 2016 due to positive cash flows from operating and financing activities and the unrealized gain increases associated with investments reported at fair value. The primary driver of the increase in cash flows was investable funds generated from single premium life insurance and annuity sales and income receipts from the investment portfolio. Sales production resulted in approximately $608.8 million of annuity deposits collected and $131.6 million in single premium life premiums during 2017.
Substantially all 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. 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 investments 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 99.0% 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.
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 14, Fair Values of Financial Instruments, of the accompanying Consolidated Financial Statements for further discussion.
During the year ended December 31, 2017, the Company recorded no other-than-temporary impairment ("OTTI") credit related write-downs on debt securities and $0.1 million of OTTI on equity securities. See Note 3, Investments Debt and Equity Securities, of the accompanying Consolidated Financial Statements for further discussion.
Since the Company's adoption of the GAAP guidance and accounting for other-than-temporary impairments due to credit loss versus non-credit loss, the Company has recognized a total of $0.6 million of other-than-temporary impairments of which $0.6 million were deemed credit related and recognized as realized investment losses in earnings, and $0.0 million that was deemed non-credit related impairments and recognized in other comprehensive income.
The Company holds approximately $13.5 million in asset-backed securities as of December 31, 2017. This portfolio includes $1.0 million of manufactured housing bonds and $12.5 million of home equity loans (also referred to as subprime securities). These holdings have declined from the levels held at December 31, 2016 of $1.6 million and $18.4 million, respectively. The Company does not have any holdings in collaterized bond obligations (“CBO”s), collateralized debt obligations (“CDO”s), or collateralized loan obligations (“CLO”s). Principal risks in holding asset-backed securities are structural, credit, and capital market risks. Structural risks include the securities’ priority in the issuer’s capital structure, the adequacy of and ability to realize proceeds from collateral and the potential for prepayments. Credit risks include corporate credit risks or consumer credit risks for financing such as subprime mortgages. Capital market risks include the general level of interest rates and the liquidity for these securities in the marketplace.
The Company's direct investments in real estate are not a significant portion of its total investment portfolio as most of these investments were acquired through mortgage loan foreclosures. For the years ended December 31, 2017 and 2016, there were no real estate properties acquired through mortgage loan foreclosure. The Company also participates in several real estate joint ventures and limited partnerships that invest primarily in income-producing retail properties.
The following table represents the mortgage loan allowance for the years ended December 31, 2017 and 2016:
The Company's direct investments in real estate total approximately $37.4 million at December 31, 2017 and $31.8 million at December 31, 2016, and consist primarily of income-producing properties which are being operated by a wholly-owned subsidiary of National Western. The Company recognized operating income on these properties of approximately $2.9 million, $2.6 million and $1.8 million for the years ended December 31, 2017, 2016 and 2015, respectively. The Company monitors the conditions and market values of these properties on a regular basis and makes repairs and capital improvements to keep the properties in good condition. The Company recorded net realized investment gains of $2.7 million, $2.9 million and $0.0 million associated with real estate investments in the years ended December 31, 2017, 2016 and 2015, respectively.
The Company offers fixed-index universal life and annuity products that guarantee the return of principal to policyholders and, at the policyholder’s election, credit interest based on a percentage gain in a specified equity market index (policyholders may alternatively elect a fixed interest rate). Premiums and deposits received on these products are predominantly invested in investment grade fixed income securities with a portion used to purchase derivatives consisting of call options on the applicable market index to fund the index credits due to fixed-index policyholders. The call options purchased are one year over-the-counter option contracts coinciding with the initial issuance of the policy and subsequent annual renewal periods in order to match the Company’s funding requirements for the underlying policies. On the respective anniversary dates of the index policies, the index used to compute the annual index credit is reset and a new one-year call option is purchased to fund the next annual index credit.
The Company's unrealized gains balance for debt securities held at December 31, 2017 and 2016 is shown in the following table.
The selection of the 100 basis point parallel shift in the yield curve was made as an illustration of the potential hypothetical impact of such an event and should not be construed as a prediction of future market events. Actual results could vary materially from those illustrated due to the nature of the estimates and assumptions used in the above analysis. Expected maturities of debt securities may differ from contractual maturities due to call or prepayment provisions. The models assume that prepayments on mortgage-backed securities are influenced by agency and pool types, the level of interest rates, loan age, refinancing incentive, month of the year, and underlying coupon. During periods of declining interest rates, principal payments on mortgage-backed securities and collateralized mortgage obligations tend to increase as the underlying mortgages are prepaid. Conversely, during periods of rising interest rates, the rate of prepayment slows. Both of these situations can expose the Company to the possibility of asset-liability cash flow and yield mismatch. The model uses a proprietary method of sampling interest rate paths along with a mortgage prepayment model to derive future cash flows. The initial interest rates used are based on the current U.S. Treasury yield curve as well as current mortgage rates for the various types of collateral in the portfolio.
In connection with the Company’s use of call options to hedge the equity return component of its fixed-indexed annuity and life products, the Company is exposed to the risk that a counterparty fails to perform under terms of the option contract. The Company purchases one-year option contracts from multiple counterparties and evaluates the creditworthiness of all counterparties prior to the purchase of the contracts. For consideration in contracting with a counterparty the rating required by the Company is a credit rating of “A” or higher. Accordingly, all options are purchased from nationally recognized financial institutions with a demonstrated performance for honoring their financial obligations and possessing substantial financial capacity. In addition, each counterparty is required to execute a credit support agreement obligating the counterparty to provide collateral to the Company when the fair value of the Company’s exposure to the counterparty exceeds specified amounts. Counterparty credit ratings and credit exposure are monitored continuously by National Western’s Investment department with adjustments to collateral levels managed under as incurred under the credit support agreements.
The Company’s net exposure to loss due to credit risk if option counterparties failed to completely perform according to the terms of their one-year contracts is as follows at December 31, 2017 and 2016.
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 level of annuity dollar outflows is indicative of a steady block of business in force which added approximately $2.1 billion in deposits over the past three years. In addition, the maturation of policies within the 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. While 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, the Company's disengagement from several international markets has influenced higher withdrawals from these areas since 2015. 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 relies on retained earnings for its capital resources as there is no long-term debt outstanding and the Company does not anticipate the need for any long-term debt in the near future. As of December 31, 2017, the Company had no commitments beyond its normal operating and investment activities. 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 the ability to take competitive advantages and acquisitions 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, 2017, the maximum amount legally available for distribution during 2018 without further regulatory approval is $127.3 million.
It is not Company practice to 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.