The Company's Domestic Division concentrates marketing efforts on federal employees, seniors, and specific employee groups in private industry, as well as individual sales. The products marketed are annuities, universal life insurance, and traditional life insurance, which includes both term and whole life products. The majority of products sold are the Company's annuities, which include single and flexible premium deferred annuities, single premium immediate annuities, and the newly introduced equity-indexed annuity. Most of these annuities can be sold as tax qualified or nonqualified products.
During 1997 the Company formed two new subsidiaries, NWL Services, Inc. and NWL Financial, Inc. The new wholly owned subsidiaries were incorporated primarily for investment related activities.
As of December 31, 1997, CMOs represent approximately 90% of the Company's mortgage-backed securities, and PAC I CMOs account for approximately 90% of this CMO portfolio. The CMOs in the Company's portfolio have been modeled and subjected to detailed, comprehensive analysis by the Company's investment staff. The overall structure of the CMO as well as the individual tranche being considered for purchase have been evaluated to ensure that the security fits appropriately within the Company's investment philosophy and asset/liability management parameters. The Company's investment mix between mortgage-backed securities and other fixed income securities helps effectively balance prepayment, extension, and credit risks.
As detailed above, debt securities classified as held to maturity comprise the majority of the Company's securities portfolio, while equity securities continue to be a small component of the portfolio. Gross unrealized gains totaling $108,695,000 on the securities portfolio at December 31, 1997, is a reflection of market interest rates at year-end. The fair values, or market values, of fixed income debt securities correlate to external market interest rate conditions. Because the interest rates are fixed on almost all of the Company's debt securities, market values typically increase when market interest rates decline, and decrease when market interest rates rise. This correlation between market values and interest rates is reflected in the tables below.
The diversification of the mortgage loan portfolio by geographic region of the United States and by property type as of December 31, 1997 and 1996, was as follows:
The contractual maturities of mortgage loans at December 31, 1997, are as follows:
Insurance Operations Net Earnings: For the year ended December 31, 1997, the Company recognized earnings from insurance operations totaling $43,604,000, a decrease of 3.5% from 1996 earnings. The lower earnings in 1997 were primarily due to higher life insurance benefit claims and amortization of deferred policy acquisition costs. Deferred policy acquisitions costs, which are primarily capitalized agents' commissions, are amortized in direct relation to anticipated future gross profits on applicable life and annuity business. Increases in anticipated future gross profits resulted in retrospective adjustments to deferred policy acquisition costs, which lowered the amortization in 1996 relative to 1997 amounts. Also, other income in 1997 declined $1.5 million, net of taxes, as 1996 included nonrecurring income primarily due to litigation related recoveries.
The Company recognized record earnings from insurance operations in 1996 totaling $45,167,000, an increase of 21.4% over 1995 earnings. Increases in universal life and annuity revenues of 8.9% and net investment income of 6.2%, coupled with lower expenses, resulted in the record earnings. Lower expenses were primarily from decreases in life insurance benefit claims, amortization of deferred policy acquisition costs, and state guaranty fund assessments.
Earnings for 1995 include a $5.7 million tax benefit resulting from the Company's subsidiary brokerage losses. The tax benefits were recognized in accordance with the Company's tax allocation agreement with its subsidiaries. Excluding the tax benefits, earnings from insurance operations for 1996 were actually up $13.7 million from 1995 due to the increases in revenues and lower expenses as previously described.
Although policy surrenders increased again in 1997 from 1996 and 1995 levels, surrender charge revenues actually declined in 1997 primarily due to changes in the types of surrenders. Life insurance surrenders increased only slightly in 1997 over 1996 amounts, while single-tier annuities increased significantly compared to declines in surrenders of two-tier annuities. As a result, because single-tier annuities typically have lower surrender charges than two- tier annuities, surrender charge revenues declined in 1997. The increase in these revenues in 1996 from 1995 was due to higher surrenders coupled with a higher ratio of two-tier annuity surrenders in 1996.
Policy fees and other revenues consist primarily of policy administration fee charges on universal life products and recognition of deferred revenues relating to immediate annuities. The significant increase in these revenues in 1997 is primarily due to increases in deferred revenues on immediate annuities. As the Company's deferred annuities in force continue to increase, so do the immediate annuities as policyholders annuitize their policies. Annuitizations result in transfers of policies from deferred to immediate or pay-out status. The deferred revenues related to the immediate annuities are amortized into income during the payout period. A comparative detail of the components of universal life and investment annuity contract revenues is provided below:
Actual universal life and investment annuity deposits collected for the years ended December 31, 1997, 1996, and 1995 are detailed below. Deposits collected on these non-traditional products are not reflected as revenues in the Company's statements of earnings, as they are recorded directly to policyholder liabilities upon receipt, in accordance with generally accepted accounting principles.
The Company has implemented an investment hedging program to offset the potential higher returns required to be paid on these products. Specifically, the Company purchases index options from highly rated banks and brokerage firms. These index options act as hedges to match closely the returns based on the S&P 500 Composite Stock Price Index which may be paid to policyholders. As the equity-indexed annuity was just recently introduced, sales of this product totaled only $6 million in 1997.
While international life insurance production remains consistent, the Company's goal is to increase sales in this market. To accomplish this goal, the Company has continued to modify its market, distribution, and product strategies. The Company's plans for international products include the development of two new equity-indexed investment products similar to the equity-indexed annuity developed for the domestic market. The new products will be targeted primarily to specific South American countries for pension and retirement planning needs. The Company also plans to modify the current portfolio of international universal life products to better meet the needs in expanded market niches. For example, new life insurance products will be developed for large policy cases and with low minimum premiums specifically for business cases.
An analysis of net investment income also requires a review of market interest rates. Market interest rates declined significantly during 1995 from 1994 levels. Interest rates were somewhat volatile during 1996, but overall were at levels comparable to 1995. However, interest rates declined again in 1997 from 1996 rates. Detailed below is the Company's investment performance for 1997, 1996, and 1995, and the changes in the Company's yield reflect the changes in market interest rates. However, changes in market rates affect the Company's portfolio yield slowly because of the relative small volume of new investment purchases during a year in comparison to the size of the overall investment portfolio. Yields in 1997 were also affected by the change in the mix of the investment portfolio and by lower returns from real estate joint ventures as previously described above.
Realized Gains and Losses on Investments: The Company realized losses of $1.6 million in 1997 compared to realized gains of $1.6 million in 1996 and losses of $2.4 million in 1995. The losses in 1997 were primarily from net losses on debt securities totaling $1.2 million and writedowns on real estate and mortgage loans totaling $1.2 million, primarily related to a single foreclosure. The gains in 1996 were primarily from sales of investments in debt securities and real estate. The losses in 1995 were also primarily from sales of investments in debt securities, the majority of which were from the Company's remaining investments in principal exchange rate linked securities. The Company made the decision to realize these losses to obtain tax benefits related to the losses which were scheduled to expire on December 31, 1995. The gains and losses in 1997, 1996, and 1995 are net of writedowns on real estate and mortgage loans totaling $1,179,000, $1,026,000, and $882,000, respectively.
Amortization of Deferred Policy Acquisition Costs: This expense item represents the amortization of the costs of acquiring or producing new business, which consists primarily of agents' commissions. The majority of such costs are amortized in direct relation to the anticipated future gross profits of the applicable blocks of business. Amortization is also impacted by the level of policy surrenders. Amortization for 1997, 1996, and 1995 was $39.9 million, $30.4 million, and $33.7 million, respectively. Increases in anticipated future gross profits resulted in retrospective adjustments to deferred policy acquisition costs which lowered the amortization in 1996 relative to 1997 and 1995 amounts. Additionally, an increase in policy surrenders of 24% since 1995 contributed to the higher amortization in 1997.
Other Insurance Operating Expenses: These expenses totaled $27.6 million, $25.7 million, and $27.1 million for 1997, 1996, and 1995, respectively. The increase in expenses in 1997 is attributable to several items. Salaries expense increased during 1997 primarily due to cost of living type increases and additions of domestic marketing personnel. Legal fees were higher due to litigation related expenses, and the Company increased allowances for uncollectible agents' balances.
The significant decline in expenses in 1996 is primarily due to reduced expenses for state guaranty association assessments. The Company is subject to state guaranty association assessments in all states in which it is licensed to do business. These associations generally guarantee certain levels of benefits payable to resident policyholders of insolvent insurance companies. Most states allow premium tax credits for all or a portion of such assessments, thereby allowing potential recovery of these payments over a period of years. However, several states do not allow such credits. The National Organization of Life and Health Insurance Guaranty Associations annually publishes assessment data on nationwide life and health insurance company insolvencies. Based on this information, the Company revises its estimates for assessment liabilities relating to such insolvencies. The Company will continue to monitor and revise its estimates for assessments as additional information becomes available. Other insurance operating expenses related to state guaranty association assessments totaled $952,000, $1,146,000, and $2,371,000 for the years ended December 31, 1997, 1996, and 1995, respectively.
On September 29, 1997, the United States Bankruptcy Court, Southern District of Texas, Houston, Texas, entered an order approving claims in the amount of $56,173,000 against The Westcap Corporation and its wholly owned subsidiary, Westcap Enterprises, Inc. The claims were filed by the Board of Trustees of Community College District No. 508, County of Cook, State of Illinois (The City Colleges). The Westcap Corporation and Westcap Enterprises, Inc. have appealed this order. While The Westcap Corporation is a wholly owned brokerage subsidiary of National Western Life Insurance Company, National Western is not a party to the order or the bankruptcy proceeding.
The liquidity requirements of the Company are met primarily by funds provided from operations. Premium deposits and revenues, investment income, and investment maturities are the primary sources of funds, while investment purchases and policy benefits are the primary uses of funds. Primary sources of liquidity to meet cash needs are the Company's securities available for sale portfolio, net cash provided by operations, and bank line of credit. The Company's investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs. The Company may also borrow up to $60 million on its bank line of credit for short-term cash needs.
Stockholders' equity totaled $401 million at December 31, 1997, reflecting an increase of $48 million from 1996. The increase in capital is primarily from net earnings of $42 million. Net unrealized gains on investment securities totaling $3.9 million and a foreign currency translation adjustment of $2.5 million also contributed to the rise in stockholder's equity. Book value per share at December 31, 1997, was $114.80, reflecting a 13.6% increase for the year.
In June, 1997, the FASB issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information." This statement establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports issued to shareholders. It also establishes standards for related disclosures about products and services, geographic areas, and major customers.
In February, 1998, the FASB issued SFAS No. 132, "Employers' Disclosures about Pension and Other Postretirement Benefits." This statement revises employers' disclosures about pension and other postretirement benefit plans, but does not change the measurement or recognition of those plans. SFAS No. 132 standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in the benefit obligations and fair values of plan assets that will facilitate financial analysis, and eliminates certain less useful disclosures. The new statement also suggests combined formats for presentation of pension and other postretirement benefit disclosures.
In December, 1995, the National Association of Insurance Commissioners (NAIC) adopted for statutory accounting practices Actuarial Guideline 33, previously referred to as Actuarial Guideline GGG. This reserve guideline helps define the minimum reserves for policies with multiple benefit streams, such as two-tier annuities. The Company had been reserving for its two-tier annuities according to an agreement reached in 1993 with its state of domicile, Colorado. However, in 1995, the Company entered into discussions with the Colorado Division of Insurance (the Division) to implement Actuarial Guideline 33 and to phase it in over a three-year period as allowed by the guideline. In January, 1996, the Division approved the proposal for this three-year phase-in.
Subsequently, Actuarial Guideline 33 has undergone a review by the NAIC to clarify certain aspects of the guideline. This review resulted in a new interpretation of the guideline which becomes effective after year-end 1997. The Company has also received approval from the Division for a phase-in of this new interpretation. The effect of these two phase-in adjustments will not have a material effect on the Company's statutory capital and surplus position. Also, Actuarial Guideline 33 and the related phase-in adjustments do not affect the Company's policy reserves which are prepared under generally accepted accounting principles as reported in the accompanying consolidated financial statements.
The Company has reviewed potential costs to modify its existing systems, and such costs are not expected to exceed $200,000. A significant amount of any such costs will not be incremental costs to the Company, as internal information technology resources are primarily being used and will continue to be utilized and reallocated as needed. Also, for externally developed systems under licensing contracts, costs are primarily borne by the software developer.