The Company's brokerage subsidiary, The Westcap Corporation, leases its office facilities in Houston, Texas, under a lease which terminates in 1997. The total leased space is approximately 4,200 square feet. The annual lease costs will be approximately $74,000 and $35,000 in 1996 and 1997, respectively.
The following five-year financial summary includes comparative amounts taken from the audited financial statements. The results have been reclassified to reflect The Westcap Corporation as discontinued brokerage operations.
National Western Life Insurance Company is a life insurance company, chartered in the State of Colorado in 1956, and doing business in forty-three states and the District of Columbia. It also accepts applications from and issues policies to residents of Central and South American countries. These policies are accepted and issued in the United States and accounted for approximately 14% of the Company's total premium revenues, universal life, and investment annuity contract deposits in 1995. The primary products marketed by the Company are its universal life and single and flexible premium annuity products.
In addition to the life insurance business, the Company has a brokerage operations segment through its wholly owned subsidiary, The Westcap Corporation. However, during 1995 The Westcap Corporation closed its sales offices and approved a plan to cease all brokerage operations. Accordingly, the brokerage segment is now reported as discontinued operations throughout this report and in the accompanying financial statements.
The Company's investment philosophy is to maintain a diversified portfolio of investment grade debt and equity securities that provide adequate liquidity to meet policyholder obligations and other cash needs. The prevailing strategy within this philosophy is the intent to hold investments in debt securities to maturity. However, the Company manages its portfolio, which entails monitoring and reacting to all components which affect changes in the price, value, or credit rating of investments in debt and equity securities.
Investments in debt and equity securities are classified and reported into the following categories: held to maturity, available for sale, and trading. The reporting category chosen for the Company's securities investments depends on various factors including the type and quality of the particular security and how it will be incorporated into the Company's overall asset/liability management strategy. At December 31, 1995, approximately 26% of the Company's total debt and equity securities, based on fair values, were classified as securities available for sale. These holdings provide flexibility to the Company to react to market opportunities and conditions and to practice active management within the portfolio to provide adequate liquidity to meet policyholder obligations and other cash needs.
Securities that are not classified as either held to maturity or trading securities are reported as securities available for sale. These securities may be sold if market or other measurement factors change unexpectedly after the securities were acquired. For example, opportunities arise when factors change that allow the Company to improve the performance and credit quality of the investment portfolio by replacing an existing security with an alternative security while still maintaining an appropriate matching of expected maturities of assets and liabilities. Examples of such improvements are as follows: improving the yield earned on invested assets, improving the credit quality, changing the duration of the portfolio, and selling securities in advance of anticipated calls or other prepayments. Securities available for sale are reported in the Company's financial statements at fair value. Any unrealized gains or losses resulting from changes in the fair value of the securities are reflected as a component of stockholders' equity.
The Company's overall conservative investment philosophy is reflected in the allocation of investments of its insurance operations which is detailed below as of December 31, 1995 and 1994. The Company emphasizes debt securities, with smaller holdings in mortgage loans and real estate than industry averages.
At December 31, 1995, securities held to maturity totaled $1.643 billion, or 62.6% of total invested assets. The fair value of these securities was $1.726 billion, which reflects gross unrealized gains of $83 million. The unrealized gains within this portfolio result from decreases in market interest rates during 1995. The unrealized gains have no effect on the Company's financial statements, as securities held to maturity are recorded at amortized cost.
On December 29, 1995, the Company also transferred securities totaling $284 million to the available for sale category from securities held to maturity. This transfer resulted in an increase to stockholder's equity of $4,266,000 as of December 31, 1995, net of effects of deferred policy acquisition costs and taxes. This transfer was made to restructure the Company's portfolio to provide increased flexibility for both portfolio and asset/liability management. Accounting principles typically do not allow transfers from the held to maturity category to the available for sale category except under certain prescribed circumstances. However, in 1995 the Financial Accounting Standards Board permitted a one-time reassessment by companies of their securities classifications and allowed transfers out of the held to maturity category without regard to the prescribed circumstances. The reassessment and any resulting transfers had to be completed by December 31, 1995.
Because expected maturities of securities may differ from contractual maturities due to prepayments and calls, the Company takes steps to manage and minimize such risks. In previous years, the Company has experienced increased calls, particularly in the public utilities portfolio. As a result, the Company has been increasing its holdings in noncallable corporate securities. Corporate holdings as a percentage of the entire portfolio increased from 32.5% in 1994 to 40.3% in 1995.
In addition to managing prepayment, extension, and call risks, the Company continues to concentrate on improving the credit quality of its investments in debt securities. Much attention is often placed on a company's holdings of below investment grade debt securities, as these securities generally have greater default risk than higher rated corporate debt. These issuers usually have high levels of indebtedness and are more sensitive to adverse industry or economic conditions than are investment grade issuers. The Company's small holdings of below investment grade debt securities are summarized as follows:
The level of investments in debt securities which are in default as to principal or interest payments is indicative of the Company's minimal holdings of below investment grade debt securities. At December 31, 1995 and 1994, securities with principal balances totaling $3,575,000 and $2,415,000 were in default and on non-accrual status.
The Company seeks to minimize the credit and default risk in its mortgage loan portfolio through strict underwriting guidelines and diversification of underlying property types and geographic locations. In addition to being secured by the property, mortgage loans with leases on the underlying property are often guaranteed by the lessee, in which case the Company approves the loan based on the credit strength of the lessee. This approach, implemented in 1991, has significantly improved the quality of the Company's mortgage loan portfolio and reduced defaults.
The Company's level of mortgage loan originations declined in 1995 to approximately $18 million. This is in comparison to originations totaling $30 million and $33 million in 1994 and 1993, respectively. Market conditions in 1995 included a decreasing interest rate environment and increasing competition. As a result, mortgage loan originations declined in 1995, as the Company has maintained its strict underwriting policies and its commitment to quality loans.
The Company's direct investments in real estate are not a significant portion of its total investment portfolio, and the majority of real estate owned was acquired through mortgage loan foreclosures. However, the Company is also currently participating in several real estate joint ventures and limited partnerships. The joint ventures and partnerships invest primarily in income-producing retail properties. While not a significant portion of the Company's investment portfolio, these investments have produced favorable returns to date. The Company has no current plans to significantly increase its investments in real estate in the foreseeable future.
The Company held net investments in mortgage loans totaling $191,674,000 and $189,632,000, or 7.3% and 8.1% of total invested assets, at December 31, 1995 and 1994. The loans are real estate mortgages, substantially all of which are related to commercial properties and developments and have fixed interest rates.
As of December 31, 1995, the allowance for possible losses on mortgage loans was $5,668,000. Additions to the allowance totaling $307,000 were recognized as realized losses on investments in the Company's 1994 financial statements. No additions were made in 1995. Management believes that the allowance for possible losses is adequate. However, while management uses available information to recognize losses, future additions to the allowance may be necessary based on changes in economic conditions, particularly in the West South Central region which includes Texas, Louisiana, Oklahoma, and Arkansas, as this area contains the highest concentrations of the Company's mortgage loans.
The Company currently places all loans past due three months or more on non-accrual status, thus recognizing no interest income on the loans. At December 31, 1995 and 1994, the Company had approximately $202,000 and $2,292,000, respectively, of mortgage loan principal balances on non-accrual status. In addition to the non-accrual loans, the Company had mortgage loan principal balances with restructured terms totaling approximately $13,355,000 and $13,123,000 at December 31, 1995 and 1994, respectively. For the years ended December 31, 1995 and 1994, the reductions in interest income due to non-accrual and restructured mortgage loans were not significant.
The Company owns real estate that was acquired through foreclosure and through direct investment totaling approximately $19,066,000 and $17,766,000 at December 31, 1995 and 1994, respectively. This small concentration of properties represents less than one percent of the Company's entire investment portfolio. The real estate holdings consist primarily of income-producing properties which are being operated by the Company. The Company recognized operating income on these properties of approximately $404,000 for the year ended December 31, 1995, and operating losses of approximately $62,000 for the year ended December 31, 1994. The Company does not anticipate significant changes in these operating results in the near future.
A summary of operating results, net of taxes, for the years ended December 31, 1995, 1994, and 1993 is provided below:
Net Investment Income: During 1995, net investment income increased 6.2% from 1994 while total invested assets increased 12.0% for the same period. The increase in invested assets was primarily due to the increased annuity production as previously described. The growth in net investment income lagged the growth in invested assets for several reasons. Interest rates declined significantly throughout 1995, resulting in investments in lower yielding securities. Also, net investment income was up significantly in 1994 due to yield and amortization adjustments on mortgage-backed securities as more fully described below. There were no significant corresponding adjustments in 1995.
Life and Other Policy Benefits: Expenses in 1995 and 1993 were significantly higher at $39.8 million and $36.3 million than 1994 expenses which totaled only $32.1 million. The significant fluctuation in expenses is due to higher life insurance benefit claims and high policy surrenders on traditional insurance products in both 1995 and 1993. Life insurance benefit claims, which accounted for the majority of the fluctuation, totaled $24.6 million, $19.1 million, and $21.3 million in 1995, 1994, and 1993, respectively. The 1995 and 1993 expenses were abnormally high due to adverse claims experience. Throughout the Company's history, it has experienced both periods of higher and lower benefit claims in comparison to Company averages. Years 1995 and 1993 reflect such periods, as benefits were significantly higher. Such deviations are not uncommon in the life insurance industry and, over extended periods of time, tend to be offset by periods of more favorable claims experience.
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 1995, 1994, and 1993 has been relatively consistent at $33.7 million, $32.1 million, and $33.2 million, respectively. The higher amortization in 1995 and 1993 correlates to increased policy surrenders in those years.
Universal Life and Investment Annuity Contract Interest: Prior to 1995, interest expense declined steadily as amounts totaled $129.1 million, $130.9 million, and $135.8 million for 1994, 1993, and 1992, respectively. This decline was due to the lowering of credited interest rates on most universal life and investment annuity products throughout these years. Additional interest costs related to increasing business was not significant, as the policy liabilities remained relatively constant over those years. However, in the latter part of 1994, annuity production began to increase significantly, which continued through 1995. This increase in annuity deposits resulted in corresponding increases in policy liabilities and significantly higher interest costs in 1995. Also, the Company's new annuity products typically credit significantly higher interest rates in the first policy year, again resulting in higher 1995 interest costs.
The Company closely monitors its credited interest rates, taking into consideration such factors as profitability goals, policyholder benefits, product marketability, and economic market conditions. Rates are established or adjusted after careful consideration and evaluation of these factors against established objectives.
In connection with the plan to cease brokerage operations, Westcap's assets are being carried at their estimated fair value, and its liabilities include estimated costs to dispose of assets and estimated future costs to cease operations. As a result of the plan and in accordance with generally accepted accounting principles, the assets and liabilities of Westcap have been reclassified in the accompanying consolidated balance sheets to separately identify them as assets and liabilities of the discontinued operations.
Losses from the discontinued brokerage operations have been reflected separately from continuing operations of the Company in the accompanying consolidated financial statements. The 1995 losses disclosed above include estimated future operating losses as well as estimated costs to cease brokerage operations totaling $6,381,000 and have resulted in the complete write-off of the Company's investment in Westcap on a consolidated basis.
Cumulative Effect of Change in Accounting for Income Taxes: In February, 1992, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 109, "Accounting for Income Taxes." SFAS No. 109 requires a change from the deferred method of accounting for income taxes of Accounting Principles Board Opinion 11 to the asset and liability method of accounting for income taxes. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company also has significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows totaled $69 million, $133 million, and $486 million in 1995, 1994, and 1993, respectively. The Company again expects significant cash flows from these sources in 1996 at levels similar to 1995 and 1994.
Stockholders' equity totaled $312 million at December 31, 1995, reflecting an increase of $37 million from 1994. The increase in capital is primarily from net earnings of $19 million and the change in net unrealized gains on investment securities totaling $17 million in 1995. The decrease in market interest rates during 1995 resulted in the significant increase in unrealized gains. Book value per share at December 31, 1995, was $89.36, reflecting a 13% increase for the year.
Under the fair value based method, compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. For stock options, fair value is determined using an option pricing model that takes into account various information and assumptions regarding the Company's stock and options. Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date or other measurement date over the amount an employee must pay to acquire the stock.
In December, 1995, the National Association of Insurance Commissioners adopted for statutory accounting practices Actuarial Guideline 33, previously referred to as Actuarial Guideline GGG. This reserve guideline, which has not been adopted by any states at this time, helps define the minimum reserves for policies with multiple benefit streams, such as two-tier annuities.
As of December 31, 1995, the Company's statutory reserving practices for two-tier annuities follow an agreement reached in 1993 with its state of domicile, Colorado. This agreement requires the Company to phase-in a different reserve basis by the end of 1996. The agreement states the acceptable difference between the target reserve and the statutory reserve held by the Company will meet the following schedule:
The information required by this item is reported in Attachment A beginning on page ____. See Index to Financial Statements and Schedules on page ___ for a list of financial information included in Attachment A.