-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CxZbmS569NsAamji0z6bVe/Dm/QGN4GNvJcmjReSU8Fv9lDq7KhfJhH4qb+lF6F6 0yqJN18jQQBp8Wm00gvfbQ== 0000070684-99-000004.txt : 19990518 0000070684-99-000004.hdr.sgml : 19990518 ACCESSION NUMBER: 0000070684-99-000004 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 19990517 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL WESTERN LIFE INSURANCE CO CENTRAL INDEX KEY: 0000070684 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 840467208 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 002-17039 FILM NUMBER: 99627034 BUSINESS ADDRESS: STREET 1: 850 E ANDERSON LN CITY: AUSTIN STATE: TX ZIP: 78752-1602 BUSINESS PHONE: 5128361010 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended March 31, 1999 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________ Commission File Number: 2-17039 NATIONAL WESTERN LIFE INSURANCE COMPANY (Exact name of Registrant as specified in its charter) COLORADO 84-0467208 (State of Incorporation) (I.R.S. Employer Identification Number) 850 EAST ANDERSON LANE AUSTIN, TEXAS 78752-1602 (512) 836-1010 (Address of Principal Executive Offices) (Telephone Number) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes [ X ] No [ ] As of May 10, 1999, the number of shares of Registrant's common stock outstanding was: Class A - 3,298,928 and Class B - 200,000. NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES INDEX Part I. Financial Information: Page Item 1. Financial Statements Condensed Consolidated Balance Sheets March 31, 1999 (Unaudited) and December 31, 1998 Condensed Consolidated Statements of Earnings For the Three Months Ended March 31, 1999 and 1998 (Unaudited) Condensed Consolidated Statements of Comprehensive Income For the Three Months Ended March 31, 1999 and 1998 (Unaudited) Condensed Consolidated Statements of Stockholders' Equity For the Three Months Ended March 31, 1999 and 1998 (Unaudited) Condensed Consolidated Statements of Cash Flows For the Three Months Ended March 31, 1999 and 1998 (Unaudited) Notes to Condensed Consolidated Financial Statements (Unaudited) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Item 3. Quantitative and Qualitative Disclosures About Market Risk Part II. Other Information: Item 1. Legal Proceedings Item 6. Exhibits and Reports on Form 8-K Signatures Exhibit 11 - Computation of Earnings per Share For the Three Months Ended March 31, 1999 and 1998 (Unaudited) PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)
(Unaudited) March 31, December 31, 1999 1998 ASSETS Cash and investments: Securities held to maturity, at amortized cost $ 2,084,285 2,029,728 Securities available for sale, at fair value 732,543 735,587 Mortgage loans, net of allowances for possible losses ($4,640 and $4,640) 169,675 174,921 Policy loans 121,286 124,441 Index options 28,464 23,900 Other long-term investments 28,020 24,999 Cash and short-term investments 6,692 24,508 Total cash and investments 3,170,965 3,138,084 Accrued investment income 44,441 44,777 Deferred policy acquisition costs 328,665 314,493 Other assets 15,614 20,601 Assets of discontinued operations - 48 $ 3,559,685 3,518,003 Note: The balance sheet at December 31, 1998, has been taken from the audited financial statements at that date. See accompanying notes to condensed consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands except share amounts)
(Unaudited) March 31, December 31, 1999 1998 LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Future policy benefits: Traditional life and annuity products $ 167,007 167,248 Universal life and investment annuity contracts 2,857,818 2,812,230 Other policyholder liabilities 23,482 23,955 Federal income taxes payable: Current 5,880 5,221 Deferred 7,922 9,646 Other liabilities 51,727 61,290 Liabilities of discontinued operations - 48 Total liabilities 3,113,836 3,079,638 COMMITMENTS AND CONTINGENCIES (Note 3) STOCKHOLDERS' EQUITY: Common stock: Class A - $1 par value; 7,500,000 shares authorized; 3,298,528 and 3,298,128 shares issued and outstanding in 1999 and 1998 3,299 3,298 Class B - $1 par value; 200,000 shares authorized, issued, and outstanding in 1999 and 1998 200 200 Additional paid-in capital 24,930 24,899 Accumulated other comprehensive income 11,983 18,634 Retained earnings 405,437 391,334 Total stockholders' equity 445,849 438,365 $ 3,559,685 3,518,003 Note: The balance sheet at December 31, 1998, has been taken from the audited financial statements at that date. See accompanying notes to condensed consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS For the Three Months Ended March 31, 1999 and 1998 (Unaudited) (In thousands except per share amounts) [CAPTION] 1999 1998 Premiums and other revenue: Life and annuity premiums $ 2,411 3,110 Universal life and investment annuity contract revenues 21,532 20,300 Net investment income 57,852 55,538 Other income 150 535 Realized gains on investments 4,805 662 Total premiums and other revenue 86,750 80,145 Benefits and expenses: Life and other policy benefits 8,688 10,674 Decrease in liabilities for future policy benefits (241) (957) Amortization of deferred policy acquisition costs 9,571 8,945 Universal life and investment annuity contract interest 40,611 38,335 Other operating expenses 6,701 7,241 Total benefits and expenses 65,330 64,238 Earnings before Federal income taxes 21,420 15,907 Provision for Federal income taxes: Current 5,460 5,217 Deferred 1,857 320 Total Federal income taxes 7,317 5,537 Net earnings $ 14,103 10,370 Basic Earnings Per Share: Net earnings $ 4.03 2.97 Diluted Earnings Per Share: Net earnings $ 3.99 2.94 See accompanying notes to condensed consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the Three Months Ended March 31, 1999 and 1998 (Unaudited) (In thousands)
1999 1998 Net earnings $ 14,103 10,370 Other comprehensive income, net of effects of deferred policy acquisition costs and taxes: Unrealized losses on securities: Unrealized holding losses arising during period (4,886) (346) Less: reclassification adjustment for gains included in net earnings (1,671) - Amortization of net unrealized gains related to transferred securities (85) (323) Net unrealized losses on securities (6,642) (669) Foreign currency translation adjustments (9) 58 Other comprehensive loss (6,651) (611) Comprehensive income $ 7,452 9,759 See accompanying notes to condensed consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Three Months Ended March 31, 1999 and 1998 (Unaudited) (In thousands)
1999 1998 Common stock: Balance at beginning of year $ 3,498 3,492 Shares exercised under stock option plan 1 - Balance at end of period 3,499 3,492 Additional paid-in capital: Balance at beginning of year 24,899 24,662 Shares exercised under stock option plan 31 - Balance at end of period 24,930 24,662 Accumulated other comprehensive income: Unrealized gains (losses) on securities: Balance at beginning of year 16,000 13,782 Change in unrealized gains (losses) during period (6,642) (669) Balance at end of period 9,358 13,113 Foreign currency translation adjustments: Balance at beginning of year 2,634 2,486 Change in translation adjustments during period (9) 58 Balance at end of period 2,625 2,544 Accumulated other comprehensive income at end of period 11,983 15,657 Retained earnings: Balance at beginning of year 391,334 356,441 Net earnings 14,103 10,370 Balance at end of period 405,437 366,811 Total stockholders' equity $ 445,849 410,622 See accompanying notes to condensed consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS For the Three Months Ended March 31, 1999 and 1998 (Unaudited) (In thousands)
1999 1998 Cash flows from operating activities: Net earnings $ 14,103 10,370 Adjustments to reconcile net earnings to net cash from operating activities: Universal life and investment annuity contract interest 40,611 38,335 Surrender charges and other policy revenues (11,066) (10,415) Realized gains on investments (4,805) (662) Accrual and amortization of investment income (1,207) (1,870) Depreciation and amortization 265 242 Decrease (increase) in insurance receivables and other assets 4,925 (151) Decrease in accrued investment income 336 330 Increase in deferred policy acquisition costs (5,884) (1,714) Decrease in liability for future policy benefits (241) (957) Decrease in other policyholder liabilities (473) (457) Increase in Federal income taxes payable 2,516 4,026 Increase (decrease) in other liabilities (9,563) 5,919 Other (1,073) (1,270) Net cash provided by operating activities 28,444 41,726 Cash flows from investing activities: Proceeds from sales of: Securities held to maturity - 2,978 Securities available for sale 24,446 - Other investments 5,585 391 Proceeds from maturities and redemptions of: Securities held to maturity 24,763 27,394 Securities available for sale 17,181 18,079 Purchases of: Securities held to maturity (78,744) (49,476) Securities available for sale (53,699) (41,263) Other investments (10,370) (1,540) Principal payments on mortgage loans 13,584 9,016 Cost of mortgage loans acquired (8,282) (3,211) Decrease in policy loans 3,155 2,029 Decrease in assets of discontinued operations 48 118 Decrease in liabilities of discontinued operations (48) (118) Other (50) (138) Net cash used in investing activities (62,431) (35,741) (Continued on next page)
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED For the Three Months Ended March 31, 1999 and 1998 (Unaudited) (In thousands)
1999 1998 Cash flows from financing activities: Deposits to account balances for universal life and investment annuity contracts $ 109,827 74,784 Return of account balances on universal life and investment annuity contracts (93,688) (86,143) Issuance of common stock under stock option plan 32 - Net cash provided by (used in) financing activities 16,171 (11,359) Net decrease in cash and short-term investments (17,816) (5,374) Cash and short-term investments at beginning of year 24,508 7,870 Cash and short-term investments at end of period $ 6,692 2,496 See accompanying notes to condensed consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (1) BASIS OF PRESENTATION The accompanying condensed consolidated financial statements include the accounts of National Western Life Insurance Company and its wholly-owned subsidiaries (the Company), The Westcap Corporation (Westcap), NWL Investments, Inc., NWL Properties, Inc., NWL 806 Main, Inc., NWL Services, Inc., and NWL Financial, Inc. The Westcap Corporation ceased brokerage operations during 1995 and filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code in 1996. As a result, The Westcap Corporation is reflected as discontinued operations in the accompanying financial statements for 1998 and prior years. The bankruptcy reorganization was completed in January, 1999 and National Western retained 100% continuing ownership of the reorganized subsidiary. Westcap is now operating as a real estate management company. All significant intercorporate transactions and accounts have been eliminated in consolidation. In the opinion of the Company, the accompanying consolidated financial statements contain all adjustments necessary to present fairly the financial position of the Company as of March 31, 1999, and the results of its operations and its cash flows for the three months ended March 31, 1999 and 1998. The results of operations for the three months ended March 31, 1999 and 1998 are not necessarily indicative of the results to be expected for the full year. (2) STOCKHOLDERS' EQUITY (A) Changes in Common Stock Shares Outstanding Details of changes in shares of common stock outstanding are provided below:
Three Months Ended March 31, 1999 1998 (In thousands) Common stock shares outstanding: Shares outstanding at beginning of year 3,498 3,492 Shares exercised under stock option plan 1 - Shares outstanding at end of peroid 3,499 3,492
(B) Dividends The Company paid no cash dividends on common stock during the three months ended March 31, 1999 and 1998. (3) DISCONTINUED BROKERAGE OPERATIONS The Chapter 11 bankruptcy reorganization of the Company's wholly owned subsidiary, The Westcap Corporation, was completed in the first quarter of 1999. Pursuant to the reorganization plan, National Western retained 100% continuing ownership of the reorganized Westcap and the subsidiary is now operating as a real estate management company. No losses were reported for discontinued brokerage operations in the first quarter of 1999 as the entire $14,125,000 settlement payment was accrued and reported as a loss in the third quarter of 1998. Any additional losses will depend on the results of The City Colleges lawsuit filed against National Western on March 28, 1994, for alleged federal or state securities law "control person" violations relating to Westcap, and which is pending in the United States District Court, Western District of Texas. National Western believes it has reasonable and adequate defenses to this suit and, accordingly, no amounts have been accrued in National Western's financial statements for potential losses relating to such suit. (4) SEGMENT AND OTHER OPERATING INFORMATION The Company's reportable operating segments include domestic life insurance, international life insurance, and annuities. These segments are organized based on product types and geographic marketing areas. A summary of segment information for the quarters ended March 31, 1999 and 1998 is provided below. Selected Segment Information:
Domestic International Life Life All Insurance Insurance Annuities Others Totals (In thousands) March 31, 1999: Premiums and contract revenues $ 5,791 10,228 7,924 - 23,943 Net investment income 6,331 5,443 45,896 182 57,852 Other income 16 12 122 - 150 Universal life and investment annuity contract interest 2,449 3,433 34,729 - 40,611 Amortization of deferred policy acquisition costs 932 3,279 5,360 - 9,571 Federal income taxes 1,069 724 3,781 61 5,635 Segment earnings 2,082 1,410 7,367 121 10,980 Segment assets 408,548 372,867 2,730,023 32,634 3,544,072 March 31, 1998: Premiums and contract revenues $ 5,845 9,585 7,980 - 23,410 Net investment income 6,506 5,377 43,709 (54) 55,538 Other income 454 8 73 - 535 Universal life and investment annuity contract interest 2,431 3,288 32,616 - 38,335 Amortization of deferred policy acquisition costs 464 2,842 5,639 - 8,945 Federal income taxes 1,268 485 3,571 (19) 5,305 Segment earnings 2,375 909 6,691 (35) 9,940 Segment assets 406,528 364,602 2,459,066 13,512 3,243,708
Reconciliations of segment information to the Company's consolidated financial statements are provided below:
Three Months Ended March 31, 1999 1998 (In thousands) Premiums and Other Revenue: Premiums and contract revenues $ 23,943 23,410 Net investment income 57,852 55,538 Other income 150 535 Realized gains on investments 4,805 662 Total consolidated premiums and other revenue $ 86,750 80,145
Three Months Ended March 31, 1999 1998 (In thousands) Federal Income Taxes: Total segment Federal income taxes $ 5,635 5,305 Taxes on realized gains on investments 1,682 232 Total consolidated Federal income taxes $ 7,317 5,537
Three Months Ended March 31, 1999 1998 (In thousands) Net Earnings: Total segment earnings $ 10,980 9,940 Realized gains on investments, net of taxes 3,123 430 Total consolidated net earnings $ 14,103 10,370
March 31, 1999 1998 (In thousands) Assets: Total segment assets $ 3,544,072 3,243,708 Assets of discontinued operations - 774 Other unallocated assets 15,613 15,433 Total consolidated assets $ 3,559,685 3,259,915
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL 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 various Central and South American, Caribbean, and Pacific Rim countries. A distribution of the Company's direct premium revenues and deposits by domestic and international markets is provided below:
Three Months Ended March 31, 1999 1998 United States domestic market: Investment annuities 82.5 % 77.3 % Life insurance 5.7 8.6 Total domestic market 88.2 85.9 International market: Investment annuities 1.1 - Life insurance 10.7 14.1 Total international market 11.8 14.1 Total direct premiums collected 100.0 % 100.0 %
Insurance Operations - Domestic The Company's domestic operations concentrate 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 equity-indexed annuities. Most of these annuities can be sold as tax qualified or nonqualified products. National Western markets and distributes its domestic products primarily through independent marketing organizations (IMOs). These IMOs assist the Company in recruiting, contracting, and supervising agents. The Company currently has over 80 IMOs contracted for sales of life and annuity products. These IMOs are expected to meet minimum production standards set by the Company. Insurance Operations - International The Company's international operations focus marketing efforts on foreign nationals in upper socioeconomic classes with substantial financial resources. Insurance sales are on insureds from countries in Central and South America, the Caribbean, and the Pacific Rim. Policy sales on insureds from numerous countries in these different regions provides diversification that helps to minimize large fluctuations in sales that can occur due to various economic, political, and competitive pressures that may occur from one country to another. Products sold in the international market are almost entirely universal life and traditional life insurance products. However, certain annuity and investment contracts are also available in this market. International sales production is from broker-agents, many of whom have been selling National Western products for 20 or more years. The Company continues to expand its sales networks in specifically targeted South American and Pacific Rim countries which have higher growth potential than other countries. There are inherent risks of conducting international business that are not present within the domestic market. The risks involved with international business are reduced substantially by the Company in several ways. As previously described, the Company focuses its marketing efforts on a specific niche group, which is foreign nationals in upper socioeconomic classes who have substantial financial resources. This targeted customer base coupled with National Western's conservative, yet competitive, underwriting practices have historically resulted in claims experience similar to that in the United States. The Company also minimizes exposure to foreign currency risks, as almost all foreign policies require payment of premiums and claims in United States dollars. Finally, the Company's experience in the international market and its strong broker-agent relationships, which in many cases exceed 20 years, help minimize risks and problems when selling products to foreign nationals. INVESTMENTS IN DEBT AND EQUITY SECURITIES Investment Philosophy 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 as either securities held to maturity or securities available for sale. The Company does not maintain a portfolio of trading securities. 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 March 31, 1999, approximately 25.5% 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 the Company purchases with the intent to hold to maturity are classified as securities held to maturity. Because the Company has strong cash flows and matches expected maturities of assets and liabilities, the Company has the ability to hold the securities, as it would be unlikely that forced sales of securities would be required prior to maturity to cover payments of liabilities. As a result, securities held to maturity are carried at amortized cost less declines in value that are other than temporary. However, certain situations may change the Company's intent to hold a particular security to maturity, the most notable of which is a deterioration in the issuer's creditworthiness. Accordingly, a security may be sold to avoid a further decline in realizable value when there has been a significant change in the credit risk of the issuer. Securities that are not classified as held to maturity 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 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 in accumulated other comprehensive income. As an integral part of its investment philosophy, the Company performs an ongoing process of monitoring the creditworthiness of issuers within the investment portfolio. Review procedures are also performed on securities that have had significant declines in fair value. The Company's objective in these circumstances is to determine if the decline in fair value is due to changing market expectations regarding inflation and general interest rates or other factors. Additionally, the Company closely monitors financial, economic, and interest rate conditions to manage prepayment and extension risks in its mortgage-backed securities portfolio. The Company's overall conservative investment philosophy is reflected in the allocation of its investments which is detailed below as of March 31, 1999 and December 31, 1998. The Company emphasizes investment grade debt securities, with smaller holdings in mortgage loans and real estate.
Percent of Investments March 31, December 31, 1999 1998 Debt securities 88.3% 87.6% Mortgage loans 5.4 5.6 Policy loans 3.8 4.0 Index options 0.9 0.8 Equity securities 0.5 0.5 Real estate 0.4 0.4 Other 0.7 1.1 Totals 100.0% 100.0%
Portfolio Analysis The Company maintains a diversified debt securities portfolio which consists of various types of fixed income securities including primarily corporate, mortgage-backed securities, and public utilities. Investments in mortgage-backed securities include primarily U.S. government agency pass-through securities and collateralized mortgage obligations (CMOs). At March 31, 1999, the Company's debt and equity securities were classified as follows:
Fair Amortized Unrealized Value Cost Gains (In thousands) Securities held to maturity: Debt securities $ 2,143,302 2,084,285 59,017 Securities available for sale: Debt securities 714,755 697,365 17,390 Equity securities 17,788 14,183 3,605 Totals $ 2,875,845 2,795,833 80,012
As detailed above, debt securities classified as held to maturity comprise the majority of the Company's securities portfolio, while equity securities are a small component of the portfolio. Unrealized gains totaling $80,012,000 on the securities portfolio at March 31, 1999, is a reflection of market interest rates at quarter-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. An analysis of unrealized gains and losses on the Company's securities portfolio for the quarter ended March 31, 1999, is detailed below:
Change in Unrealized Unrealized Gains Gains At At (Losses) March 31, December 31, During 1st 1999 1998 Quarter 1999 (In thousands) Securities held to maturity: Debt securities $ 59,017 94,987 (35,970) Securities available for sale: Debt securities 17,390 35,560 (18,170) Equity securities 3,605 3,694 (89) Totals $ 80,012 134,241 (54,229)
Changes in interest rates typically have a significant impact on the market values of the Company's debt securities. Unrealized gains at March 31, 1999, decreased 40% from year-end 1998 as market interest rates of the ten year U.S. Treasury bond increased approximately 60 basis points during the quarter. Because the majority of the Company's debt securities are classified as held to maturity, which are recorded at amortized cost, changes in market values have relatively small effects on the Company's financial statements. Also, the Company has the intent and ability to hold these securities to maturity, and it is unlikely that sales of such securities would be required which would realize market gains or losses. Changes in fair values of securities due to changes in market interest rates is an example of market risk. Market risk is the risk of change in market values of financial instruments due to changes in interest rates, currency exchange rates, commodity prices, or equity prices. The most significant market risk exposure for National Western is interest rate risk. The Company manages interest rate risk through on-going cash flow testing required for insurance regulatory purposes. Computer models are used to perform cash flow testing under various commonly used stress test interest rate scenarios to determine if existing assets would be sufficient to meet projected liability outflows. Management strives to closely match the durations of its assets and liabilities. Sensitivity analysis allows the Company to measure the potential gain or loss in fair value of its interest-sensitive instruments and to seek to protect its economic value and achieve a predictable spread between what is earned on invested assets and what is paid on liabilities. The Company seeks to minimize the impact of interest risk through surrender charges that are imposed to discourage policy surrenders. Interest rate changes can be anticipated and risk may be limited due to management actions regarding asset and liability instruments. However, potential changes in the values of financial instruments indicated by hypothetical interest changes will likely be different from actual changes experienced, and the differences may be material. Market risk-sensitive assets include debt securities, equity securities which are almost entirely preferred stocks, mortgage loans, policy loans, and index options. The Company does not maintain a securities trading portfolio. Market risk- sensitive liabilities include policy liabilities for deferred and immediate investment annuity contracts and supplemental contracts. Sensitivity analysis expresses the potential gain or loss in fair value, over a selected time period, from one or more selected hypothetical changes in interest rates which are reasonably possible in the near term. The Company performed detailed sensitivity analysis at December 31, 1998, for its interest rate-sensitive assets. Based on the recent increase in market interest rates as previously described above, the changes in market values of the Company's assets are within the expected range of results of this analysis. In addition to the securities described above, the Company invests in index options which are derivative financial instruments used to hedge the equity return component of the Company's equity-indexed annuities. The values of these options are primarily impacted by equity price risk, as the options' fair values are dependent on the performance of the S&P 500 Composite Stock Price Index. However, increases or decreases in investment returns from these options are directly offset by corresponding increases or decreases in amounts paid to equity-indexed annuity policyholders. The Company's market risk liabilities, which include policy liabilities for investment annuity and supplemental contracts, are managed for interest rate risk through cash flow testing as previously described. As part of this cash flow testing, the Company has analyzed the potential impact on net earnings of a 100 basis point decline in the U.S. Treasury yield curve as of December 31, 1998. This interest rate decline would reduce net earnings for 1999 by less than $200,000 based on the Company's projections. This estimated earnings decline is net of tax benefits determined at a tax rate of 35%. The Company has modeled this scenario, as a decline in market interest rates could pose potential risks to the current profitability levels of this business. A downward movement in interest rates is also a reasonably possible near-term scenario. The risks from such a change are primarily due to possible lower interest rate spreads which are the differences between investment income earned and credited interest paid to policyholders. However, the relatively small projected impact to earnings of the interest rate change is a reflection on the effectiveness of the Company's asset/liability and interest risk management. Another important aspect of the Company's investment philosophy is managing the cash flow stability of the portfolio. Because expected maturities of securities may differ from contractual maturities due to prepayments, extensions, and calls, the Company takes steps to manage and minimize such risks. The Company continues to invest primarily in corporate debt securities, many of which are noncallable, which helps reduce prepayment and call risks. At March 31, 1999, corporate and public utility securities represented over 67% of the entire debt securities portfolio. Mortgage-backed securities are also an important component of the Company's debt securities portfolio, representing 22% of the portfolio at March 31, 1999. Although holdings of mortgage-backed securities are subject to prepayment and extension risks, both of these risks are addressed by specific portfolio management strategies which add stability to the Company's cash flow management. The Company substantially reduces both prepayment and extension risks of mortgage-backed securities by investing primarily in collateralized mortgage obligations which have more predictable cash flow patterns than pass-through securities. These securities, known as planned amortization class I (PAC I) CMOs, are designed to amortize in a more predictable manner than other CMO classes or pass-throughs. Using this strategy, the Company can more effectively manage and reduce prepayment and extension risks, thereby helping to maintain the appropriate matching of the Company's assets and liabilities. As of March 31, 1999, CMOs represent about 93% of the Company's mortgage- backed securities. 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. In addition to managing prepayment, extension, and call risks, the Company closely manages the credit quality of its investments in debt securities. Thorough credit analysis is performed on potential corporate investments including examinations of a company's credit and industry outlook, financial ratios and trends, and event risks. The Company continues to follow its conservative investment philosophy by minimizing its holdings of below investment grade debt securities, as these securities generally have greater default risk than higher rated corporate debt. These issuers usually 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 below.
Below Investment Grade Debt Securities % of Carrying Fair Invested Value Value Assets (In thousands) March 31, 1999 $ 55,003 53,709 1.7% December 31, 1998 $ 44,974 45,317 1.4% December 31, 1997 $ 41,149 41,969 1.4%
The Company's strong credit risk management and commitment to quality has resulted in minimal defaults in the debt securities portfolio in recent years. At March 31, 1999, and December 31, 1998, no securities were in default and on nonaccrual status. MORTGAGE LOANS AND REAL ESTATE Investment Philosophy In general, the Company seeks loans on high quality, income producing properties such as shopping centers, freestanding retail stores, office buildings, industrial and sales or service facilities, selected apartment buildings, motels, and health care facilities. The location of these loans is typically in growth areas that offer a potential for property value appreciation. These growth areas are found primarily in major metropolitan areas, but occasionally in selected smaller communities. 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 has resulted in higher quality mortgage loans with fewer defaults. While mortgage loans remain an important component of the Company's investment portfolio, loans as a percentage of the portfolio have been declining in recent years. Competition for high quality mortgage loans in a declining interest rate environment has impacted the Company's level of mortgage loan originations, and the Company is unwilling to compromise its strict underwriting guidelines to maintain specific mortgage loan levels. 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 also participates in several real estate joint ventures and limited partnerships. The joint ventures and partnerships invest primarily in income-producing retail properties. Portfolio Analysis The Company held net investments in mortgage loans totaling $169,675,000 and $174,921,000, or 5.4% and 5.6% of total invested assets, at March 31, 1999, and December 31, 1998, respectively. The loans are real estate mortgages, substantially all of which are related to commercial properties and developments and have fixed interest rates. The diversification of the mortgage loan portfolio by geographic regions of the United States and by property type as of March 31, 1999, and December 31, 1998, was as follows:
March 31, December 31, 1999 1998 West South Central 58.8% 57.1% Mountain 20.4 19.4 Pacific 7.8 7.7 South Atlantic 5.5 4.8 East South Central 4.7 4.6 Middle Atlantic 2.3 2.2 Other 0.5 4.2 Totals 100.0% 100.0%
March 31, December 31, 1999 1998 Retail 56.8% 56.7% Office 22.3 21.0 Hotel/Motel 8.0 7.9 Land/Lots 3.6 4.1 Apartment 3.2 4.2 Nursing Homes 3.0 3.0 Other 3.1 3.1 Totals 100.0% 100.0%
As of March 31, 1999, the allowance for possible losses on mortgage loans was $4,640,000. No additions were made to the allowance in the first quarter of 1999. Although management believes that the current balance is adequate, 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 nonaccrual status, thus recognizing no interest income on the loans. Also, the Company will at times restructure mortgage loans under certain conditions which may involve changes in interest rates, payment terms, or other modifications. For the three months ended March 31, 1999 and 1998, the reductions in interest income due to nonaccrual and restructured mortgage loans were not significant. The Company owns real estate that was acquired through foreclosure and through direct investment totaling approximately $11,547,000 and $13,553,000 at March 31, 1999, and December 31, 1998, 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 $283,000 and $122,000 for the three months ended March 31, 1999 and 1998. The Company does not anticipate significant changes in these operating results in the near future. Also during the first quarter of 1999, the Company sold a real estate property resulting in a realized gain on investments totaling $1,419,000. The Company monitors the conditions and market values of these properties on a regular basis. No significant realized losses were recognized due to declines in values of properties for the three months ended March 31, 1999 and 1998, respectively. The Company makes repairs and capital improvements to keep the properties in good condition and will continue this maintenance as needed. RESULTS OF OPERATIONS Consolidated Operations Summary of Consolidated Operating Results A summary of operating results for the three months ended March 31, 1999 and 1998 is provided below:
Three Months Ended March 31, 1999 1998 (In thousands except per share data) Revenues: Revenues, excluding realized gains on investments $ 81,945 79,483 Realized gains on investments 4,805 662 Total revenues $ 86,750 80,145 Earnings: Earnings from operations $ 10,980 9,940 Net realized gains on investments 3,123 430 Net earnings $ 14,103 10,370 Basic Earnings Per Share: Earnings from operations $ 3.14 2.85 Net realized gains on investments 0.89 0.12 Net earnings $ 4.03 2.97 Diluted Earnings Per Share: Earnings from operations $ 3.11 2.82 Net realized gains on investments 0.88 0.12 Net earnings $ 3.99 2.94
Consolidated Operating Results: Earnings from operations, excluding net realized gains on investments, were $10,980,000 for the quarter ended March 31, 1999, compared to $9,940,000 for the first quarter of 1998. This reflects an increase of $1,040,000, or 10.5%, over 1998 first quarter earnings. Several factors contributed to the increase in earnings. Universal life and annuity contract revenues increased 6.1% from the first quarter of 1998 and life insurance benefit claims were significantly lower. Life insurance benefit claims were 27.1% lower in the first quarter of 1999 compared to the 1998 first quarter in which claims were higher than historical averages. The Company recorded realized gains on investments, net of taxes, totaling $3,123,000 for the quarter ended March 31, 1999, compared to gains of $430,000 for the first quarter of 1998. The 1999 gains were primarily from sales and calls of investments in debt securities totaling $1,687,000, net of taxes. Also included in 1999 was a net gain totaling $922,000 from the sale of investment real estate owned by one of National Western's subsidiaries, NWL 806 Main, Inc. As previously reported, the bankruptcy reorganization of the Company's wholly owned subsidiary, The Westcap Corporation, was completed in the first quarter of 1999. Pursuant to the reorganization plan, National Western retained 100% continuing ownership of the reorganized Westcap and the subsidiary is now operating as a real estate management company. No losses were reported for discontinued brokerage operations in the first quarter of 1999 as the entire $14,125,000 settlement payment was accrued and reported as a loss in the third quarter of 1998. Net Investment Income: Net investment income increased 4.2% from the first quarter of 1998, due primarily to corresponding increases in invested assets for the same period and due to other investment income from index options used to hedge the equity return component of the Company's equity-indexed annuity products. The increase in invested assets was primarily from debt securities. The Company experienced declines in investment income from mortgage loans which is consistent with decreases in mortgage loans as previously described. A detail of net investment income is provided below:
Three Months Ended March 31, 1999 1998 (In thousands) Investment income: Debt securities $ 50,379 47,336 Mortgage loans 4,248 4,488 Policy loans 2,111 2,425 Index options 1,575 1,270 Other investment income 832 607 Total investment income 59,145 56,126 Investment expenses 1,293 588 Net investment income $ 57,852 55,538
Other Income: Other income decreased significantly from $535,000 in 1998 to $150,000 in 1999. The higher income in 1998 was due to proceeds received from the U.S. government related to previous litigation involving a failed savings and loan institution. The litigation related to the Company's previous investment in bonds of the financial institution and subsequent losses incurred upon its failure. Realized Gains and Losses on Investments: The Company recorded realized gains of $4,805,000 and $662,000 in the first quarters of 1999 and 1998, respectively. As previously described, the 1999 gains were primarily from sales and calls of investments in debt securities totaling $2,595,000 and a gain of $1,419,000 from the sale of investment real estate. The gains in 1998 were primarily from debt securities that were called. Life and Other Policy Benefits: Expenses in 1999 and 1998 were $8.7 million and $10.7 million, respectively. The significant decrease in expenses is due to lower life insurance benefit claims. Mortality claims experience fluctuates from period to period, and such deviations are not uncommon in the life insurance industry. Over extended periods of time, higher claims experience tends to be offset by periods of lower claims experience. The Company utilizes reinsurance to help minimize its exposure to adverse mortality experience. The Company's general policy is to reinsure amounts in excess of $200,000 on the life of any one individual. A comparative detail of life and other policy benefits is provided below:
Three Months Ended March 31, 1999 1998 (In thousands) Life insurance benefit claims $ 5,524 7,578 Surrenders of traditional products 2,460 2,642 Other policy benefits 704 454 Totals $ 8,688 10,674
Universal Life and Investment Annuity Contract Interest: 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. Average credited rates, calculated based on policy reserves for the Company's universal life and investment annuity business, have declined since 1996, which is consistent with declines in market interest rates. As market interest rates fluctuate, the Company's credited interest rates are often adjusted accordingly, while also taking into consideration other factors as described above. Contract interest totaled $40.6 million and $38.3 million for the quarters ended March 31, 1999 and 1998, respectively. The increase is primarily attributable to interest totaling $4.7 million for the Company's equity-indexed annuity products. As previously described, the Company purchases index options to provide the potential higher interest to be credited on these products. The income provided by the index options substantially offsets the interest credited to the policyholders. Other Insurance Operating Expenses: These expenses totaled $6,701,000 and $7,241,000 for the quarters ended March 31, 1999 and 1998, respectively. Included in 1998 expenses is a $200,000 lawsuit settlement payment by National Western to San Patricio County, Texas. The lawsuit arose from derivative investments purchased by San Patricio County from affiliates of The Westcap Corporation. As part of the settlement, National Western received a general release of all claims asserted with no admission of liability. Federal Income Taxes: Federal income taxes include no unusual items as effective tax rates for the quarters ended March 31, 1999 and 1998 were 34.2% and 34.8%, respectively. Segment Operations Summary of Segment Earnings A summary of segment earnings for the quarters ended March 31, 1999 and 1998 is provided below. The segment earnings exclude realized gains and losses on investments, net of taxes.
Domestic International Life Life All Insurance Insurance Annuities Others Totals (In thousands) Segment earnings (losses): March 31, 1999 $ 2,082 1,410 7,367 121 10,980 March 31, 1998 2,375 909 6,691 (35) 9,940
Domestic Life Insurance Operations The Company's domestic life insurance operations concentrate marketing efforts on federal employees, seniors, and specific employee groups in private industry, as well as individual sales. The products marketed are universal life insurance and traditional life insurance, which includes both term and whole life products. National Western markets and distributes its domestic products primarily through independent agents and brokers and independent marketing organizations (IMOs). The IMOs also assist the Company in recruiting, contracting, and supervising agents as well as providing additional financial resources for product marketing. Geographically, the domestic life insurance operations market products in most of the United States, which encompasses 43 states and the District of Columbia. The states in which the Company does not conduct business are primarily in the northeast and include Connecticut, Delaware, Massachusetts, New Hampshire, New Jersey, New York, and Vermont. Earnings for the domestic life insurance operating segment were $2,082,000 and $2,375,000 for the three months ended March 31, 1999 and 1998, respectively. The slight decrease in earnings in 1999 is primarily due to higher amortization of deferred policy acquisition costs and lower other income. However, these fluctuations were substantially offset by lower life insurance benefit claims and other operating expenses during the first quarter of 1999. A detailed analysis of significant revenues and expenses for this segment is provided below. Revenues from domestic life insurance operations include life insurance premiums on traditional type products and revenues from universal life insurance. The Company's current marketing efforts focus more on universal life insurance, and, as a result, revenues from these products continue to increase over traditional products. Revenues from traditional products are simply premiums collected, while revenues from universal life insurance consist of policy charges for the cost of insurance, policy administration fees, and surrender charges assessed during the period. A comparative detail of premiums and contract revenues is provided below:
Three Months Ended March 31, 1999 1998 (In thousands) Universal life insurance: Cost of insurance $ 2,837 2,547 Surrender charges 406 480 Policy fees and other revenues 308 336 Traditional life insurance premiums 2,240 2,482 Totals $ 5,791 5,845
Actual universal life insurance deposits collected for the quarters ended March 31, 1999 and 1998 are detailed below. Deposits collected on these nontraditional 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.
Three Months Ended March 31, 1999 1998 (In thousands) Universal life insurance: First year and single premiums $ 1,105 1,730 Renewal premiums 3,769 3,569 Totals $ 4,874 5,299
Other income for the quarters ended March 31, 1999 and 1998 totaled $16,000 and $454,000, respectively. Other income was higher in 1998 primarily due to proceeds totaling $444,000 received from the U.S. government related to previous litigation involving a failed savings and loan institution. The litigation involved the Company's previous investment in bonds of the financial institution and subsequent losses incurred upon its failure. The financial institution had also purchased life insurance from National Western, the cash values of which served as collateral for the bonds. Significant expenses for domestic life insurance operations are summarized below:
Three Months Ended March 31, 1999 1998 (In thousands) Life insurance benefit claims $ 2,838 4,319 Universal life insurance contract interest 2,449 2,431 Amortization of deferred policy acquisition costs 932 464 Other operating expenses 2,062 2,392
Life insurance benefit claims were significantly lower in 1999 at $2,838,000 compared to $4,319,000 in 1998. The 1998 benefit claims were higher than historical averages. Mortality claims experience fluctuates from period to period, and such deviations are not uncommon in the life insurance industry. Over extended periods of time, higher claims experience tends to be offset by periods of lower claims experience. Additionally, the Company utilizes reinsurance to help minimize its exposure to adverse mortality experience. The Company's general policy is to reinsure amounts in excess of $200,000 on the life of any one individual. Universal life insurance contract interest has remained relatively constant at $2,449,000 in 1999 compared to $2,431,000 in 1998. The small growth in the domestic block of business has resulted in relatively stable overall interest. Amortization of deferred policy acquisition costs has increased from $464,000 in 1998 to $932,000 in 1999. These expenses represent 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. International Life Insurance Operations The Company's international life insurance operations focus marketing efforts on foreign nationals in upper socioeconomic classes with substantial financial resources. Insurance sales are primarily on insureds from countries in Central and South America, the Caribbean, and the Pacific Rim. Policy sales on insureds from numerous countries in these different regions provides diversification that helps to minimize large fluctuations in sales that can occur due to various economic, political, and competitive pressures that may occur from one country to another. Historically, the top three countries in insurance sales have often been Argentina, Chile, and Peru. Products sold in the international market include both universal life and traditional life insurance products. The Company minimizes exposure to foreign currency risks, as almost all foreign policies require payment of premiums and claims in United States dollars. Sales production from the international market is from independent broker-agents, many of whom have been selling National Western products for 20 or more years. Earnings for the international life insurance operating segment were $1,410,000 and $909,000 for the quarters ended March 31, 1999 and 1998, respectively. Earnings in 1999 were higher primarily due to increases in universal life insurance revenues and lower life insurance benefit claims. The higher earnings were somewhat tempered by higher amortization of deferred policy acquisition costs and other operating expenses. A detailed analysis of significant revenues and expenses for this segment is provided below. As with domestic operations, revenues from the international life insurance segment include both premiums on traditional type products and revenues from universal life insurance. The international operations' marketing efforts are also focused more on universal life insurance, and, as a result, revenues from these products continue to increase over traditional products. Cost of insurance revenues continue to increase as the international block of business grows. Surrender charge revenues were also higher in 1999 as international surrenders increased during the first quarter of 1999. A comparative detail of premiums and contract revenues is provided below:
Three Months Ended March 31, 1999 1998 (In thousands) Universal life insurance: Cost of insurance $ 7,221 6,651 Surrender charges 1,956 1,487 Policy fees and other revenues 898 839 Traditional life insurance premiums 153 608 Totals $ 10,228 9,585
Actual universal life insurance deposits collected for the quarters ended March 31, 1999 and 1998 are detailed below. Deposits collected on these nontraditional 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.
Three Months Ended March 31, 1999 1998 (In thousands) Universal life insurance: First year and single premiums $ 2,569 2,588 Renewal premiums 8,486 7,728 Totals $ 11,055 10,316
Significant expenses for international life insurance operations are summarized below:
Three Months Ended March 31, 1999 1998 (In thousands) Life insurance benefit claims $ 2,686 3,259 Universal life insurance contract interest 3,433 3,288 Amortization of deferred policy acquisition costs 3,279 2,842 Other operating expenses 2,135 1,722
Life insurance benefit claims were abnormally high in 1998 at $3,259,000 compared to $2,686,000 in 1999. As previously described for domestic life insurance operations, mortality claims fluctuate from period to period. These deviations, which can at times be significant, are not uncommon in the life insurance industry. Universal life insurance contract interest increased slightly from $3,288,000 in 1998 to $3,433,000 in 1999. The increase in contract interest is consistent with growth in the universal life insurance business. Amortization of deferred policy acquisition costs was significantly higher in 1999, totaling $3,279,000 compared to $2,842,000 in 1998. This increase is consistent with the increase in policy surrenders for the first quarter of 1999 as previously described. Annuity Operations The Company's annuity operations are almost exclusively in the United States. Like the Company's domestic life insurance operations, annuities are marketed in 43 states and the District of Columbia using independent agents, brokers, and independent marketing organizations (IMOs). In fact, many of the agents, brokers, and IMOs that sell life insurance also sell annuities for National Western. For most of these organizations, annuity sales are much more significant and are the primary focus of their business operations. Although some of the Company's annuities are available in the international market, current sales are insignificant to total annuity sales. Annuities sold include single and flexible premium deferred annuities, single premium immediate annuities, and equity-indexed annuities. These products can be tax qualified or nonqualified annuities. In recent years the majority of annuities sold have been nonqualified deferred annuities. The Company also continues to collect additional premiums on existing two-tier annuities, as a large portion of the two-tier block of business is flexible premium annuities on which renewal premiums continue to be collected. However, the Company has not sold two-tier annuities since 1992. Earnings for the annuity operating segment were $7,367,000 and $6,691,000 for the quarters ended March 31, 1999 and 1998, respectively. Earnings for 1999 were up from 1998 primarily due to lower amortization of deferred policy acquisition costs and other operating expenses. A detailed analysis of significant revenues and expenses for this segment is provided below. Revenues from annuity operations include primarily surrender charges and recognition of deferred revenues relating to immediate or payout annuities. Annuitizations result in transfers of policies from deferred to immediate or payout status. The deferred revenues related to these annuities are amortized into income during the payout period. A comparative detail of the components of premiums and annuity contract revenues is provided below.
Three Months Ended March 31, 1999 1998 (In thousands) Surrender charges: Two-tier annuities $ 4,643 4,830 Single-tier annuities 1,829 1,491 Total surrender charges 6,472 6,321 Payout annuity and other revenues 1,434 1,639 Traditional annuity premiums 18 20 Totals $ 7,924 7,980
Actual annuity deposits collected for the quarters ended March 31, 1999 and 1998 are detailed below. Deposits collected on these nontraditional 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.
Three Months Ended March 31, 1999 1998 (In thousands) Deferred annuities: Equity-indexed $ 45,630 21,732 Other 51,818 43,243 Total deferred annuities 97,448 64,975 Immediate annuities 7,624 4,499 Totals $ 105,072 69,474
The growth in annuity deposits as reflected in the table above is primarily attributable to the Company's equity-indexed annuities. The Company diversified its annuity products offered to customers by introducing an equity-indexed annuity in late 1997. As this product was still very new, sales continued to grow throughout the first quarter of 1998. Sales then began to level off in the second quarter of 1998. The equity-indexed annuity is a flexible premium deferred annuity which combines the features associated with traditional fixed annuities, with the option to have interest rates that are linked in part to an equity index, the S&P 500 Composite Stock Price Index. This annuity is a long-term contract designed as a planning vehicle for retirement security. It is attractive to customers, as it has guaranteed minimum interest rates, coupled with the potential for significantly higher returns based on an equity index component. Also, because the Company does not offer variable products or mutual funds, this product provides a key equity-based alternative to the Company's existing fixed annuity products. The Company 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. Net investment income for the first quarters of 1999 and 1998 totaled $45,896,000 and $43,709,000, respectively. The increase in net investment income in 1999 is due primarily to the increase in premium production from sales of the Company's equity-indexed annuities, which resulted in increases in invested assets. Net investment income also includes $1,575,000 and $1,270,000 of income from index options for the quarters ended March 31, 1999 and 1998, respectively. Significant expenses for annuity operations are summarized below:
Three Months Ended March 31, 1999 1998 (In thousands) Annuity contract interest $ 34,729 32,616 Amortization of deferred policy acquisition costs 5,360 5,639 Other operating expenses 2,504 3,127
Annuity contract interest was $34.7 million in 1999 compared to $32.6 million in 1998. The increase is largely due to increases in annuities in force from sales of equity-indexed annuities and higher credited rates that can be paid on these policies. Contract interest on equity-indexed annuities totaled $4,726,000 in 1999. Amounts for 1998 were relatively insignificant, as total equity-indexed annuities in force were small as of March 31, 1998. Although 1999 contract interest is higher due to equity-indexed annuities, net investment income for 1999 also includes an additional $1,575,000 from index options which are used to hedge the equity return component of these products. Differences between income from index options and contract interest credited to policyholders will occur for several reasons. The most significant reason is the costs of the index options are essentially amortized against net investment income as the options are marked to fair value each reporting period. The costs of options are covered by additional income earned on debt securities purchased with equity-indexed annuity premiums. Other differences are due to asset fees charged against policyholder contract interest, surrenders and death benefits on annuities within the annual hedging period, and inherent differences between index option fair values and policy liability reserving requirements such as minimum guaranteed interest rates. Amortization of deferred policy acquisition costs represents the amortization of the costs of acquiring or producing new business, primarily agents' commissions, the majority of which 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 1999 and 1998 was $5,360,000 and $5,639,000, respectively. Other operating expenses totaled $2,504,000 for the first quarter of 1999 compared to $3,127,000 for the comparable 1998 period. Expenses for 1998 were higher primarily due to the previously mentioned San Patricio County lawsuit settlement. Other Operations National Western's primary business encompasses its domestic and international life insurance operations and its annuity operations. However, National Western also has small real estate and other investment operations through the following wholly owned subsidiaries: NWL Investments, Inc., NWL Properties, Inc., NWL 806 Main, Inc., NWL Services, Inc., and NWL Financial, Inc. Also, during January, 1999, the Company's wholly owned subsidiary, The Westcap Corporation, completed its Chapter 11 bankruptcy reorganization. With the reorganization complete, National Western transferred its investment real estate holdings totaling approximately $11,589,000 to Westcap and the subsidiary is now operating as a real estate management company. Earnings for these other operations totaled $121,000 for the first quarter of 1999. Operating results for the comparable 1998 period reflected losses totaling $35,000. Most of the income from the Company's subsidiaries is from a life interest in the Libbie Shearn Moody Trust. This asset was owned by National Western Life Insurance Company during 1996 but was transferred to NWL Services, Inc., in 1997. Dividend distributions from the Trust are declared semi-annually in June and December each year. Because the asset is a life interest, these distributions are only accrued in the Company's financial statements when declared. Semi-annual distributions in recent years typically exceed $1.6 million. LIQUIDITY AND CAPITAL RESOURCES Liquidity 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 a 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. A primary liquidity concern for the Company's life insurance operations is the risk of early policyholder withdrawals. Consequently, the Company closely evaluates and manages the risk of early surrenders or withdrawals. The Company includes provisions within annuity and universal life insurance policies, such as surrender charges, that help limit early withdrawals. The Company also prepares cash flow projections and performs cash flow tests under various market interest rate scenarios to assist in evaluating liquidity needs and adequacy. The Company currently expects available liquidity sources and future cash flows to be adequate to meet the demand for funds. In the past, cash flows from the Company's insurance operations have been more than adequate to meet current needs. Cash flows from operating activities were $28.4 million and $41.7 million for the three months ended March 31, 1999 and 1998, respectively. Net cash flows from the Company's deposit product operations, which includes universal life and investment annuity products, totaled $16.1 million in the first quarter of 1999, and reflected cash outflows of $11.4 million for the comparable period of 1998. The net cash outflows in 1998 from the deposit product operations were due primarily to higher policy surrenders, offset significantly by higher annuity production from the Company's equity-indexed annuity product. The Company also has significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows totaled $41.9 million and $45.5 million for the quarters ended March 31, 1999 and 1998, respectively. The Company again expects significant cash flows from these sources throughout the remainder of 1999. Capital Resources The Company relies on stockholders' equity for its capital resources, as there has been no long-term debt outstanding in 1999 or recent years. The Company does not anticipate the need for any long-term debt in the near future. There are also no current or anticipated material commitments for capital expenditures in 1999. Stockholders' equity totaled $445.8 million at March 31, 1999, reflecting an increase of $7.5 million from December 31, 1998. The increase in capital is primarily from net earnings of $14.1 million, offset by a decline in net unrealized gains on investment securities totaling $6.6 million during the first quarter of 1999. Book value per share at March 31, 1999, was $127.44. YEAR 2000 ISSUES The Year 2000 problem, also known as Y2K, is the result of concerns that many computer software systems today cannot distinguish the year 2000 from the year 1900. The Year 2000 problem arose because many existing computer programs use only the last two digits to refer to a year, resulting in these programs' inability to recognize "00" in the date field as the year 2000. If not corrected, many computer systems may be unable to process date-sensitive data accurately beyond the year 1999, resulting in possible system failures or generation of erroneous results. National Western has been cognizant of these problems for many years, as life insurance and annuity products can have very long life spans. Thus, many of our systems have been developed to process and administer our insurance products into the next century. National Western has been working to alleviate or eliminate Year 2000 problems for many years and has assigned the responsibility for the analysis of the problem to its Senior Vice President-Information Services, who deemed the most complete and cost- effective approach to the problem was to use existing staff and facilities. Accordingly, the Company's Year 2000 plan includes staff review and analysis of internal systems, embedded chip technology, and external vendor interfaces as described below. National Western's primary internal software systems include its policy administration system and investment accounting system. The policy administration system is an important software system for National Western, as it is a comprehensive system involving the following functions: policy issuance, maintenance, and accounting, cash receipts, cash disbursements, general ledger, agent commissions, and various other accounting functions. While this policy administration system was not developed by National Western, several key employees of the National Western Information Services department were involved in the system's original development process. As a result, National Western does not maintain a service agreement with the original developer but, rather, maintains and services the system internally. National Western has performed an assessment of this system regarding Year 2000 issues, which revealed that there is some exposure to insufficient date processing that must be corrected. However, the assessment also revealed that much of the date-sensitive data is already in four-digit format, which avoids the Year 2000 processing problems. Accordingly, National Western commenced a project to perform a comprehensive review of the entire policy administration system. This project has been substantially completed and changes are currently being made to correct any software coding problems. All changes that were made as of December 31, 1998, have been tested and implemented. Testing will continue throughout 1999. Final implementation of any additional necessary system changes is currently planned for mid-year 1999 based on anticipated favorable results of testing. The Company's investment accounting system is also a critical system, as it provides accounting, analysis, and transaction processing for the Company's bond and stock securities which comprise most of its investments. Like the Company's policy administration system, this system was developed by a third- party software vendor. However, National Western does maintain a product support agreement with the original vendor. Maintenance and changes to this investment system are the responsibility of the vendor in accordance with this support agreement. National Western has addressed Year 2000 issues with the vendor, and the vendor has provided assurance that their system has been subjected to significant review for any problems. The review included assessment, correction, and testing of date-sensitive problems, and the vendor has provided us written acknowledgment that we should encounter no significant Year 2000 related problems. The Company is using the vendor's Year 2000 modified software release for current processing and has not encountered any problems. National Western does have some exposure to date-sensitive embedded technology such as microcontrollers, but the Company views this exposure as minimal. Unlike other industries that may be equipment intensive, such as manufacturing, National Western is a financial services company providing insurance and annuities to its customers. As such, the primary equipment and electronic devices used are computers and telephone-related equipment. This type of hardware can have date-sensitive embedded technology which could be subject to Year 2000 problems. Because of this exposure, National Western has reviewed its computer hardware and telephone systems, with assistance from the applicable vendors, and has replaced items that would not properly process date-sensitive data in the Year 2000 or beyond. This project was substantially completed as of December 31, 1998. The final area of concern is the Company's use of third-party systems or interfaces with vendor systems. National Western's most significant interfaces and uses of third-party vendor systems are in the bank and trust services area. The Company utilizes various banks to handle numerous types of financial transactions. Several of these banks also provide trustee and custodial services for National Western's investment holdings and transactions. These services are critical to a financial service company such as National Western, as its business centers around cash receipts and disbursements to policyholders and the investment of policyholder funds. As a result, National Western has received written confirmation from its vendor banks regarding their status on Year 2000 issues. The banks indicate their dedication to resolving any Year 2000 issues related to their systems and services prior to the critical date. These banks have completed assessments of their exposure to Year 2000 issues and are in problem resolution and testing phases of their Y2K projects. In reviewing the Year 2000 issue, National Western has identified various risks to the Company that could impact daily operations and its ability to satisfactorily transact business with its primary customers and vendors. Risks related to servicing our customers are inabilities to process policyholder and agent commission-related transactions timely, which could lead to some loss of business. The accuracy of policyholder transactions should not be affected, as the Company's policy administration system already uses four-digit year data for policy calculations. Risks in the investment accounting area center around accuracy of accounting for investments but should not actually impact cash receipt and disbursement transactions. However, the Company has various controls which should identify and enable correction of such issues should they arise. Risks in interfaces with third- party systems, which are primarily banking systems for National Western, include the inability to timely and accurately receive and disburse cash and process investment-related transactions. This could affect the Company's service to its policyholders if cash flow issues arise due to delays in bank processing. Based on information from the Company's banks, National Western does not anticipate significant Year 2000 issues relating to bank processing. Based on its analysis, the Company believes it is on schedule with its Year 2000 plan so that any disruptions by Year 2000 will be minimal. National Western recognizes, however, that it is virtually impossible to assure that the Company will be 100% compliant until Year 2000 is here. We anticipate there will be problems that will have to be resolved in the ordinary course of business on and after Year 2000. However, the Company does not believe that the problems will have a material effect on the Company's operations or financial condition. Under a worst case scenario, where systems do not function adequately on or after Year 2000, the Company intends to place all available resources it can to remedy any problems as soon as possible. The resources include National Western staff as well as outside consulting services. The Company has reviewed Year 2000-related costs incurred to date and is monitoring potential future costs to complete its Year 2000 plan. Such costs are not expected to exceed $250,000. A significant amount of these costs have not and will not be incremental costs to the Company, as internal 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. Costs already incurred as of March 31, 1999, related to the Year 2000 plan total approximately $170,000. FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information contained herein or in other written or oral statements made by or on behalf of National Western Life Insurance Company or its subsidiaries are or may be viewed as forward-looking. Although the Company has used appropriate care in developing any such information, forward-looking information involves risks and uncertainties that could significantly impact actual results. These risks and uncertainties include, but are not limited to, matters described in the Company's SEC filings such as exposure to market risks, anticipated cash flows, future capital needs, and Year 2000 issues. However, National Western, as a matter of policy, does not make any specific projections as to future earnings, nor does it endorse any projections regarding future performance that may be made by others. Whether or not actual results differ materially from forward- looking statements may depend on numerous foreseeable and unforeseeable events or developments. Also, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future developments, or otherwise. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This information is included in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, in the Investments in Debt and Equity Securities section. PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The Westcap Corporation Bankruptcy Proceedings As previously reported in the Company's 1998 Form 10-K, the bankruptcy reorganization of the Company's wholly owned subsidiary, The Westcap Corporation, was completed in the first quarter of 1999. Pursuant to the reorganization plan, National Western retained 100% continuing ownership of the reorganized Westcap and the subsidiary is now operating as a real estate management company. No losses were reported for discontinued brokerage operations in the first quarter of 1999 as the entire $14,125,000 settlement payment was accrued and reported as a loss in the third quarter of 1998. Any additional losses will depend on the results of The City Colleges lawsuit filed against National Western on March 28, 1994, for alleged federal or state securities law "control person" violations relating to Westcap, and which is pending in the United States District Court, Western District of Texas. National Western believes it has reasonable and adequate defenses to this suit, and, accordingly, no amounts have been accrued in National Western's financial statements for potential losses relating to such suit. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits Exhibit 11 - Computation of Earnings Per Share (filed on page __ of this report). Exhibit 27 - Financial Data Schedule (filed electronically pursuant to Regulation S-K). (b) Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended March 31, 1999. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. NATIONAL WESTERN LIFE INSURANCE COMPANY (Registrant) Date: May 14, 1999 /S/ Ross R. Moody Ross R. Moody President, Chief Operating Officer, and Director (Authorized Officer) Date: May 14, 1999 /S/ Robert L. Busby, III Robert L. Busby, III Senior Vice President - Chief Administrative Officer, Chief Financial Officer and Treasurer (Principal Financial Officer) Date: May 14, 1999 /S/ Vincent L. Kasch Vincent L. Kasch Vice President - Controller and Assistant Treasurer (Principal Accounting Officer) EX-11 2 EXHIBIT 11 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES COMPUTATION OF EARNINGS PER SHARE For the Three Months Ended March 31, 1999 and 1998 (Unaudited) (In thousands except per share data)
1999 1998 Numerator for basic and diluted earnings per share: Earnings available to common stockholders before and after assumed conversions: Net earnings $ 14,103 10,370 Denominator: Basic earnings per share - weighted-average shares 3,498 3,492 Effect of dilutive stock options 37 33 Diluted earnings per share - adjusted weighted-average shares for assumed conversions 3,535 3,525 Basic earnings per share: Net earnings $ 4.03 2.97 Diluted earnings per share: Net earnings $ 3.99 2.94
EX-27 3
7 This schedule contains summary financial information extracted from the National Western Life Insurance Company and subsidiaries consolidated financial statements and is qualified in its entirety by reference to such financial statements. 1,000 3-MOS DEC-31-1999 JAN-01-1999 MAR-31-1999 714,755 2,084,285 2,143,302 17,788 169,675 11,547 3,170,965 6,692 893 328,665 3,559,685 3,024,825 0 13,432 10,050 0 0 0 3,499 442,350 3,559,685 23,943 57,852 4,805 150 49,058 9,571 6,701 21,420 7,317 14,103 0 0 0 14,103 4.03 3.99 0 0 0 0 0 0 00 Consists of $2,411 revenues from traditional contracts subject to FAS 60 accounting treatment and $21,532 revenues from universal life and investment annuity contracts subject to FAS 97 accounting treatment. Consists of $8,688 benefits paid to policyholders, $(241) decrease in reserves on traditional contracts and $40,611 interest on universal life and investment annuity contracts.
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