| Summary of Significant Accounting Policies | (2)
Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of NLIC
and companies in which NLIC directly or indirectly has a
controlling financial interest. The consolidated financial
statements include wholly-owned subsidiaries and consolidated
variable interest entities (“VIEs”). All intercompany
transactions have been eliminated.
Use of Estimates
The Company’s consolidated financial statements have been
prepared in accordance with U.S. generally accepted accounting
principles (“GAAP”). The preparation of the
consolidated financial statements in accordance with GAAP requires
the Company to make estimates and assumptions that affect the
amounts reported in the consolidated financial statements and
accompanying notes. Significant estimates include the balance and
amortization of deferred policy acquisition costs
(“DAC”), legal and regulatory reserves, certain
investment and derivative valuations, certain future policy
benefits and claims, goodwill, provision for income taxes and
valuation of net deferred tax assets. Actual results could differ
significantly from those estimates.
Revenues and Benefits
Investment and universal life insurance
products.
Traditional life insurance
products.
Future Policy Benefits and Claims
The liability for future policy benefits and claims is primarily
comprised of policyholder account balances. The assumptions and
methods used in calculating the portion of the liability that does
not represent the policyholder account balances depend on the type
of product.
Investment and universal life insurance
products.
The Company offers guarantees on variable and fixed indexed annuity
products, which can include a return of no less than the total
deposits made on the contract less any customer withdrawals, total
deposits made on the contract less any customer withdrawals plus a
minimum return, or the highest contract value on a specified
anniversary date less any customer withdrawals following the
contract anniversary. These guarantees can also include benefits
payable in the event of death, upon annuitization, upon periodic
withdrawal or at specified dates during the accumulation
period.
As part of its valuation procedures, the Company makes an
assumption of the expected utilization of guarantee benefits by
participants. Guarantees that include a benefit that is wholly life
contingent are accounted for as insurance liabilities that
accumulate over time. Guarantees that are expected to be exercised
using a net settlement option are accounted for as embedded
derivatives, which are required to be separated and valued apart
from the host variable annuity contracts.
Guaranteed minimum death benefits (“GMDB”) and certain
guaranteed living withdrawal benefits (“GLWB”) on
variable annuity and fixed indexed annuity products, as well
as no-lapse
Certain GLWB that are expected to net settle on variable annuity
products represent embedded derivatives which are held at fair
value and include the present value of attributed fees. Subsequent
changes in the fair value of the embedded derivatives are
recognized in results of operations as a component of net realized
investment gains and losses. The fair value of the embedded
derivatives is calculated based on a combination of capital market
and actuarial assumptions. Projections of cash flows inherent in
the valuation of the embedded derivatives incorporate numerous,
unobservable assumptions including, but not limited to, mortality,
lapse rates, index volatility, benefit utilization and discounting.
Benefit utilization includes a wait period (the number of years the
policyholder is assumed to wait prior to beginning withdrawals once
eligible) and efficiency of benefit utilization (the percent of the
maximum permitted withdrawal that a policyholder takes).
Discounting includes liquidity and non-performance
The Company offers certain indexed life insurance and annuity
products for which the policyholders’ interest credits are
based on market performance with caps and floors. The interest
credits represent embedded derivatives within the insurance
contract and therefore are required to be separated and valued
apart from the host contracts. The embedded derivatives are held at
fair value. Subsequent changes in the fair value of the embedded
derivatives are recognized in results of operations as a component
of interest credited to policyholder account values. The fair value
of the embedded derivatives is calculated based on a combination of
capital market and actuarial assumptions. Projections of cash flows
inherent in the valuation of the embedded derivatives incorporate
numerous unobservable assumptions including, but not limited to,
mortality, lapse rates and index volatility. The assumptions used
to calculate the fair value of embedded derivatives are based on
actual experience and industry data and are reviewed as part of an
annual comprehensive study of assumptions. Quarterly, consideration
is given as to whether adjustments to these assumptions are
necessary.
Traditional life and other insurance
products. in-force
The liability for future policy benefits and claims for traditional
life insurance policies was determined using the net level premium
method, with a weighted average interest rate of 6.6% for the years
ended December 31, 2018 and 2017 and estimates of mortality,
morbidity, investment yields and persistency that were used or
being experienced at the time the policies were issued, with a
provision for adverse deviation.
The liability for future policy benefits for certain annuities with
life contingencies was calculated using the present value of future
benefits and certain expenses, discounted using weighted average
interest rates of 4.7% and 4.8% for the years ended
December 31, 2018 and 2017, respectively, with a provision for
adverse deviation.
The Company offers certain short duration traditional insurance,
consisting primarily of accident and health contracts. These short
duration insurance contracts are subject to an internal modified
coinsurance treaty where activity including premiums, investment
income, losses paid and adjustments to reserves, dividends paid and
expenses incurred are ceded from NLIC to NMIC. The Company’s
reserve for short duration contracts was $137 million and
$70 million as of December 31, 2018 and 2017,
respectively.
Advances under FHLB funding agreements
Reinsurance Ceded
The Company cedes insurance to other companies in order to limit
potential losses and to diversify its exposures. The Company
obtains reinsurance from a diverse group of reinsurers and monitors
concentration as well as financial strength ratings of the
reinsurers to minimize counterparty credit risk. Such agreements do
not relieve the original insurer from its primary obligation to the
policyholder in the event the reinsurer is unable to meet the
obligations it has assumed. On an ongoing basis, the Company
monitors the financial condition of reinsurers. Reinsurance
premiums ceded and reinsurance recoveries on benefits and claims
incurred are deducted from the respective income and expense
accounts. Assets and liabilities related to reinsurance ceded are
reported in the consolidated balance sheets on a gross basis,
separately from the related future policy benefits and claims of
the Company.
Amounts recoverable from reinsurers are estimated in a manner
consistent with future policy benefits and claims reserves. The
Company reports its reinsurance recoverables net of any allowance
for estimated uncollectible reinsurance recoverables, if deemed
necessary. The Company’s consideration is based upon ongoing
reviews of amounts outstanding, changes in reinsurer credit
standings and other relevant factors.
Under the terms of contracts held with certain unaffiliated
reinsurers, specified assets have been placed in trusts as
collateral for the recoveries. The trust assets are invested in
investment grade securities, the fair value of which must at all
times be greater than or equal to 100% of the reinsured reserves,
as outlined in the underlying reinsurance contracts.
Deferred Policy Acquisition Costs
The Company has deferred certain costs that are directly related to
the successful acquisition of new and renewal insurance and
investment contracts. The methods and assumptions used to amortize
and assess recoverability of the DAC balance depend on the type of
product.
Investment and universal life insurance
products. available-for-sale
The assumptions used in the estimation of gross profits are based
on the Company’s current best estimates of future events and
are reviewed as part of an annual comprehensive study of
assumptions. The most significant assumptions that are involved in
the estimation of future gross profits include future net general
and separate account investment performance, surrender/lapse rates,
interest margins, renewal premiums and mortality. Quarterly,
consideration is given as to whether adjustments to these
assumptions are necessary. The Company uses a reversion to the mean
process to determine the assumption for the future net separate
account investment performance. This process assumes different
performance levels over the next three years, such that the
separate account mean return, measured through the end of the life
of the product, equals the long-term assumption. The
Company’s long-term assumption for net separate account
investment performance is approximately 6.3% growth per year as of
December 31, 2018.
Changes in assumptions can have a significant impact on the amount
of DAC reported for investment and universal life insurance
products and on their related amortization patterns. In the event
actual experience differs from assumptions or future assumptions
are revised, the Company will record an increase or decrease in DAC
amortization expense at the time such assessment is made, which
could be significant.
Traditional life insurance
products. premium-paying
Refer to Note 5 for discussion regarding DAC amortization and
related balances.
Investments
Available-for-sale . Available-for-sale available-for-sale
As of December 31, 2018 and 2017, 99% of fixed maturity
securities were priced using externally sourced data. Independent
pricing services are most often utilized (85% as of
December 31, 2018 and 2017), and compared to pricing from
additional sources, to determine the fair value of securities for
which market quotations or quotations on comparable securities are
available. For these securities, the Company obtains the pricing
services’ methodologies and classifies the investments
accordingly in the fair value hierarchy.
A corporate pricing matrix is used in valuing certain corporate
debt securities. The corporate pricing matrix was developed using
publicly and privately available spreads for privately placed
corporate securities with varying weighted average lives and credit
quality ratings. The weighted average life and credit quality
rating of a particular fixed maturity security to be priced using
this matrix are important inputs into the model and are used to
determine a corresponding spread that is added to the appropriate
U.S. Treasury yield to create an estimated market yield for that
security. The estimated market yield and other relevant factors are
then used to estimate the fair value of the particular
security.
Non-binding
When the collectability of contractual interest payments on fixed
maturity securities is considered doubtful, such securities are
placed in non-accrual
The Company has entered into securities lending agreements with a
custodial bank whereby eligible securities are loaned to third
parties, primarily major brokerage firms. These transactions are
used to generate additional income in the securities portfolio. The
Company is entitled to receive from the borrower any payments of
interest and dividends received on loaned securities during the
loan term. The agreements require a minimum of 102% of the fair
value of the loaned securities to be held as collateral. Cash
collateral is invested by the custodial bank in investment-grade
securities, which are included in the total investments of the
Company. As of December 31, 2018 and 2017, cash collateral
received was $195 million and $313 million, respectively.
Additionally, the Company may
receive non-cash off-balance off-balance available-for-sale
For investments in certain residential and commercial
mortgage-backed securities, the Company recognizes income and
amortizes discounts and premiums using the effective-yield method,
based on prepayment assumptions and the estimated economic life of
the securities. When actual prepayments differ significantly from
estimated prepayments, the effective-yield is recalculated to
reflect actual payments to date and anticipated future payments.
Any resulting adjustment is included in net investment income in
the period the estimates are revised. All other investment income
is recorded using the effective-yield method without anticipating
the impact of prepayments.
The Company periodically reviews its available-for-sale
In assessing corporate debt securities for other-than-temporary
impairment (“OTTI”), the Company evaluates the ability
of the issuer to meet its debt obligations, the value of the
company or specific collateral securing the debt, the
Company’s intent to sell the security and whether it is more
likely than not the Company will be required to sell the security
before the recovery of its amortized cost basis. The Company
evaluates U.S. government and agencies and obligations of states
and political subdivisions securities for OTTI by examining similar
characteristics.
Mortgage-backed securities are assessed for impairment using
default estimates based on loan level data, where available. Where
loan level data is not available, a proxy based on collateral
characteristics is used. The impairment assessment considers loss
severity as a function of multiple factors, including unpaid
balance, interest rate, mortgage insurance ratios, assessed
property value at origination, change in property
value, loan-to-value
Certain asset-backed securities are assessed for impairment using
expected cash flows based on various inputs, including default
estimates based on the underlying corporate securities, historical
and forecasted loss severities or other market inputs when recovery
estimates are not feasible. When the collateral is regional bank
and insurance company trust preferred securities, default estimates
used to estimate cash flows are based on U.S. Bank Rating service
data and broker research.
The Company evaluates its intent to sell on an individual security
basis. OTTI losses on securities when the Company does not intend
to sell the security and it is not more likely than not it will be
required to sell the security prior to recovery of the
security’s amortized cost basis are bifurcated, with the
credit related portion of the impairment loss being recognized in
results of operations and the non-credit
The Company invests in fixed maturity securities that could qualify
as VIEs, including corporate securities, mortgage-backed securities
and asset-backed securities. The Company is not the primary
beneficiary of these securities as the Company does not have the
power to direct the activities that most significantly impact the
entities’ performance. The Company’s potential loss is
limited to the carrying values of these securities. There are no
liquidity arrangements, guarantees or other commitments by third
parties that affect the fair value of the Company’s interest
in these assets.
Mortgage loans, net of
allowance . held-for-investment
As part of the underwriting process, specific guidelines are
followed to ensure the initial quality of each new mortgage loan.
Third-party appraisals are obtained to support loaned amounts, as
the loans are usually collateral dependent.
The collectability and value of a mortgage loan are based on the
ability of the borrower to repay and/or the value of the underlying
collateral. The Company’s commercial mortgage loans are
typically structured with balloon payment maturities, exposing the
Company to risks associated with the borrower’s ability to
make the balloon payment or refinance the property.
Mortgage loans require a loan-specific reserve when, based on
current information and events, it is probable that the Company
will be unable to collect all amounts due according to the
contractual terms of the loan agreement. When management determines
that a loan requires a loan-specific reserve, a provision for loss
is established equal to the difference between the carrying value
and either the fair value of the collateral less costs to sell or
the present value of expected future cash flows, discounted at the
loan’s effective interest rate. Loan-specific reserve charges
are recorded in net realized investment gains and losses. In the
event a loan-specific reserve charge is reversed, the recovery is
also recorded in net realized investment gains and losses.
In addition to the loan-specific reserves, the Company maintains
a non-specific non-specific Non-specific
Management evaluates the credit quality of individual commercial
mortgage loans and the portfolio as a whole through a number of
loan quality measurements, including but not limited to LTV and
debt service coverage (“DSC”) ratios. The LTV ratio is
calculated as a ratio of the amortized cost of a loan to the
estimated value of the underlying collateral. DSC is the amount of
cash flow generated by the underlying collateral of the mortgage
loan available to meet periodic interest and principal payments of
the loan. These loan quality measurements contribute to
management’s assessment of relative credit risk in the
commercial mortgage loan portfolio. Based on underwriting criteria
and ongoing assessment of the properties’ performance,
management believes the amounts, net of valuation allowance, are
collectible. This process identifies the risk profile and potential
for loss individually and in the aggregate for the commercial
mortgage loan portfolios. These factors are updated and evaluated
at least annually.
Interest income on performing mortgage loans is recognized in net
investment income over the life of the loan using the
effective-yield method. Loans in default or in the process of
foreclosure are placed on non-accrual non-accrual
Policy loans.
Short-term investments.
Other investments. mark-to-market
The Company holds alternative investments as described above and
applies the equity method of accounting to these investments as it
does not have a controlling financial interest. The Company
recognizes income or losses from equity method investments in net
investment income. These equity method investments are reviewed for
impairment whenever events or changes in circumstances indicate
that the carrying value of the investment might not be recoverable.
The Company’s unfunded commitments related to alternative
investments were $750 million and $787 million as of
December 31, 2018 and 2017, respectively. The carrying value
of alternative investments was $797 million and
$582 million as of December 31, 2018 and 2017,
respectively.
In the normal course of business, the Company has relationships
with VIEs. If the Company determines that it has a variable
interest and is the primary beneficiary, it consolidates the VIE.
The Company is the primary beneficiary if the Company has the power
to direct the activities of the VIE that most significantly impact
the economic performance of the entity and the obligation to absorb
losses or receive benefits from the entity that could be
potentially significant to the VIE. This determination is based on
a review of the entity’s contract and other deal-related
information, such as the entity’s equity investment at risk,
decision-making abilities, obligations to absorb economic risks and
right to receive economic rewards of the entity.
Consolidated VIEs are primarily made up of tax credit funds whereby
the Company serves as the managing member and has
guaranteed after-tax after-tax after-tax after-tax
Net assets (controlling and noncontrolling interests) of all
consolidated VIEs totaled $821 million and $738 million
as of December 31, 2018 and 2017, respectively, and are
included within the consolidated balance sheets primarily as other
investments of $757 million, other assets of $369 million
and other liabilities of $335 million as of December 31,
2018, and other investments of $680 million, other assets of
$189 million and other liabilities of $158 million as of
December 31, 2017. The Company’s general credit is not
exposed to the creditors or beneficial interest holders of these
consolidated VIEs. The results of operations and financial
positions of each VIE for which the Company is the primary
beneficiary, as well as the corresponding noncontrolling interests,
are recorded in the consolidated financial statements. Ownership
interests held by unrelated third parties in the consolidated VIEs
are presented as noncontrolling interests in the equity section of
the consolidated financial statements. Losses attributable to
noncontrolling interests are excluded from the net income
attributable to the Company on the consolidated statements of
operations.
The Company is not required and does not intend to provide
financial or other support outside of contractual requirements to
any VIE.
Derivative Instruments
The Company uses derivative instruments to manage exposures and
mitigate risks primarily associated with interest rates, equity
markets and foreign currency. These derivative instruments
primarily include swaps, futures contracts and options. All
derivative instruments are held at fair value and are reflected as
other assets or liabilities in the consolidated balance sheets.
The fair value of derivative instruments is determined using
various valuation techniques relying predominantly on observable
market inputs. These inputs include interest rate swap curves,
credit spreads, interest rates, counterparty credit risk, equity
volatility and equity index levels. In cases where observable
inputs are not available, the Company will
utilize non-binding
For derivatives that are not designated for hedge accounting, the
unrealized and realized gains or losses are recognized in net
realized investment gains and losses.
For derivative instruments that are designated and qualify for cash
flow hedge accounting, the effective portion of the gain or loss on
the derivative instrument is reported as a component of AOCI and
reclassified into results of operations in the same period or
periods that the hedged transaction impacts results of operations.
The ineffective portion of the derivative’s change in value,
if any, along with any of the derivative’s change in value
that is excluded from the assessment of hedge effectiveness, are
recorded in net realized investment gains and losses.
The Company’s derivative transaction counterparties are
generally financial institutions. To reduce the credit risk
associated with open contracts, the Company enters into master
netting agreements, which permit the closeout and netting of
transactions with the same counterparty upon the occurrence of
certain events. In addition, the Company attempts to reduce credit
risk by obtaining collateral from counterparties. The determination
of the need for and the levels of collateral vary based on an
assessment of the credit risk of the counterparty. The Company
accepts collateral in the forms of cash and marketable
securities. Non-cash off-balance
Fair Value Measurements
Fair value is defined as the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date. Fair value
measurements are based upon observable and unobservable inputs.
Observable inputs reflect market data obtained from independent
sources, while unobservable inputs reflect the Company’s view
of market assumptions in the absence of observable market
information. The Company utilizes valuation techniques that
maximize the use of observable inputs and minimize the use of
unobservable inputs. In determining fair value, the Company uses
various methods, including market, income and cost approaches.
The Company categorizes its financial instruments into a
three-level hierarchy based on the priority of the inputs to the
valuation technique. The fair value hierarchy gives the highest
priority to quoted prices in active markets for identical assets or
liabilities (Level 1) and the lowest priority to unobservable
inputs (Level 3). If the inputs used to measure fair value fall
within different levels of the hierarchy, the category level is
based on the lowest priority level input that is significant to the
fair value measurement of the instrument in its entirety.
The Company categorizes assets and liabilities held at fair value
in the consolidated balance sheets as follows:
Level 1.
Level 2.
Level 3.
The Company reviews its fair value hierarchy classifications for
assets and liabilities quarterly. Changes in the observability of
significant valuation inputs identified during these reviews may
trigger reclassifications. Reclassifications are reported as
transfers at the beginning of the period in which the change
occurs.
Fair Value Option.
Cash and Cash Equivalents
Cash and cash equivalents include highly liquid investments with
original maturities of less than three months.
Goodwill and Other Intangibles
In connection with business acquisitions, the Company recognizes
goodwill as the excess of the purchase price or fair value of
consideration exchanged over the fair values of tangible assets
acquired, liabilities assumed and separately identified intangible
assets. Goodwill is not amortized, but is evaluated for impairment
at the reporting unit level annually or on an interim basis, in
addition to the annual evaluation, if an event occurs or
circumstances change which would more likely than not reduce the
fair value of a reporting unit below its carrying amount. If a
reporting unit’s fair value is less than its carrying value,
the Company will calculate implied goodwill. Goodwill is impaired
at the reporting unit level if its carrying value exceeds the
implied value of its goodwill.
The process of evaluating goodwill for impairment requires several
judgments and assumptions to be made to determine the fair value of
the reporting units, including the method used to determine fair
value, discount rates, expected levels of cash flows, revenues and
results of operations, and the selection of comparable companies
used to develop market-based assumptions. The carrying value of
goodwill was $269 million as of December 31, 2018 and
2017 and is included in other assets in the consolidated balance
sheets. There were no impairments or additions to goodwill for the
year ended December 31, 2018. There were no impairments to
goodwill and total additions to goodwill were $69 million for
the year ended December 31, 2017.
Indefinite-lived intangibles are evaluated for impairment annually
in conjunction with the Goodwill impairment test and were
immaterial as of December 31, 2018 and 2017. All other
intangibles are amortized over the useful life of the intangible
asset and are monitored for indicators of impairment. All other
intangibles totaled $255 million and $267 million as of
December 31, 2018 and 2017, respectively.
Separate Accounts
Separate account assets and liabilities represent
contractholders’ funds that have been legally segregated into
accounts with specific investment objectives. In the separate
account, investment income and gains and losses on investments
accrue directly to, and investment risk is borne by, the
contractholder. Separate account assets are recorded at fair value,
with the value of separate account liabilities set to equal the
fair value of separate account assets. Separate account assets are
primarily comprised of public, privately-registered
and non-registered
Federal Income Taxes
The Company recognizes deferred tax assets and liabilities for the
expected future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases, net operating
losses and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply
to taxable income or loss in the years in which those temporary
differences are expected to be recovered or settled. Under this
method, the effect on deferred tax assets and liabilities due to a
change in tax rates is recognized in income in the period that
includes the enactment date. Valuation allowances are recorded to
reduce a deferred tax asset to the amount expected to be realized.
Interest expense and any associated penalties which relate to tax
years still subject to review by the Internal Revenue Service
(“IRS”) are recorded as income tax expenses.
The Company provides for federal income taxes based on amounts the
Company believes it ultimately will owe. Inherent in the provision
for federal income taxes are estimates regarding the deductibility
of certain items and the realization of certain tax credits. In the
event the ultimate deductibility of certain items or the
realization of certain tax credits differs from estimates, the
Company may be required to change the provision for federal income
taxes recorded in the consolidated financial statements, which
could be significant.
Tax reserves are reviewed regularly and are adjusted as events
occur that the Company believes impact its liability for additional
taxes, such as the lapsing of applicable statutes of limitations,
conclusion of tax audits or substantial agreement with taxing
authorities on the deductibility/nondeductibility of uncertain
items, additional exposure based on current calculations,
identification of new issues, release of administrative guidance or
rendering of a court decision affecting a particular tax issue. The
Company believes its tax reserves reasonably provide for potential
assessments that may result from IRS examinations and
other tax-related
The Company files with the NMIC consolidated federal income tax
return.
Jefferson National Financial Corp Acquisition
On March 1, 2017, the Company completed its acquisition of
JNF. The Company acquired 100% of the stock of JNF for a total
consideration of $201 million in cash. As a result of the
acquisition, JNF and its subsidiaries became wholly-owned
subsidiaries of Nationwide. JNF, based in Louisville, Kentucky, is
a distributor of tax-advantaged fee-based
The determination of fair value of assets acquired, liabilities
assumed and purchase consideration reflects the Company’s
estimates and assumptions.
The following table summarizes the fair value of consideration
exchanged in the acquisition of JNF:
(in millions)
Total assets acquired $ 5,522
Total liabilities assumed (5,321 )
Total consideration $ 201
As a result of the JNF acquisition, the Company recognized goodwill
of $69 million, representing the excess of fair value of
consideration exchanged over the fair values of tangible assets
acquired, liabilities assumed and separately identified intangible
assets.
Subsequent Events
The Company evaluated subsequent events through February 27,
2019, the date the consolidated financial statements were
issued. |
