GUARANTEED TERM OPTIONS
(In a limited number of states, Guaranteed Term Options are referred to as
Target Term Options)
Under Variable Annuity Contracts Issued by
NATIONWIDE LIFE INSURANCE COMPANY
One Nationwide Plaza
Columbus, Ohio 43215
Telephone: 1-800-848-6331
The date of this Prospectus is April 30, 2004 as amended September 30, 2004
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Certain state insurance laws applicable to these investment options may
preclude, or be interpreted to preclude, Nationwide from providing a contractual
guarantee in conjunction with the Specified Interest Rate. In such jurisdictions
the investment options are referred to as "Target Term Options" as opposed to
"Guaranteed Term Options." DESPITE THIS DISTINCTION IN TERMINOLOGY, NATIONWIDE
WILL ADMINISTER ALL OBLIGATIONS DESCRIBED IN THIS PROSPECTUS, REGARDLESS OF THE
JURISDICTION, IN PRECISELY THE SAME MANNER. Thus, there will be no difference
between the calculation, crediting, and administration of Specified Interests
Rates in "Guaranteed Term Options" issued in states permitting a contractual
guarantee, and the calculation, crediting, and administration of Specified
Interest Rates in "Target Term Options" issued in states not permitting a
contractual guarantee.
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THIS PROSPECTUS MUST BE READ ALONG WITH THE APPROPRIATE VARIABLE CONTRACT
PROSPECTUS AND THE PROSPECTUSES DESCRIBING THE UNDERLYING MUTUAL FUND INVESTMENT
OPTIONS. ALL OF THESE PROSPECTUSES SHOULD BE READ CAREFULLY AND MAINTAINED FOR
FUTURE REFERENCE.
This Prospectus describes investment options referred to as Guaranteed Term
Options (GTOs), offered by Nationwide Life Insurance Company (Nationwide), and
is accompanied by a copy of Nationwide's latest annual report on Form 10-K for
the period ended December 31, 2003, and the latest quarterly report on Form 10Q
for the period ended (June 30, 2004). The GTOs are available under certain
variable annuity contracts or variable life insurance policies (collectively,
"variable contracts") issued by Nationwide. Generally, the variable contracts
offered by Nationwide provide an array of underlying mutual fund investment
options, to which the contract owner allocates his or her purchase payments. The
GTOs are separate, guaranteed interest investment options available under
variable contracts.
GTOs will produce a guaranteed annual effective yield at the Specified Interest
Rate SO LONG AS AMOUNTS INVESTED ARE NEITHER WITHDRAWN NOR TRANSFERRED PRIOR TO
THE END OF THE GUARANTEED TERM. IN THE EVENT OF A WITHDRAW OR TRANSFER FOR ANY
REASON PRIOR TO THE EXPIRATION OF THE GUARANTEED TERM, THE AMOUNT WITHDRAWN OR
TRANSFERRED WILL BE SUBJECT TO A MARKET VALUE ADJUSTMENT. Pleae refer to the
variable contract prospectus for specific information regarding transfers or
withdraws that may incur a market value adjustment.
Variable contract prospectuses in which the GTOs are offered describe
certain charges and deductions that may apply to the GTOs. A more detailed
discussion of these charges and deductions, as they relate to particular
variable contracts, is contained in the variable contract prospectuses. The
variable contract prospectuses also state what Guaranteed Terms are available.
That GTOs are available under a variable contract does not mean all Guaranteed
Terms are available. Please refer to the variable contract prospectus for the
specific information.
The minimum amount that may be allocated to a GTO is $1,000 per allocation.
Nationwide established the Nationwide Multiple Maturity Separate Account,
pursuant to Ohio law, to aid in reserving and accounting for GTO obligations.
However, all of the general assets of Nationwide are available for the purpose
of meeting the guarantees of the GTOs. Amounts allocated to
the GTOs are generally invested in fixed income investments purchased by
Nationwide. Variable contract owners allocating amounts to a GTO have no claim
against any assets of Nationwide, including assets held in the Nationwide
Multiple Maturity Separate Account.
NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The GTOs described in this Prospectus may not be available in all state
jurisdictions and, accordingly, representations made in this Prospectus do not
constitute an offering in such jurisdictions.
TABLE OF CONTENTS
GLOSSARY..........................................................................................................1
INFORMATION ABOUT THE GTOS........................................................................................2
GENERAL.......................................................................................................2
THE SPECIFIED INTEREST RATE...................................................................................3
THE INVESTMENT PERIOD.........................................................................................4
GUARANTEED TERMS..............................................................................................4
GTOS AT MATURITY..............................................................................................5
A SURRENDER, TRANSFER OR DISTRIBUTION BEFORE MATURITY.........................................................5
The Market Value Adjustment...............................................................................5
MVA Interest Rates........................................................................................6
The Market Value Adjustment Formula.......................................................................6
CONTRACT CHARGES..............................................................................................7
GTOS AT ANNUITIZATION.........................................................................................8
NATIONWIDE LIFE INSURANCE COMPANY.................................................................................8
INVESTMENTS.......................................................................................................8
CONTRACTS AND THE DISTRIBUTION (MARKETING) OF THE GTOS............................................................8
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE.................................................................8
LEGAL OPINION.....................................................................................................9
EXPERTS...........................................................................................................9
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION..............................................................9
APPENDIX........................................................................................................A-1
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AVAILABLE INFORMATION
Nationwide Life Insurance Company files reports with the Securities and Exchange
Commission on Forms 10-Q, 10-K and 8-K.
The public may read and copy these reports at the SEC's Public Reference Room at
450 Fifth Street, N.W., Washington, D.C. 20549. You may obtain information on
the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
The SEC maintains an Internet site that contains reports, proxy and information
statements, and other information regarding issuers, like Nationwide Life
Insurance Company, that file electronically with the SEC (http://www.sec.gov).
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GLOSSARY
MVA INTEREST RATE- The rate of interest used in the Market Value formula.
Depending on the variable contracts under which the GTO is offered, the interest
rate will be the Constant Maturity Treasury (CMT) rates, or interest rate swaps,
for maturity durations of 1, 3, 5, 7 and 10 years, as declared regularly by the
Federal Reserve Board.
GUARANTEED TERM OPTION (GTO)- An investment option offered under variable
contracts that provides a Specified Interest Rate over Guaranteed Terms, so long
as certain conditions are met. In some jurisdictions the GTO is referred to as a
Target Term Option (TTO).
GUARANTEED TERM- The period corresponding to a 1, 3, 5, 7 or 10 year GTO.
Amounts allocated to a GTO will be credited with a Specified Interest Rate over
the corresponding Guaranteed Term, so long as such amounts are not distributed
from the GTO prior to the Maturity Date. Because every Guaranteed Term will end
on the final day of a calendar quarter, the Guaranteed Term may last for up to 3
months beyond the 1, 3, 5, 7 or 10 year anniversary of the allocation to the
GTO.
MARKET VALUE ADJUSTMENT- The upward or downward adjustment in value of amounts
allocated to a GTO that are withdrawn from the GTO for any reason prior to the
Maturity Date.
MATURITY DATE- The date on which a GTO matures. The date will be the last day of
the calendar quarter during or within 30 days after the first, third, fifth,
seventh or tenth anniversary on which amounts are allocated to a 1, 3, 5, 7 or
10 year GTO, respectively.
MATURITY PERIOD- The period during which the value of amounts allocated under a
GTO may be distributed without any Market Value Adjustment. The Maturity Period
will begin on the day following the Maturity Date and will end on the thirtieth
day after the Maturity Date.
SPECIFIED INTEREST RATE- The interest rate guaranteed to be credited to amounts
allocated to a GTO so long as the allocations are not distributed for any reason
prior to the Maturity Date. The Specified Interest Rate will not be less than
the minimum required by applicable state law.
SPECIFIED VALUE- The amount of a GTO allocation, plus interest accrued at the
Specified Interest Rate, minus surrenders, transfers and any other amounts
distributed. The Specified Value is subject to a Market Value Adjustment at all
times other than during the Maturity Period.
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INFORMATION ABOUT THE GTOS
GENERAL
GTOs are guaranteed interest rate investment options available under certain
variable contracts issued by Nationwide. There are five different Guaranteed
Terms available: 1 year; 3 years; 5 years; 7 years; and 10 years. Not all
Guaranteed Terms may be available in all states. A GTO may be purchased using
purchase payments made to the contracts, or by using funds transferred from
other investment options available in the variable contracts. Not all of the
variable contracts issued by Nationwide offer GTOs, nor are GTOs available in
every state. If GTOs are available under a variable annuity contract or variable
life insurance policy, the prospectus for the variable contract and this
prospectus must be read together.
The guarantees associated with the GTOs are borne exclusively by, and are
legal obligations of, Nationwide. The Nationwide Multiple Maturity Separate
Account, authorized and created in accordance with Ohio law, was established for
the sole purpose of reserving and accounting for assets associated with the
GTOs. Its assets are owned by Nationwide. Contract owners with GTOs have no
claim against, and maintain no interest in, the assets. Also, contract owners do
not participate in the investment experience.
GTOs provide for a Specified Interest Rate to be credited as long as any
amount allocated to a Guaranteed Term is not distributed for any reason prior to
the Maturity Date. Note, however, that the Maturity Date may extend for up to 3
months beyond the 1, 3, 5, 7 or 10 year term since every GTO will end on the
final day of a calendar quarter.
Amounts allocated to a GTO will be credited interest at the Specified
Interest Rate for the duration of the Guaranteed Term at a rate no less than the
minimum required by state law. Specified Interest Rates are declared
periodically at Nationwide's sole discretion and available for new allocations
typically for one month, but they may be available for longer or shorter periods
depending on interest rate fluctuations in financial markets. During this time,
any transfer allocation or new purchase payment allocation to a GTO will earn
the Specified Interest Rate effective for that Investment Period for the
duration of the Guaranteed Term (see "Specified Interest Rates and Guaranteed
Terms").
The Specified Interest Rate will be credited daily to amounts allocated to
a GTO to provide an annual effective yield. The Specified Interest Rate will
continue to be credited as long as allocations remain in the GTO until the
Maturity Date. Any surrenders, transfers or withdrawals for any reason prior to
the Maturity Date will be subject to a Market Value Adjustment.
Nationwide applies the Market Value Adjustment by using the Market Value
Adjustment factor, which is derived from the Market Value Adjustment formula.
The Market Value Adjustment factor is multiplied by the part of the Specified
Value being withdrawn or transferred, resulting in either an increase or
decrease in the amount of the withdrawal or transfer. The Market Value
Adjustment formula reflects the relationship between three components:
(1) the MVA Interest Rate for the period coinciding with the Guaranteed Term of
the GTO at investment;
(2) the MVA Interest Rate for the number of years remaining in a Guaranteed
Term when the surrender, transfer or other withdrawal from the GTO occurs;
and
(3) the number of days remaining in the Guaranteed Term of the GTO.
2
Generally, the Market Value Adjustment formula approximates the
relationship between prevailing interest rates at the time of the GTO
allocation, prevailing interest rates at the time of transfer or surrender and
the amount of time remaining in a Guaranteed Term (see "The Market Value
Adjustment").
Contract owners having GTOs with Maturity Dates coinciding with the end of
the calendar quarter will be notified of the impending expiration of the
Guaranteed Term at least 15 days, and at most 30 days, prior to the end of each
calendar quarter. Contract owners will then have the option of directing the
withdrawal or transfer of any amount in the GTO during the Maturity Period,
without any Market Value Adjustment. However, any transfers from the GTO during
this period may be subject to a surrender charge, assessed by the variable
contract and as further explained in the variable contract prospectus.
If no direction is received by the thirtieth day following the Maturity
Date, amounts in the GTO will be automatically transferred (with no Market Value
Adjustment) to the money market sub-account available in the variable contract.
For the period commencing with the first day after the Maturity Date and ending
on the thirtieth day following the Maturity Date, the GTO will be credited with
the same Specified Interest Rate in effect before the Maturity Date (see "GTOs
at Maturity").
The minimum amount of any allocation to a GTO is $1,000.
Under certain rare circumstances, when volatility in financial markets
compromises the ability of Nationwide to process allocations to or from the GTOs
in an orderly manner, Nationwide may temporarily suspend the right to make
additional allocations to the GTOs and/or to effect transfers or withdrawals
from the GTOs. Nationwide anticipates invoking this suspension only when
acceptance of additional allocations or the processing of withdrawals or
transfers from GTOs cannot be executed by Nationwide in a manner consistent with
its obligations to contract owners with existing or prospective interests in one
or more GTOs. Under no circumstances, however, will Nationwide limit a contract
owner's right to make at least one allocation to a GTO, and one transfer or
withdrawal from a GTO, in any calendar year. All contract owners will be
promptly notified of Nationwide's determination to invoke any suspension in the
right to make allocations to, or to effect withdrawals or transfers from, the
GTOs.
In addition, the variable contracts that offer GTOs may impose certain
restrictions on the transferability of invested assets within the variable
contract. The variable product prospectus should be reviewed with regard to
specific transfer limitation provisions.
THE SPECIFIED INTEREST RATE
The Specified Interest Rate is the rate of interest guaranteed by
Nationwide to be credited to amounts allocated to the GTOs for the Guaranteed
Term, so long as no portion of the allocation is distributed for any reason
prior to the Maturity Date. Different Specified Interest Rates may be
established for the five available GTO terms.
Generally, Nationwide will declare new Specified Interest Rates monthly;
however, depending on interest rate fluctuations, Nationwide may declare new
Specified Interest Rates more or less frequently.
Nationwide observes no specific method in establishing the Specified
Interest Rates. However, Nationwide will attempt to declare Specified Interest
Rates that are related to interest rates associated with fixed-income
investments available at the time and having durations and cash flow attributes
compatible with the Guaranteed Terms of the GTOs. In addition, the establishment
of Specified Interest Rates may be influenced by other factors, including
competitive considerations, administrative costs and
3
general economic trends. Nationwide has no way of precisely predicting what
Specified Interest Rates may be declared in the future, however, the Specified
Interest Rate will not be less than the minimum rate required by applicable
state law.
Some Nationwide variable contracts offer Extra Value Options. Under these
contracts, where the contract owner has elected an Extra Value Option,
allocations made to the GTOs for the first 7-8 contract years, depending on the
variable annuity contract, will be credited a guaranteed interest rate of
0.10-0.70% less than the guaranteed interest rate that applies to the GTOs if
the Extra Value Option is not elected.
Some Nationwide variable contracts offer a Beneficiary Protector option.
Under these contracts, where the contract owner has elected the Beneficiary
Protector option, allocations made to the GTOs will be credited a guaranteed
interest rate of 0.35-0.40% less than the guaranteed interest rate that applies
to the GTOs if the Beneficiary Protector option is not elected.
Some Nationwide variable contracts offer a Capital Preservation Plus option.
Under these contracts, where the contract owner has elected the Capital
Preservation Plus option, allocations made to the GTOs will be credited a
guaranteed interest rate of up to 0.50% less than the guaranteed interest rate
that applies to the GTOs if the Capital Preservation Plus option is not elected.
In certain jurisdictions, the Capital Preservation Plus option must be elected
in conjunction with the GTO.
THE INVESTMENT PERIOD
The Investment Period is the period of time during which a particular
Specified Interest Rate is in effect for new allocations to the available GTOs.
All allocations made to a GTO during an Investment Period are credited with the
Specified Interest Rate in effect at the time of allocation. An Investment
Period ends when a new Specified Interest Rate relative to the applicable GTO is
declared. Subsequent declarations of new Specified Interest Rates have no effect
on allocations made to GTOs during prior Investment Periods. Prior allocations
to the GTO will be credited with the Specified Interest Rate in effect when the
allocation was made.
Interest at the Specified Interest Rate is credited to allocations made to
GTOs on a daily basis, resulting in an annual effective yield guaranteed by
Nationwide, unless amounts are withdrawn or transferred from the GTO for any
reason prior to the Maturity Date. Interest at the Specified Interest Rate will
be credited for the entire Guaranteed Term. If amounts are withdrawn or
transferred from the GTO for any reason prior to the Maturity Date, a Market
Value Adjustment will be applied to that amount.
Information concerning the Specified Interest Rates in effect for the
various GTOs can be obtained by calling the following toll free phone number:
1-800-848-6331.
GUARANTEED TERMS
The Guaranteed Term is the period of time corresponding with the selected
GTO for which the Specified Interest Rate is guaranteed to be in effect, so long
as the amounts allocated remain in the GTO until the Maturity Date. A Guaranteed
Term always expires on a Maturity Date which will be the last day of a calendar
quarter. Consequently, a Guaranteed Term may last up to 3 months longer than the
anniversary date of the allocation to the GTO.
For example, if an allocation is made to a 10 year GTO on August 1, 1999,
the Specified Interest Rate for that GTO will be credited until September 30,
2009; the Guaranteed Term will begin on August 1, 1999 and end on September 30,
2009.
4
Guaranteed Terms will be exactly 1, 3, 5, 7 or 10 years only when an
allocation to a GTO occurs on the last day of a calendar quarter.
GTOS AT MATURITY
Nationwide will send notice to contract owners of impending Maturity Dates
(always the last day of a calendar quarter) at least 15 days and at most 30 days
prior to the end of a Guaranteed Term. The notice will include the projected
value of the GTO on the Maturity Date, and will also specify options that
contract owners have with respect to the maturing GTO.
Once the GTO matures, contract owners may:
(1) surrender the GTO, in part or in whole, without a Market Value
Adjustment during the Maturity Period; however, any surrender charges
that may be applicable under the variable contract will be assessed;
(2) transfer (all or part) of the GTO, without a Market Value Adjustment,
to any other investment option under the variable contract, including
any of the underlying mutual fund sub-accounts, or another GTO of the
same or different duration during the Maturity Period. A confirmation
of any such transfer will be sent immediately after the transfer is
processed; or
(3) elect not to transfer or surrender all or a portion of the GTO, in
which case the GTO will be automatically transferred to the available
money market sub-account of the contract at the end of the Maturity
Period. A confirmation will be sent immediately after the automatic
transfer is executed.
The GTO will continue to be credited with the Specified Interest Rate in
effect before the Maturity Date during the Maturity Period, and prior to any of
the transactions set forth in (1), (2), or (3) above.
A SURRENDER, TRANSFER OR DISTRIBUTION BEFORE MATURITY
GTOs that are surrendered, transferred or distributed for any reason prior
to the Maturity Date for the GTO will be subject to a Market Value Adjustment.
The Market Value Adjustment
The Market Value Adjustment is determined by multiplying a Market Value
Adjustment factor (arrived at by using the Market Value Adjustment formula) by
the Specified Value, or the portion of the Specified Value being withdrawn. The
Specified Value is the amount allocated to the GTO, plus interest accrued at the
Specified Interest Rate, minus prior distributions. The Market Value Adjustment
may either increase or decrease the amount of the distribution.
The Market Value Adjustment is intended to approximate, without
duplicating, Nationwide's experience when it liquidates assets in order to
satisfy contractual obligations. Such obligations arise when contract owners
make withdrawals or transfers, or when the operation of the variable contract
requires a distribution. Nationwide does not make the adjustment on
distributions to pay death benefits in certain jurisdictions. When liquidating
assets, Nationwide may realize either a gain or a loss.
5
MVA Interest Rates
The Market Value Adjustment formula used to determine the Market Value
Adjustment factor is based on either CMT rates, or interest rate swaps,
depending on the variable contracts under which the GTO is offered. CMT rates
and interest rate swaps are declared by the Federal Reserve Board on a regular
basis. Nationwide either uses CMT rates or interest rate swaps in its Market
Value Adjustment formula because they represent a readily available and
consistently reliable interest rate benchmark in financial markets, which can be
relied upon to reflect the relationship between Specified Interest Rates
declared by Nationwide and the prospective interest rate fluctuations.
CMT rates and interest rate swaps for 1, 3, 5, 7 and 10 years are published
by the Federal Reserve Board on a regular basis. To the extent that the Market
Value Adjustment formula shown below requires a rate associated with a maturity
not published (such as a 4, 6, 8 or 9 year maturity), Nationwide will calculate
such rates based on the relationship of the published rates. For example, if the
published 3 year rate is 6% and the published 5 year rate is 6.50%, the 4 year
rate will be calculated as 6.25%.
The Market Value Adjustment Formula
The Market Value Adjustment formula is used when a distribution is made
from a GTO during the Guaranteed Term. The Market Value Adjustment is a
calculation expressing the relationship between three factors:
(1) the MVA Interest Rate for the period of time coinciding with the
Guaranteed Term of the GTO;
(2) the MVA Interest Rate for a period coinciding with the time remaining
in the Guaranteed Term of a GTO when a distribution giving rise to a
Market Value Adjustment occurs; and
(3) the number of days remaining in the Guaranteed Term of the GTO.
The formula for determining the Market Value Adjustment factor is:
t
1 + a
------------------
1 + b + .0025
Where:
a= the MVA Interest Rate for a period equal to the Guaranteed Term at the
time of deposit in the GTO;
b= the MVA Interest Rate at the time of distribution for a period of time
equal to the time remaining in the Guaranteed Term. In determining the
number of years to maturity, any partial year will be counted as a
full year, unless it would cause the number of years to exceed the
Guaranteed Term; and
t= the number of days until the Maturity Date, divided by 365.25.
In certain jurisdictions the denominator is 1+b without the addition of
...0025.
6
In the case of "a" above, the MVA Interest Rate used will either be the CMT
rate or interest rate swap, depending on the variable contract. For variable
contracts using CMT rates, "a" will be the CMT rate declared on Fridays by the
Federal Reserve Board, and placed in effect by Nationwide for allocations made
to the GTO on the following Wednesday through Tuesday. For variable contracts
using interest rate swaps, "a" is the interest rate swap published by the
Federal Reserve Board two days before the date the allocation to the GTO was
made.
In the case of "b" above, the MVA Interest Rate used will either be the CMT
rate or interest rate swap, depending on the variable contract. For variable
contracts using CMT rates, "b" will be the CMT rate declared on Fridays by the
Federal Reserve Board, and placed in effect by Nationwide for withdrawals,
transfers or other distributions giving rise to a Market Value Adjustment on the
following Wednesday through Tuesday. For variable contracts using interest rate
swaps, "b" is the interest rate swap published by the Federal Reserve Board two
days before the date of withdrawal, transfer or other distribution giving rise
to a Market Value Adjustment.
The Market Value Adjustment factor will be equal to 1 during the Investment
Period.
The Market Value Adjustment formula shown above also accounts for some of
the administrative and processing expenses incurred when fixed-interest
investments are liquidated. This is represented by the addition of .0025 in the
Market Value Adjustment formula.
The result of the Market Value Adjustment formula shown above is the Market
Value Adjustment factor. The Market Value Adjustment factor is multiplied by the
Specified Value, or that portion of the Specified Value being distributed from a
GTO, in order to effect a Market Value Adjustment. The Market Value Adjustment
factor will either be greater than, less than, or equal to 1 and will be
multiplied by the Specified Value (or a portion of the Specified Value) being
withdrawn from the GTO for any reason. If the Market Value Adjustment factor is
greater than 1, a gain will be realized by the contract owner; if the Market
Value Adjustment factor is less than 1, a loss will be realized. If the Market
Value Adjustment factor is exactly 1, no gain or loss will be realized.
If the Federal Reserve Board halts publication of CMT rates or interest
rate swaps, or if, for any other reason, they are not available, Nationwide will
use appropriate rates based on U.S. Treasury Bond yields.
Examples of how to calculate Market Value Adjustments based on CMT rates
are provided in the Appendix.
CONTRACT CHARGES
The variable contracts under which GTOs are made available have various
fees and charges, including charges for optional benefits, some of which may be
assessed against allocations made to GTOs. Contract charges assessed against
allocations made to the GTOs will reduce the credited guaranteed interest rate
by the amount of the applicable charge. The variable contract prospectus fully
describes these fees and charges and any impact such charges may have on the
credited guaranteed interest rate of the GTOs. Please refer to the variable
contract prospectus for complete details.
Surrender charges, if applicable, will be assessed against full or partial
surrenders from the GTOs. If a surrender occurs prior to the Maturity Date for a
particular GTO, the amount surrendered is subject to a Market Value Adjustment
in addition to any surrender charge assessed pursuant to the terms of the
variable contract.
7
GTOS AT ANNUITIZATION
GTOs are not available as investment options for variable annuity contracts
that are annuitized. If a variable annuity contract is annuitized while a GTO is
in effect, and prior to the Maturity Date of the GTO, a Market Value Adjustment
will apply to amounts transferred to other investment options under the variable
annuity contract that may be used during annuitization, unless such an
adjustment is not permitted in your jurisdiction.
NATIONWIDE LIFE INSURANCE COMPANY
Nationwide is a stock life insurance company organized under Ohio law in
March, 1929, with its home office at One Nationwide Plaza, Columbus, Ohio 43215.
Nationwide is a provider of life insurance, annuities and retirement products.
It is admitted to do business in all states, the District of Columbia and Puerto
Rico.
INVESTMENTS
Nationwide intends to invest amounts allocated to GTOs in high quality,
fixed interest investments (investment grade bonds, mortgages, and
collateralized mortgage obligations) in the same manner as Nationwide invests
its general account assets. Nationwide takes into account the various maturity
durations of the GTOs (1, 3, 5, 7 and 10 years) and anticipated cash-flow
requirements when making investments. Nationwide is not obligated to invest GTO
allocations in accordance with any particular investment objective, but will
generally adhere to Nationwide's overall investment philosophy. The Specified
Interest Rates declared by Nationwide for the various GTOs will not necessarily
correspond to the performance of the non-unitized separate account.
CONTRACTS AND THE DISTRIBUTION (MARKETING) OF THE GTOS
The GTOs are available only as investment options under certain variable
contracts issued by Nationwide. The appropriate variable contract prospectus
and, if applicable, the Statement of Additional Information should be consulted
for information regarding the distribution of the variable contracts.
INCORPORATION OF CERTAIN INFORMATION BY REFERENCE
The latest Annual Report on Form 10-K (for the period ended December 31, 2003),
and the latest Quarterly Report on Form 10-Q (for the period June 30, 2004) for
Nationwide have been filed with the Commission. These reports are incorporated
by reference, and copies must accompany this Prospectus. These reports contain
additional information about Nationwide, including financial statements. The
financial statements of the Annual Report are audited. The financial statements
of the Quarterly Reports are unaudited. Nationwide filed these reports, via
EDGAR, File No. 002-64559 on the following dates: 10-K on March 11, 2004; 10-Q
on May 7, 2004; and 10-Q on August 6, 2004.
If requested, Nationwide will furnish, without charge, a copy of any and
all of the documents incorporated by reference, other than exhibits to those
documents (unless such exhibits are specifically incorporated by reference in
those documents).
8
LEGAL OPINION
Legal matters in connection with federal laws and regulations affecting the
issue and sale of the GTOs described in this Prospectus and the organization of
Nationwide, its authority to issue GTOs under Ohio law, and the validity of the
endorsement to the variable annuity contracts under Ohio law have been passed on
by Nationwide's Office of General Counsel.
EXPERTS
The consolidated financial statements and schedules of Nationwide Life
Insurance Company and subsidiaries as of December 31, 2003 and 2002, and for the
years ended December 31, 2003, 2002, and 2001 have been incorporated by
reference herein in reliance upon the report of KPMG LLP, independent registered
public accounting firm, appearing elsewhere herein, and upon the authority of
such firm as experts in accounting and auditing. The report of KPMG LLP covering
the December 31, 2001 financial statements of Nationwide Life Insurance Company
and subsidiaries refers to a change to the method of accounting for derivative
instruments and hedging activities, and for purchased or retained interests in
securitized financial assets.
DISCLOSURE OF COMMISSION POSITION ON INDEMNIFICATION
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Act") may be permitted to directors, officers and controlling
persons of Nationwide pursuant to the foregoing provisions, or otherwise,
Nationwide has been advised that in the opinion of the Securities and Exchange
Commission such indemnification is against public policy as expressed in the Act
and is, therefore, unenforceable. In the event that a claim for indemnification
against such liabilities (other than the payment by the registrant of expenses
incurred or paid by a director, officer or controlling person of the registrant
in the successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, Nationwide will, unless in the opinion of its counsel the matter has
been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
9
APPENDIX
Example A
Assume that a variable annuity contract owner made a $10,000 allocation on the
last day of a calendar quarter into a 5-year Guaranteed Term Option. The
Specified Interest Rate at the time is 8.5% and the 5-year Constant Maturity
Treasury Rate in effect is 8%. The variable annuity contract owner decides to
surrender the GTO 985 days from maturity. The Specified Value of the GTO is
$12,067.96. At this time, the 3-year Constant Maturity Treasury Rate is 7%.
(985/365.25 is 2.69, which rounds up to 3, so the 3-year CMT Rate is Used.)
D
---------------
1 + A 365.25
-------------------------
MVA FACTOR = 1 + B + 0.0025
985
--------------
1 + 0.08 365.25
------------------------
MVA FACTOR = 1 + 0.07 + 0.0025
MVA FACTOR = 1.01897
SURRENDER VALUE = SPECIFIED VALUE .........X MVA FACTOR
SURRENDER VALUE = $12,067.96 .........X 1.01897
*SURRENDER VALUE = $12,296.89
*Assumes no variable annuity contract contingent deferred sales charges are
applicable. In jurisdictions where the .0025 is not permitted in the
denominator, the Surrender Value is $12,374.52.
Specified Value (for purposes of the Example) = the amount of the GTO allocation
($10,000), plus interest accrued at the Specified Interest Rate (8.5%).
a= The Constant Maturity Treasury Rate declared by the Federal Reserve
Board on Friday, and placed in effect by Nationwide for allocations
made to the GTO on the following Wednesday through Tuesday.
b= The Constant Maturity Treasury Rate declared by the Federal Reserve
Board on Friday, and placed in effect by Nationwide for withdrawals,
transfers or other distributions giving rise to a Market Value
Adjustment on the following Wednesday through Tuesday.
d= The number of days remaining in the Guaranteed Term.
Example B
Assume that a variable annuity contract owner made a $10,000 allocation on the
last day of a calendar quarter into a 5-year Guaranteed Term Option. The
Specified Interest Rate at the time is 8.5% and the 5-year Constant Maturity
Treasury Rate in effect is 8%. The variable annuity contract owner decides to
surrender his money 985 days from maturity. The Specified Value of the GTO is
$12,067.96. At this time, the 3-year Constant Maturity Treasury Rate is 9%.
(985/365.25 is, 2.69 which rounds up to 3, so the 3-year CMT Rate is used.)
D
----------------
1 + A 365.25
------------------------
MVA FACTOR = 1 + B + 0.0025
985
---------------
1 + 0.08 365.25
------------------------
MVA FACTOR = 1 + 0.09 + 0.0025
MVA FACTOR = 0.96944
SURRENDER VALUE = SPECIFIED VALUE .........X MVA FACTOR
SURRENDER VALUE = $12,067.96 .........X 0.96944
*SURRENDER VALUE = $11,699.17
*Assumes no variable annuity contract contingent deferred sales charges are
applicable. In jurisdictions where the .0025 is not permitted in the
denominator, the Surrender Value is $11,771.69.
Specified Value (for purposes of the Example) = the amount of the GTO allocation
($10,000), plus interest accrued at the Specified Interest Rate (8.5%).
a= The Constant Maturity Treasury Rate declared by the Federal Reserve
Board on Friday, and placed in effect by Nationwide for allocations
made to the GTO on the following Wednesday through Tuesday.
b= The Constant Maturity Treasury Rate declared by the Federal Reserve
Board on Friday, and placed in effect by Nationwide for withdrawals,
transfers or other distributions giving rise to a Market Value
Adjustment on the following Wednesday through Tuesday.
d= The number of days remaining in the Guaranteed Term.
Example C
Assume that a variable annuity contract owner made a $10,000 allocation on the
last day of a calendar quarter into a 5-year Guaranteed Term Option. The
Specified Interest Rate at the time is 8.5% and the 5-year interest rate swap in
effect is 8%. The variable annuity contract owner decides to surrender the GTO
985 days from maturity. The Specified Value of the GTO is $12,067.96. At this
time, the 3-year interest rate swap is 7%. (985/365.25 is 2.69, which rounds up
to 3, so the 3-year interest rate swap is used.)
D
--------------
1 + A 365.25
------------------------
MVA FACTOR = 1 + B + 0.0025
985
--------------
1 + 0.08 365.25
------------------------
MVA FACTOR = 1 + 0.07 + 0.0025
MVA FACTOR = 1.01897
SURRENDER VALUE = SPECIFIED VALUE .........X MVA FACTOR
SURRENDER VALUE = $12,067.96 .........X 1.01897
*SURRENDER VALUE = $ 12,296.89
*Assumes no variable annuity contract contingent deferred sales charges are
applicable. In jurisdictions where the .0025 is not permitted in the
denominator, the Surrender Value is $12,374.52.
Specified Value (for purposes of the Example) = the amount of the GTO allocation
($10,000), plus interest accrued at the Specified Interest Rate (8.5%).
a= The interest rate swap published by the Federal Reserve Board two days
before the date the allocation to the GTO was made. If no interest
rate swap is available for this date, then the most recent available
rate prior to that date will be used.
b= The interest rate swap published by the Federal Reserve Board two days
before the date of withdrawal, transfer or other distribution giving
rise to a Market Value Adjustment. If no interest rate swap is
available for this date, then the most recent available rate prior to
that date will be used.
d= The number of days remaining in the Guaranteed Term.
Example D
Assume that a variable annuity contract owner made a $10,000 allocation on the
last day of a calendar quarter into a 5-year Guaranteed Term Option. The
Specified Interest Rate at the time is 8.5% and the 5-year interest rate swap in
effect is 8%. The variable annuity contract owner decides to surrender the GTO
985 days from maturity. The Specified Value of the GTO is $12,067.96. At this
time, the 3-year interest rate swap is 9%. (985/365.25 is 2.69, which rounds up
to 3, so the 3-year interest rate swap is used.)
D
---------------
1 + A 365.25
----------------------------
MVA FACTOR = 1 + B + 0.0025
985
---------------
1 + 0.08 365.25
----------------------------
MVA FACTOR = 1 + 0.09 + 0.0025
MVA FACTOR = 0.96944
SURRENDER VALUE = SPECIFIED VALUE ......X MVA FACTOR
SURRENDER VALUE = $12,067.96 .........X 0.96944
*SURRENDER VALUE = $11,699.17
*Assumes no variable annuity contract contingent deferred sales charges are
applicable. In jurisdictions where the .0025 is not permitted in the
denominator, the Surrender Value is $11,771.69.
Specified Value (for purposes of the Example) = the amount of the GTO allocation
($10,000), plus interest accrued at the Specified Interest Rate (8.5%).
a= The interest rate swap published by the Federal Reserve Board two days
before the date the allocation to the GTO was made. If no interest
rate swap is available for this date, then the most recent available
rate prior to that date will be used.
b= The interest rate swap published by the Federal Reserve Board two days
before the date of the withdrawal, transfer or other distribution
giving rise to a Market Value Adjustment. If no interest rate swap is
available for this date, then the most recent available rate prior to
that date will be used.
d= The number of days remaining in the Guaranteed Term.
The table set forth below illustrates the impact of a Market Value Adjustment
applied upon a full surrender of a 10-year GTO allocation, at various stages of
the corresponding Guaranteed Term. These figures assume a $10,000 allocation to
the 10-year GTO on the last day of a calendar quarter. These figures assume a
Specified Interest Rate of 8.5% on the date the allocation to the GTO was made.
These figures are based on a 10-year CMT Rate of 8% in effect on the date the
allocation to the GTO was made (a in the Market Value Adjustment Formula) and
varying current yield CMT Rates shown in the first column (b in the Market Value
Adjustment Formula).
- - --------------------------------------------------------------------------------------------------
TIME REMAINING TO THE
END OF THE GUARANTEED SPECIFIED VALUE MARKET VALUE MARKET
CURRENT YIELD TERM ADJUSTMENT VALUE
- - --------------------------------------------------------------------------------------------------
12.00% 9 Years $10,850 -29.35% $7,665
- - --------------------------------------------------------------------------------------------------
7 Years $12,776 -23.68% $9,751
- - --------------------------------------------------------------------------------------------------
5 Years $15,040 -17.56% $12,399
- - --------------------------------------------------------------------------------------------------
2 Years $19,215 -7.43% $17,786
- - --------------------------------------------------------------------------------------------------
180 Days $21,733 -1.88% $21,323
- - --------------------------------------------------------------------------------------------------
10.00% 9 Years $10,850 -16.94% $9,012
- - --------------------------------------------------------------------------------------------------
7 Years $12,776 -13.44% $11,059
- - --------------------------------------------------------------------------------------------------
5 Years $15,040 -9.80% $13,566
- - --------------------------------------------------------------------------------------------------
2 Years $19,215 -4.04% $18,438
- - --------------------------------------------------------------------------------------------------
180 Days $21,733 -1.01% $21,513
- - --------------------------------------------------------------------------------------------------
9.00% 9 Years $10,850 -9.84% $9,782
- - --------------------------------------------------------------------------------------------------
7 Years $12,776 -7.74% $11,787
- - --------------------------------------------------------------------------------------------------
5 Years $15,040 -5.59% $14,199
- - --------------------------------------------------------------------------------------------------
2 Years $19,215 -2.28% $18,777
- - --------------------------------------------------------------------------------------------------
180 Days $21,733 -0.57% $21,610
- - --------------------------------------------------------------------------------------------------
8.00% 9 Years $10,850 -2.06% $10,627
- - --------------------------------------------------------------------------------------------------
7 Years $12,776 -1.61% $12,571
- - --------------------------------------------------------------------------------------------------
5 Years $15,040 -1.15% $14,867
- - --------------------------------------------------------------------------------------------------
2 Years $19,215 -0.46% $19,126
- - --------------------------------------------------------------------------------------------------
180 Days $21,733 -0.11% $21,708
- - --------------------------------------------------------------------------------------------------
7.00% 9 Years $10,850 6.47% $11,552
- - --------------------------------------------------------------------------------------------------
7 Years $12,776 5.00% $13,414
- - --------------------------------------------------------------------------------------------------
5 Years $15,040 3.55% $15,573
- - --------------------------------------------------------------------------------------------------
2 Years $19,215 1.40% $19,484
- - --------------------------------------------------------------------------------------------------
180 Days $21,733 0.34% $21,808
- - --------------------------------------------------------------------------------------------------
6.00% 9 Years $10,850 15.84% $12,569
- - --------------------------------------------------------------------------------------------------
7 Years $12,776 12.11% $14,324
- - --------------------------------------------------------------------------------------------------
5 Years $15,040 8.51% $16,321
- - --------------------------------------------------------------------------------------------------
2 Years $19,215 3.32% $19,853
- - --------------------------------------------------------------------------------------------------
180 Days $21,733 0.81% $21,909
- - --------------------------------------------------------------------------------------------------
4.00% 9 Years $10,850 37.45% $14,914
- - --------------------------------------------------------------------------------------------------
7 Years $12,776 28.07% $16,362
- - --------------------------------------------------------------------------------------------------
5 Years $15,040 19.33% $17,948
- - --------------------------------------------------------------------------------------------------
2 Years $19,215 7.32% $20,623
- - --------------------------------------------------------------------------------------------------
180 Days $21,733 1.76% $22,115
- - --------------------------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------------
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _________ TO _________
COMMISSION FILE NO. 2-64559
NATIONWIDE LIFE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
OHIO 31-4156830
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
ONE NATIONWIDE PLAZA
COLUMBUS, OHIO 43215
(614) 249-7111
(Address, including zip code, and
telephone number, including area code, of
Registrant's principal executive offices)
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
NONE
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 the filing
requirements for at least the past 90 days.
YES X NO __
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2).
YES __ NO X
All voting stock was held by affiliates of the Registrant on March 1, 2004.
COMMON STOCK (par value $1 per share) - 3,814,779 shares issued
and outstanding as of March 1, 2004 (Title of Class)
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(A) AND
(B) OF FORM 10-K AND IS THEREFORE FILING THIS FORM WITH THE REDUCED DISCLOSURE
FORMAT.
4
PART I
ITEM 1 BUSINESS
OVERVIEW
Nationwide Life Insurance Company (NLIC, or collectively with its
subsidiaries, the Company) was incorporated in 1929 and is an Ohio
stock legal reserve life insurance company.
The Company is a member of the Nationwide group of companies
(Nationwide), which is comprised of Nationwide Mutual Insurance
Company (NMIC) and all of its subsidiaries and affiliates.
All of the outstanding shares of NLIC's common stock are owned by
Nationwide Financial Services, Inc. (NFS), a holding company formed by
Nationwide Corporation (Nationwide Corp.), a majority owned subsidiary
of NMIC.
In December 2001, NLIC issued to NFS a 7.50%, $300.0 million surplus
note maturing on December 17, 2031. In June 2002, NLIC issued to NFS
an 8.15% $300.0 million surplus note maturing on June 27, 2032. In
December 2003, NLIC issued to NFS a 6.75% $100.0 million surplus note
maturing on December 23, 2033.
Wholly owned subsidiaries of NLIC as of December 31, 2003 include
Nationwide Life and Annuity Insurance Company (NLAIC) and Nationwide
Investment Services Corporation (NISC). NLAIC offers universal life
insurance, variable universal life insurance, corporate-owned life
insurance and individual annuity contracts on a non-participating
basis. NISC is a registered broker/dealer.
The Company is a leading provider of long-term savings and retirement
products in the United States of America. The Company develops and
sells a diverse range of products including individual annuities,
private and public sector pension plans, other investment products
sold to institutions, life insurance on a participating and
non-participating basis and advisory services. The Company sells its
products through a diverse distribution network, including independent
broker/dealers, wirehouse and regional firms, financial institutions,
pension plan administrators, life insurance specialists, certified
public accounting (CPA) firms and the following affiliated producers;
Nationwide Retirement Solutions (NRS), TBG Financial, Nationwide
Provident agents and Nationwide agents. The Company believes its
diverse range of competitive product offerings and strong distributor
relationships positions it to compete effectively in the rapidly
growing retirement savings market under various economic conditions.
BUSINESS SEGMENTS
The Company has three product segments: Individual Annuity,
Institutional Products and Life Insurance. In addition, the Company
reports certain other revenues and expenses in a Corporate segment.
The Individual Annuity segment, which accounted for $170.7 million, or
32%, of the Company's pre-tax operating earnings for 2003, consists of
individual The BEST of AMERICA(R), private label and deferred variable
annuity products, deferred fixed annuity products and income products.
Individual deferred annuity contracts provide the customer with
tax-deferred accumulation of savings and flexible payout options
including lump sum, systematic withdrawal or a stream of payments for
life. In addition, variable annuity contracts provide the customer
with access to a wide range of investment options and asset protection
in the event of an untimely death, while fixed annuity contracts
generate a return for the customer at a specified interest rate fixed
for prescribed periods.
The Institutional Products segment, which accounted for $209.0
million, or 39%, of the Company's pre-tax operating earnings for 2003,
is comprised of the Company's Private and public sector group
retirement plans, medium-term note program and structured products
initiatives. The private sector includes the 401(k) business generated
through variable and fixed group annuities. The public sector includes
the Internal Revenue Code (IRC), Section 457 business in the form of
fixed and variable annuities.
The Life Insurance segment, which accounted for $150.0 million, or
28%, of the Company's pre-tax operating earnings for 2003, consists of
investment life products, including both individual variable life and
corporate-owned life insurance (COLI) products, traditional life
insurance products and universal life insurance. Life insurance
products provide a death benefit and generally also allow the customer
to build cash value on a tax-advantaged basis.
Losses in the Corporate segment accounted for $5.5 million, or 1%, of
the Company's pre-tax operating earnings (which excludes
non-securitization related net realized gains and losses on
investments, hedging instruments and hedged items) for 2003.
Additional information related to the Company's business segments is
included in note 19 to the consolidated financial statements and
Financial Statement Schedule III, included in the F pages of this
report.
REINSURANCE
The Company follows the industry practice of reinsuring a portion of
its life insurance and annuity risks with other companies in order to
reduce net liability on individual risks, to provide protection
against large losses and to obtain greater diversification of risks.
The maximum amount of individual ordinary life insurance retained by
the Company on any one life is $4.0 million. The Company cedes
insurance primarily on an automatic basis, under which risks are ceded
to a reinsurer on specific blocks of business where the underlying
risks meet certain predetermined criteria and on a facultative basis,
under which the reinsurer's prior approval is required for each risk
reinsured. The Company also cedes insurance on a case-by-case basis
particularly where the Company may be writing new risks or is
unwilling to retain the full costs associated with new lines of
business. The ceding of risk does not discharge the Company, as the
original insurer from its primary obligation to the policyholder. The
Company has entered into reinsurance contracts to cede a portion of
its general account individual annuity business. Total recoveries due
from these contracts were $635.9 million and $362.3 million as of
December 31, 2003 and 2002, respectively. Under the terms of the
contracts, trusts have been established 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% or 102% of the reinsured reserves, as outlined in
each of the underlying contracts. The Company has no other material
reinsurance arrangements with unaffiliated reinsurers. The only
sizable reinsurance agreements the Company has with affiliates are the
modified coinsurance agreements pursuant to which NLIC reinsured all
of its accident and health insurance business not ceded to
unaffiliated reinsurers to other members of Nationwide as described in
note 15 to the consolidated financial statements included in the F
pages of this report.
RATINGS
Ratings with respect to claims-paying ability and financial strength
have become an increasingly important factor in establishing the
competitive position of insurance companies. Ratings are important to
maintaining public confidence in the Company and its ability to market
its annuity and life insurance products. Rating organizations
continually review the financial performance and condition of
insurers, including the Company. Any lowering of the Company's ratings
could have a material adverse effect on the Company's ability to
market its products and could increase the rate of surrender of the
Company's products. Both of these consequences could, depending upon
the extent thereof, have a material adverse effect on the Company's
liquidity and, under certain circumstances, net income. NLIC and NLAIC
are rated "A+" (Superior) by A.M. Best Company, Inc. (A.M. Best) and
their claims-paying ability/financial strength is rated "Aa3"
(Excellent) by Moody's Investors Service, Inc. (Moody's) and "AA-"
(Very Strong) by Standard & Poor's, a Division of The McGraw-Hill
Companies, Inc. (S&P).
The foregoing ratings reflect each rating agency's opinion of NLIC's
financial strength, operating performance and ability to meet its
obligations to policyholders and are not evaluations directed toward
the protection of investors. Such factors are of concern to
policyholders, agents and intermediaries. Furthermore, ratings
organizations utilize proprietary capital adequacy models in the
process of establishing ratings for the Company and certain
subsidiaries. The Company is at risk to changes in these models and
the impact that changes in the underlying business that it is engaged
in can have on such models. To mitigate this risk, the Company
maintains regular communications with the rating agencies and performs
evaluations using such capital adequacy models and considers such
models in the design of transactions to minimize the adverse impact of
this risk.
The Company's financial strength is also reflected in the ratings of
commercial paper, which is rated "AMB-1" by A.M. Best, "P-1" by
Moody's and "A-1+" by S&P.
COMPETITION
The Company competes with a large number of other insurers as well as
non-insurance financial services companies, such as banks,
broker/dealers and mutual funds, some of whom have greater financial
resources, offer alternative products and, with respect to other
insurers, have higher ratings than the Company. The Company believes
that competition in its lines of business is based on price, product
features, commission structure, perceived financial strength,
claims-paying ratings, service and name recognition.
On November 12, 1999, the Gramm-Leach-Bliley Act (the Act), was
signed. The Act modernizes the regulatory framework for financial
services in the U.S., which allows banks, securities firms and
insurance companies to affiliate more directly than they have been
permitted to do in the past. While the Act facilitates these
affiliations, to date no significant competitors of the Company have
acquired, or have been acquired by, a banking entity under authority
of the Act. Nevertheless, it is not possible to anticipate whether
such affiliations might occur in the future.
REGULATION
General Regulation at State Level
NLIC and NLAIC, as with other insurance companies, are subject to
regulation by the states in which they are domiciled and/or transact
business. Most states have enacted legislation that requires each
insurance holding company and each insurance company in an insurance
holding company system to register with the insurance regulatory
authority of the insurance company's state of domicile and annually
furnish financial and other information concerning the operations of
companies within the holding company system that materially affect the
operations, management or financial condition of the insurers within
such system. In many cases, under such laws, a state insurance
authority must approve in advance the direct or indirect acquisition
of 10% or more of the voting securities of an insurance company
domiciled in its state. NLIC and NLAIC are subject to the insurance
holding company laws in the State of Ohio. Under such laws, all
transactions within an insurance holding company system affecting
insurers must be fair and equitable and each insurer's policyholder
surplus following any such transaction must be both reasonable in
relation to its outstanding liabilities and adequate for its needs.
The State of Ohio insurance holding company laws also require prior
notice or regulatory approval of the change of control of an insurer
or its holding company and of material intercorporate transfers of
assets within the holding company structure.
In addition, the laws of the various states establish regulatory
agencies with broad administrative powers to approve policy forms,
grant and revoke licenses to transact business, regulate trade
practices, license agents, require statutory financial statements,
limit the amount of dividends and other payments that can be paid by
insurance companies without prior approval and impose restrictions on
the type and amount of investments permitted. These regulations are
primarily intended to protect policyholders rather than shareholders.
The Company cannot predict the effect that any proposed or future
legislation may have on the financial condition or results of
operations of the Company.
Insurance companies are required to file detailed annual and quarterly
statutory financial statements with state insurance regulators in each
of the states in which they do business and their business and
accounts are subject to examination by such agencies at any time. In
addition, insurance regulators periodically examine an insurer's
financial condition, adherence to statutory accounting practices and
compliance with insurance department rules and regulations. Applicable
state insurance laws, rather than federal bankruptcy laws, apply to
the liquidation or the restructuring of insurance companies.
As part of their routine regulatory oversight process, state insurance
departments periodically conduct detailed examinations of the books,
records and accounts of insurance companies domiciled in their states.
Such examinations are generally conducted in cooperation with the
insurance departments of multiple states under guidelines promulgated
by the National Association of Insurance Commissioners (NAIC). The
most recently completed examinations of NLIC and NLAIC was conducted
by the Ohio Department of Insurance for the five-year period ended
December 31, 2001. The final reports of these examinations did not
result in any significant issues or adjustments.
In recent years, a number of life and annuity insurers have been the
subject of regulatory proceedings and litigation relating to alleged
improper life insurance pricing and sales practices. Some of these
insurers have incurred or paid substantial amounts in connection with
the resolution of such matters. In addition, state insurance
regulatory authorities regularly make inquiries, hold investigations
and administer market conduct examinations with respect to insurers'
compliance with applicable insurance laws and regulations. NLIC and
NLAIC are currently undergoing regulatory market conduct examinations
in six states. The Company and its insurance subsidiary continuously
monitor sales, marketing and advertising practices and related
activities of their agents and personnel and provide continuing
education and training in an effort to ensure compliance with
applicable insurance laws and regulations. There can be no assurance
that any non-compliance with such applicable laws and regulations
would not have a material adverse effect on the Company.
Regulation of Dividends and Other Payments
State insurance laws generally restrict the ability of insurance
companies to pay cash dividends and other payments in excess of
certain prescribed limitations without prior approval. Further
discussion about such restrictions and dividend capacity is provided
in note 14 to the consolidated financial statements included in the F
pages to this report and are hereby incorporated by reference.
Risk-Based Capital Requirements
In order to enhance the regulation of insurer solvency, the NAIC has
adopted a model law to implement risk-based capital (RBC) requirements
for life insurance companies. The requirements are designed to monitor
capital adequacy and to raise the level of protection that statutory
surplus provides for policyholders. The model law measures four major
areas of risk facing life insurers: (i) the risk of loss from asset
defaults and asset value fluctuation; (ii) the risk of loss from
adverse mortality and morbidity experience; (iii) the risk of loss
from mismatching of asset and liability cash flow due to changing
interest rates and (iv) business risks. Insurers having less statutory
surplus than required by the RBC model formula will be subject to
varying degrees of regulatory action depending on the level of capital
inadequacy.
Based on the formula adopted by the NAIC, the adjusted capital of NLIC
and NLAIC exceeded the levels at which they would be required to take
corrective action by a substantial amount as of December 31, 2003.
Assessments Against and Refunds to Insurers
Insurance guaranty association laws exist in all states, the District
of Columbia and Puerto Rico. Insurers doing business in any of these
jurisdictions can be assessed for policyholder losses incurred by
insolvent insurance companies. The amount and timing of any future
assessment on or refund to the Company's insurance subsidiaries under
these laws cannot be reasonably estimated and are beyond the control
of the Company and its insurance subsidiaries. A large part of the
assessments paid by the Company's insurance subsidiaries pursuant to
these laws may be used as credits for a portion of the Company's
insurance subsidiaries' premium taxes. For the years ended December
31, 2003, 2002 and 2001, the Company received net refunds of less than
$0.1 million, $1.4 million and $0.3 million, respectively.
Securities Laws
Certain of the Company and its insurance subsidiary and certain
policies and contracts offered by them are subject to regulation under
the federal securities laws administered by the U.S. Securities and
Exchange Commission (the Commission) and under certain state
securities laws. Certain separate accounts of the Company and its
insurance subsidiary are registered as investment companies under the
Investment Company Act of 1940, as amended (Investment Company Act).
Separate account interests under certain variable annuity contracts
and variable insurance policies issued by the Company and its
insurance subsidiary are also registered under the Securities Act of
1933, as amended. The Company and its subsidiary are registered as
broker/dealers under the Securities Exchange Act of 1934, as amended
(Securities Exchange Act) and are members of, and subject to
regulation by, the National Association of Securities Dealers.
Certain of the Company and its subsidiary are investment advisors
registered under the Investment Advisors Act of 1940, as amended. The
investment companies managed by such subsidiaries are registered with
the Commission under the Investment Company Act and the shares of
certain of these entities are qualified for sale in certain states in
the U.S. and the District of Columbia. A subsidiary of the Company is
registered with the Commission as a transfer agent. Certain
subsidiaries of the Company are also subject to the Commission's net
capital rules.
All aspects of the Company and its subsidiary investment advisory
activities are subject to various federal and state laws and
regulations in jurisdictions in which they conduct business. These
laws and regulations are primarily intended to benefit investment
advisory clients and investment company shareholders and generally
grant supervisory agencies broad administrative powers, including the
power to limit or restrict the carrying on of business for failure to
comply with such laws and regulations. In such event, the possible
sanctions which may be imposed include the suspension of individual
employees, limitations on the activities in which the investment
advisor may engage, suspension or revocation of the investment
advisor's registration as an advisor, censure and fines.
ERISA Considerations
On December 13, 1993, the U.S. Supreme Court issued its opinion in
John Hancock Mutual Life Insurance Company v. Harris Trust and Savings
Bank holding that certain assets in excess of amounts necessary to
satisfy guaranteed obligations held by Hancock in its general account
under a participating group annuity contract are "plan assets" and
therefore subject to certain fiduciary obligations under the Employee
Retirement Income Security Act of 1974, as amended (ERISA). ERISA
requires that fiduciaries perform their duties solely in the interest
of ERISA plan participants and beneficiaries, and with the care,
skill, prudence and diligence that a prudent person acting in a like
capacity and familiar with such matters would use in the conduct of an
enterprise of a like character and with like aims. The Court imposed
ERISA fiduciary obligations to the extent that the insurer's general
account is not reserved to pay benefits under guaranteed benefit
policies (i.e. benefits whose value would not fluctuate in accordance
with the insurer's investment experience).
The Secretary of Labor issued final regulations on January 5, 2000,
providing guidance for the purpose of determining, in cases where an
insurer issues one or more policies backed by the insurer's general
account to or for the benefit of an employee benefit plan, which
assets of the insurer constitute plan assets for purposes of ERISA and
the IRC. The regulations apply only with respect to a policy issued by
an insurer to an ERISA plan on or before December 31, 1998. In the
case of such a policy, most provisions of the regulations are
applicable on July 5, 2001. Generally, where the basis of a claim is
that insurance company general account assets constitute plan assets,
no person will be liable under ERISA or the IRC for conduct occurring
prior to July 5, 2001. However, certain provisions under the final
regulations are applicable as follows: (1) certain contract
termination features become applicable on January 5, 2000 if the
insurer engages in certain unilateral actions; and (2) the initial and
separate account disclosure provisions become applicable July 5, 2000.
New policies issued after December 31, 1998, which are not guaranteed
benefit policies will subject the issuer to ERISA fiduciary
obligations.
On September 19, 2002, the Second Circuit U.S. Court of Appeals held
that Hancock by following the terms of the contract did not violate
its fiduciary duty when it refused to rollover free funds or revalue
plan liabilities. However, the court said it did violate fiduciary
duties by exercising "discretionary management" decisions in matters
not addressed by the contract which included investment of plan funds
in its general account and allocation of the returns on investments
and expenses among its client accounts.
Potential Tax Legislation
Congress has, from time to time, considered possible legislation that
would eliminate many of the tax benefits currently afforded to annuity
products. In fact, the Bush administration's proposals to establish
several new types tax-advantaged retirement and life savings accounts,
each of which, if enacted as proposed, could materially reduce the tax
advantages of purchasing variable annuity and cash value life
insurance products as compared to other investment vehicles. Although
the proposals were not enacted in 2003, those proposals, or other
similar proposals, could be introduced for enactment in future
periods.
AVAILABLE INFORMATION
The Company files Current Reports on Form 8-K, Quarterly Reports on
Form 10-Q, Annual Reports on Form 10-K and other reports
electronically with the Securities and Exchange Commission, which are
available on the Securities and Exchange Commission's web site
(http://www.sec.gov). The Company also provides electronic and/or
paper copies free of charge, upon request of its Current Reports on
Form 8-K, Quarterly Reports on Form 10-Q, Annual Reports on Form 10-K
and other reports filed electronically with the Securities and
Exchange Commission. Requests should be submitted to Kevin G. O'Brien,
Vice President - Investor Relations, One Nationwide Plaza, Columbus,
Ohio 43215-2220, or you may call (614) 677-5331.
ITEM 2 PROPERTIES
Pursuant to an arrangement between NMIC and certain of its
subsidiaries, during 2003 the Company leased on average approximately
902,508 square feet of office space in the three building home office
complex and in other offices in central Ohio. The Company believes
that its present facilities are adequate for the anticipated needs of
the Company.
ITEM 3 LEGAL PROCEEDINGS
The Company is a party to litigation and arbitration proceedings and
inquiries from regulatory bodies in the ordinary course of its
business, none of which is expected to have a material adverse effect
on the Company.
In recent years, life insurance companies have been named as
defendants in lawsuits, including class action lawsuits relating to
life insurance and annuity pricing and sales practices. A number of
these lawsuits have resulted in substantial jury awards or
settlements.
On October 29, 1998, the Company was named in a lawsuit filed in Ohio
state court by plaintiff Mercedes Castillo that challenged the sale of
deferred annuity products for use as investments in tax-deferred
contributory retirement plans (Mercedes Castillo v. Nationwide
Financial Services, Inc., Nationwide Life Insurance Company and
Nationwide Life and Annuity Insurance Company). On May 3, 1999, the
complaint was amended to, among other things, add Marcus Shore as a
second plaintiff. The amended complaint was brought as a class action
on behalf of all persons who purchased individual deferred annuity
contracts or participated in group annuity contracts sold by the
Company and the other named Company affiliates, which were allegedly
used to fund certain tax-deferred retirement plans. The amended
complaint seeks unspecified compensatory and punitive damages. On May
28, 2002, the Court granted the motion of Marcus Shore to withdraw as
a named plaintiff and denied plaintiffs' motion to add new persons as
named plaintiffs. On November 4, 2002, the Court issued a decision
granting the Company's motion for summary judgment on all of plaintiff
Mercedes Castillo's individual claims, and ruling that plaintiff's
motion for class certification was moot. Following appeal by the
plaintiff, both of those decisions were affirmed by the Ohio Court of
Appeals on September 9, 2003. The plaintiff filed a notice of appeal
of the decision by the Ohio Court of Appeals on October 24, 2003. The
Ohio Supreme Court announced on January 21, 2004 that the appeal was
not accepted and the time for reconsideration has expired.
On October 31, 2003, a lawsuit seeking class action status containing
allegations similar to those made in the Castillo case was filed
against NLIC in Arizona federal court by plaintiff Robert Helman
(Robert Helman et al v. Nationwide Life Insurance Company et al). This
lawsuit is in a very preliminary stage and the Company is evaluating
its merits. The Company intends to defend this lawsuit vigorously.
On August 15, 2001, the Company was named in a lawsuit filed in
Connecticut federal court (Lou Haddock, as trustee of the Flyte Tool &
Die, Incorporated Deferred Compensation Plan, et al v. Nationwide
Financial Services, Inc. and Nationwide Life Insurance Company). The
plaintiffs first amended their complaint on September 6, 2001 to
include class action allegations, and have subsequently amended their
complaint twice. As amended, in the current complaint, the plaintiffs
seek to represent a class of ERISA qualified retirement plans that
purchased variable annuities from NLIC. Plaintiffs allege that they
invested ERISA plan assets in their variable annuity contracts, and
that the Company acquired and breached ERISA fiduciary duties by
accepting service payments from certain mutual funds that allegedly
consisted of or diminished those ERISA plan assets. The complaint
seeks disgorgement of some or all of the fees allegedly received by
the Company and other unspecified relief for restitution, along with
declaratory and injunctive relief and attorneys' fees. On December 3,
2001, the plaintiffs filed a motion for class certification.
Plaintiffs filed a supplement to that motion on September 19, 2003.
The Company opposed that motion on December 24, 2003. On January 30,
2004, the Company filed its Revised Memorandum in Support of Summary
Judgment, and a Motion Requesting that the Court Decide Summary
Judgment before Class Certification. Plaintiffs are opposing that
motion. The Company intends to defend this lawsuit vigorously.
On May 1, 2003, a class action was filed against NLIC in the United
States District Court for the Eastern District of Louisiana, (Edward
Miller, Individually, and on behalf of all others similarly situated,
v. Nationwide Life Insurance Company). The complaint alleges that in
2001, plaintiff Edward Miller purchased three group modified single
premium variable annuities issued by NLIC. Plaintiff alleges that NLIC
represented in its prospectus and promised in its annuity contracts
that contract holders could transfer assets without charge among the
various funds available through the contracts, that the transfer
rights of contract holders could not be modified and that NLIC's
expense charges under the contracts were fixed. Plaintiff claims that
NLIC has breached the contracts and violated federal securities laws
by imposing trading fees on transfers that were supposed to have been
without charge. Plaintiff seeks compensatory damages and rescission on
behalf of himself and a class of persons who purchased this type of
annuity or similar contracts issued by NLIC between May 1, 2001 and
April 30, 2002 inclusive and were allegedly damaged by paying transfer
fees. The Company's motion to dismiss the complaint was granted by the
Court on October 28, 2003. Plaintiff has appealed that dismissal.
On January 21, 2004, the Company was named in a lawsuit filed in the
U.S. District Court for the Northern District of Mississippi (United
Investors Life Insurance Company v. Nationwide Life Insurance Company
and/or Nationwide Life Insurance Company of America and/or Nationwide
Life and Annuity Insurance Company and/or Nationwide Life and Annuity
Company of America and/or Nationwide Financial Services, Inc. and/or
Nationwide Financial Corporation, and John Does A-Z). In its
complaint, the plaintiff alleges that the Company and/or its
affiliated life insurance companies (1) tortiously interfered with the
plaintiff's contractual and fiduciary relationship with Waddell &
Reed, Inc. and/or its affiliates, Waddell & Reed Financial, Inc.,
Waddell & Reed Financial Services, Inc. and W&R Insurance Agency, Inc.
(collectively, "Waddell & Reed"), (2) conspired with and otherwise
caused Waddell & Reed to breach its contractual and fiduciary
obligations to the plaintiff, and (3) tortiously interfered with the
plaintiff's contractual relationship with policyholders of insurance
policies issued by the plaintiff. The complaint seeks compensatory
damages, punitive damages, pre- and post-judgment interest, a full
accounting, and costs and disbursements, including attorneys' fees.
The plaintiff seeks to have each defendant judged jointly and
severally liable for all damages. This lawsuit is in a very
preliminary stage, and the Company intends to defend it vigorously.
The financial services industry, including mutual fund, variable
annuity and distribution companies have been the subject of increasing
scrutiny by regulators, legislators, and the media over the past year.
Numerous regulatory agencies, including the United States Securities
and Exchange Commission and the New York Attorney General, have
commenced industry-wide investigations regarding late trading and
market timing in connection with mutual funds and variable insurance
contracts, and have commenced enforcement actions against some mutual
fund companies on those issues. Investigations and enforcement actions
have also been commenced, on a smaller scale, regarding the sales
practices of mutual fund and variable annuity distributors. These
legal proceedings are expected to continue in the future. These
investigations and proceedings could result in legal precedents, as
well as new industry-wide legislation, rules, or regulations, that
could significantly affect the financial services industry, including
variable annuity companies. The Company has been contacted by
regulatory agencies for information relating to market timing, late
trading, and sales practices. The Company is cooperating with these
regulatory agencies and is responding to those information requests.
There can be no assurance that any such litigation or regulatory
actions will not have a material adverse effect on the Company in the
future.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted due to reduced disclosure format.
PART II
ITEM 5 MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER
MATTERS
There is no established public trading market for NLIC's shares of
common stock. All 3,814,779 shares of NLIC's common stock issued and
outstanding are owned by NFS.
NLIC declared and paid $60.0 million, $35.0 million and $35.0 million
in cash dividends to NFS during 2003, 2002 and 2001, respectively.
NLIC paid a non-cash dividend in the form of all of the common stock
of Nationwide Securities, Inc., valued at $10.0 million, to NFS in
2002. In addition, NLIC sought and obtained prior regulatory approval
from the Ohio Department of Insurance to return $100 million and
$475.0 million of capital to NFS during 2003 and 2002, respectively.
In February 2004, NLIC obtained prior approval from the Ohio
Department of Insurance to pay a dividend to NFS in the amount of
$75.0 million.
NLIC currently does not have a formal dividend policy.
Reference is made to Part I, Item 1 - Business - Regulation of this
report for information regarding dividend restrictions.
ITEM 6 SELECTED CONSOLIDATED FINANCIAL DATA
Omitted due to reduced disclosure format.
ITEM 7 MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS
INTRODUCTION
Management's discussion and analysis of financial condition and
results of operations of NLIC and its subsidiaries for the three years
ended December 31, 2003 follows. This discussion should be read in
conjunction with the consolidated financial statements and related
notes beginning on page F-1 of this report.
The Company is a leading provider of long-term savings and retirement
products in the U.S. The Company develops and sells a diverse range of
products including individual annuities, private and public sector
pension plans, other investment products sold to institutions, life
insurance and an advisory services program. The Company markets its
products through a diverse distribution network, including independent
broker/dealers, wirehouse and regional firms, financial institutions,
pension plan administrators, life insurance specialists, certified
public accounting firms and the following affiliated producers; NRS,
TBG Financial, Nationwide Provident agents and Nationwide agents.
FORWARD-LOOKING STATEMENTS
Management's discussion and analysis contains certain forward-looking
statements within the meaning of the Private Securities Litigation
Reform Act of 1995 with respect to the results of operations and
businesses of the Company. These forward-looking statements involve
certain risks and uncertainties. Factors that may cause actual results
to differ materially from those contemplated or projected, forecast,
estimated or budgeted in such forward-looking statements include,
among others, the following possibilities: (i) the potential impact on
the Company's reported consolidated net income that could result from
the adoption of certain accounting standards issued by the Financial
Accounting Standards Board (FASB) or other standard-setting bodies;
(ii) tax law changes impacting the tax treatment of life insurance and
investment products; (iii) repeal of the federal estate tax; (iv)
heightened competition, including specifically the intensification of
price competition, the entry of new competitors and the development of
new products by new and existing competitors; (v) adverse state and
federal legislation and regulation, including limitations on premium
levels, increases in minimum capital and reserves, and other financial
viability requirements, restrictions on mutual fund distribution
payment arrangements such as revenue sharing and 12b-1 payments and
regulation changes resulting from industry practice investigations;
(vi) failure to expand distribution channels in order to obtain new
customers or failure to retain existing customers; (vii) inability to
carry out marketing and sales plans, including, among others,
development of new products and/or changes to certain existing
products and acceptance of the new and/or revised products in the
market; (viii) changes in interest rates and the stock markets causing
a reduction of investment income and/or asset fees, an acceleration of
the amortization of deferred policy acquisition costs (DAC), reduction
in the value of the Company's investment portfolio or separate account
assets, or a reduction in the demand for the Company's products; (ix)
general economic and business conditions which are less favorable than
expected; (x) competitive, regulatory or tax changes that affect the
cost of, or demand for the Company's products; (xi) unanticipated
changes in industry trends and ratings assigned by nationally
recognized rating organizations; (xii) deviations from assumptions
regarding future persistency, mortality, morbidity and interest rates
used in calculating reserve amounts and in pricing the Company's
products; and (xiii) adverse litigation results or resolution of
litigation and/or arbitration.
CRITICAL ACCOUNTING POLICIES AND RECENTLY ISSUED ACCOUNTING
PRONOUNCEMENTS
In preparing the consolidated financial statements, management is
required to make estimates and assumptions that affect the reported
amounts of assets and liabilities and the disclosures of contingent
assets and liabilities as of the date of the consolidated financial
statements and the reported amounts of revenues and expenses for the
reporting period. Actual results could differ significantly from those
estimates.
The most critical estimates include those used in determining DAC for
investment products and universal life insurance products, impairment
losses on investments, valuation allowances for mortgage loans on real
estate, federal income taxes, pension and other postretirement
employee benefits.
See note 2 to the consolidated financial statements included in the F
pages of this report for a discussion of the Company's significant
accounting policies, including recently issued accounting
pronouncements.
Deferred Policy Acquisition Costs for Investment Products and
Universal Life Insurance Products
The costs of acquiring business, principally commissions, certain
expenses of the policy issue and underwriting department and certain
variable sales expenses that relate to and vary with the production of
new and renewal business have been deferred. DAC is subject to
recoverability testing at the time of policy issuance and loss
recognition testing at the end of each reporting period.
For investment products (principally individual and group annuities)
and universal life insurance products, DAC is being amortized with
interest over the lives of the policies in relation to the present
value of estimated future gross profits from projected interest
margins, asset fees, cost of insurance, policy administration and
surrender charges, less policy benefits and policy maintenance
expenses. The DAC asset related to investment products and universal
life insurance products is adjusted to reflect the impact of
unrealized gains and losses on fixed maturity securities
available-for-sale as described in note 2(b) to the consolidated
financial statements included in the F pages of this report.
The most significant assumptions that are involved in the estimation
of future gross profits include future net separate account
performance, surrender/lapse rates, interest margins and mortality.
The Company's long-term assumption for net separate account
performance is currently 8 percent growth per year. If actual net
separate account performance varies from the 8 percent assumption, the
Company assumes different performance levels over the next three
years, such that the mean return equals the long-term assumption. This
process is referred to as a reversion to the mean. The assumed net
separate account return assumptions used in the DAC models are
intended to reflect what is anticipated. However, based on historical
returns of the S&P 500 Index, the Company's policy regarding the
reversion to the mean process does not permit such returns to be below
zero percent or in excess of 15 percent during the three-year
reversion period.
Changes in assumptions can have a significant impact on the amount of
DAC reported for investment products and universal life insurance
products and their related amortization patterns. In the event actual
experience differs from assumptions or assumptions are revised, the
Company is required to record an increase or decrease in DAC
amortization expense (DAC unlocking), which could be significant. In
general, increases in the estimated general and separate account
returns result in increased expected future profitability and may
lower the rate of DAC amortization, while increases in lapse/surrender
and mortality assumptions reduce the expected future profitability of
the underlying business and may increase the rate of DAC amortization.
Due to the magnitude of DAC balance related to the individual variable
annuity business, the sensitivity of the calculation to minor changes
in the underlying assumptions and the related volatility that could
result in the reported DAC balance without meaningful improvement in
its reasonableness, the Company evaluates the appropriateness of the
individual variable annuity DAC balance within pre-set parameters.
Should the recorded balance of individual variable annuity DAC fall
outside of these parameters for a prescribed period of time, or should
the recorded balance fall outside of these parameters and the Company
determines it is not reasonably possible to get back within this
period of time, assumptions are required to be unlocked and the DAC is
recalculated using revised best estimate assumptions. Otherwise, DAC
is not unlocked to reflect updated assumptions. In the event DAC
assumptions are unlocked and revised, the Company will continue to use
the reversion to the mean process.
For other investment products and universal life insurance products,
DAC is set each quarter to reflect revised best estimate assumptions,
including the use of a reversion to the mean methodology over the next
three years as it relates to net separate account performance. Any
resulting DAC unlocking adjustments are reflected currently in the
consolidated financial statements.
As part of the regular quarterly analysis of DAC, at the end of the
third quarter of 2002, the Company determined that using actual
experience to date and assumptions consistent with those used in the
second quarter of 2002, its individual variable annuity DAC balance
would be outside a pre-set parameter of acceptable results. The
Company also determined that it was not reasonably possible that the
DAC would return to an amount within the acceptable parameter within a
prescribed period of time. Accordingly, the Company unlocked its DAC
assumptions for individual variable annuities and reduced the DAC
asset to the amount calculated using the revised assumptions. Because
the Company unlocked the net separate account growth rate assumption
for individual variable annuities for the three-year reversion period,
the Company unlocked that assumption for all investment products and
variable universal life insurance products to be consistent across
product lines.
Therefore, in 2002, the Company recorded an acceleration of DAC
amortization totaling $347.1 million before tax, or $225.6 million,
net of $121.5 million of federal income tax benefit, which has been
reported in the following segments in the amounts indicated, net of
tax: Individual Annuity - $213.4 million, Institutional Products -
$7.8 million and Life Insurance - $4.4 million. The acceleration of
DAC amortization was the result of unlocking certain assumptions
underlying the calculation of DAC for investment products and variable
universal life insurance products. The most significant assumption
changes were the resetting of the Company's anchor date for reversion
to the mean calculations to September 30, 2002, resetting the
assumption for annual net separate account growth to 8 percent during
the three-year reversion period for all investment products and
variable life insurance products and increasing future lapses and
costs related to guaranteed minimum death benefits (GMDB) on
individual variable annuity contracts. These adjustments were
primarily driven by the sustained downturn in the equity markets.
Impairment Losses on Investments
Management regularly reviews each investment in its fixed maturity and
equity securities portfolios to evaluate the necessity of recording
impairment losses for other-than-temporary declines in the fair value
of investments. A number of criteria are considered during this
process including, but not limited to, the current fair value as
compared to amortized cost or cost, as appropriate, of the security,
the length of time the security's fair value has been below amortized
cost/cost, and by how much, specific credit issues and financial
prospects related to the issuer, the Company's intent to hold or
dispose of the securities and current economic conditions.
Other-than-temporary impairment losses result in a permanent reduction
of the cost basis of the underlying investment.
Also, the Company estimates the cash flows over the life of purchased
beneficial interests in securitized financial assets. Based on current
information and events, if the Company estimates that the fair value
of its beneficial interests is not greater than or equal to its
carrying value and if there has been an adverse change in the
estimated cash flows since the last revised estimate, considering both
timing and amount, then an other-than-temporary impairment is
recognized and the purchased beneficial interest is written down to
fair value.
Impairment losses are recorded on long-lived assets used in operations
when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the
assets' carrying amount.
Significant changes in the factors the Company considers when
evaluating investments for impairment losses could result in a
significant change in impairment losses reported in the consolidated
financial statements.
Valuation Allowances on Mortgage Loans on Real Estate
The Company provides valuation allowances for impairments of mortgage
loans on real estate based on a review by portfolio managers. Mortgage
loans on real estate are considered impaired 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 the Company determines that a loan is impaired, a
provision for loss is established equal to the difference between the
carrying value and the present value of expected future cash flows
discounted at the loan's effective interest rate, or the fair value of
the collateral, if the loan is collateral dependent. In addition to
the valuation allowance on specific loans, the Company maintains an
unallocated allowance for estimated losses incurred as of the balance
sheet date, but not yet specifically identified by loan. Changes in
the valuation allowance are recorded in net realized gains or losses
on investments, hedging instruments and hedged items. Loans in
foreclosure are placed on non-accrual status. Interest received on
non-accrual status mortgage loans on real estate is included in net
investment income in the period received.
The valuation allowance account for mortgage loans on real estate is
maintained at a level believed adequate by the Company and reflects
the Company's best estimate of probable credit losses, including
losses incurred at the balance sheet date, but not yet identified by
specific loan. The Company's periodic evaluation of the adequacy of
the allowance for losses is based on past loan loss experience, known
and inherent risks in the portfolio, adverse situations that may
affect the borrower's ability to repay, the estimated value of the
underlying collateral, composition of the loan portfolio, current
economic conditions and other relevant factors.
Significant changes in the factors the Company considers in
determining the valuation allowance on mortgage loans on real estate
could result in a significant change in the provision for valuation
allowance reported in the consolidated financial statements. During
the third quarter of 2003, the Company refined its mortgage loan
valuation allowance process by incorporating more detailed information
in the analysis. This refined estimation process included an analysis
by property type of the current composition of the portfolio,
historical losses, current market cycles and trends and expected
losses incurred at the balance sheet date, but not yet identified by
specific loan. As a result, the valuation allowance was reduced by
$12.1 million.
Federal Income Taxes
The Company provides for federal income taxes based on amounts the
Company believes it will ultimately 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 expenses or the realization of
certain tax credits differ from estimates, the Company may be required
to significantly change the provision for federal income taxes
recorded in the consolidated financial statements.
Pension and Other Postretirement Employee Benefits
The 2003 pension expense for substantially all of the Company's
employees and certain agents totaled $13.2 million. This is an
increase of $3.2 million over the 2002 pension expense of $10.0
million. This increase is primarily due to the impact of low interest
rates and the decline in the equity market in 2002. For the Company's
primary pension plan, the discount rate used to value the cash flows
was lowered to 6.00% for 2003 expenses from the discount rate of 6.50%
for 2002 and the long-term expected return on plan assets assumption
was lowered to 7.75% in 2003 from the assumption of 8.25% in 2002.
The 2003 postretirement benefit expense for substantially all of the
Company's employees, and in 2003, certain agents totaled $1.1 million,
a decrease of $2.4 million from the 2002 postretirement benefit
expense of $3.5 million. This decrease is primarily due to reductions
in benefits provided by the plan. The discount rate used to value the
cash flows was lowered to 6.60% for 2003 expenses from 7.25% in 2002
and the long-term expected return on plan assets assumption was
lowered to 7.50% from the 2002 assumption of 7.75%.
In establishing the discount rate and the long-term expected rate of
return on plan assets, the Company employs a prospective building
block approach. This process is integrated with the determination of
other economic assumptions such as salary scale. For a given
measurement date, the discount rate is set by reference to the yield
on high-quality corporate bonds to approximate the rate at which plan
benefits could effectively be settled. For pension benefits, an
adjustment is included for plan administration and other expenses
likely to be charged by an insurer. Because post-retirement benefit
claims include administration expenses, a higher discount rate is
utilized. The historic real rate of return for the reference bonds is
subtracted from the yield on these bonds to generate an assumed
inflation rate. Expected real rates of return on various asset
sub-classes are developed based on historic risk premiums for those
sub-classes. The expected real rates of return, reduced for investment
expenses, are applied to the target allocation of each asset sub-class
to produce an expected real rate of return for the target portfolio.
This expected real rate of return will vary by plan and will change
when the plan's target investment portfolio changes. The expected
long-term rate of return for plan assets is the assumed inflation rate
plus the expected real rate of return. This process effectively sets
the expected return for the plan's portfolio at the yield for the
reference bond portfolio, adjusted for expected risk premiums of the
target asset portfolio. Given the prospective nature of this
calculation, short-term fluctuations in the market do not impact the
expected risk premiums. However, as the yield for the reference bonds
fluctuates, the assumed inflation rate and the expected long-term rate
are adjusted in tandem.
To illustrate the impact of these assumptions on net periodic pension
expense in 2003 and going forward, a 50 basis point increase in the
pension plan discount rate (without changing any other assumption)
would decrease annual expenses by approximately 10% and a 50 basis
point increase in the pension plan long-term expected rate of return
(without changing any other assumption) would decrease plan expenses
by approximately 12%. For the retiree medical and death benefit plan,
a 50 basis point increase in the discount rate would have decreased
2003 expense by approximately 14%, while a 50 basis point increase in
the long-term expected rate of return would have decreased 2003
expense by approximately 3%.
RESULTS OF OPERATIONS - OVERVIEW
Revenues
Total revenues, increased $99.2 million, or 3%, to $3.10 billion in
2003 compared to $3.00 billion in 2002. The growth in revenues in 2003
was primarily driven by an increase in net investment income as a
result of continued growth in interest spread-based businesses, offset
by lower policy charges due to depressed equity markets and an
increase in net realized losses on investments, hedging instruments
and hedged items of $16.4 million. In 2002, total revenues increased
$13.6 million, or less than one percent. Growth in net investment
income offset lower policy charges and an increase in net realized
losses on investments, hedging instruments and hedged items of $66.1
million.
Policy charges include asset fees, which are primarily earned from
separate account values generated from sales of individual and group
variable annuities and investment life insurance products; cost of
insurance charges earned on universal life insurance products;
administrative fees, which include fees charged per contract on a
variety of the Company's products and premium loads on universal life
insurance products; and surrender fees, which are charged as a
percentage of premiums withdrawn during a specified period of annuity
and certain life insurance contracts.
Policy charges for each of the last three years were as follows:
(in millions) 2003 2002 2001
=============================================================================================================
Asset fees $ 516.8 $ 538.8 $ 614.2
Cost of insurance charges 250.0 235.5 201.9
Administrative fees 82.0 119.2 128.5
Surrender fees 75.3 80.3 72.7
- - -------------------------------------------------------------------------------------------------------------
Total policy charges $ 924.1 $ 973.8 $ 1,017.3
=============================================================================================================
The decline in asset fees reflect decreases in total average separate
account assets of $2.71 billion or 5% and $6.78 billion or 11% in 2003
and 2002, respectively. The decrease in average separate account
values over the past two years was fueled by market depreciation on
investment options underlying variable annuity and investment life
insurance products as a result of the sharp declines in the equity
markets.
Cost of insurance charges are assessed on the net amount at risk on
universal life insurance policies. The net amount at risk is equal to
a policy's death benefit minus the related policyholder account value.
The amount charged is based on the insured's age and other
underwriting factors. The increase in cost of insurance charges is due
primarily to growth in the net amount at risk related to corporate and
individual investment life insurance reflecting new sales, favorable
persistency on policies sold in prior periods and equity market
declines which lowered policyholder account values. The net amount at
risk related to corporate and individual investment life insurance
grew to $37.23 billion at the end of 2003 compared to $36.15 billion
and $32.93 billion at the end of 2002 and 2001, respectively.
The $37.2 million decline in administrative fees in the year ended
December 31, 2003 compared to 2002 is due to a decline in sales
production in the Investment Life products which resulted in a
decrease in sales loads collected, higher deferred revenue on premium
and lower amortized revenue. In addition, there was a decrease in the
number of individual annuity contracts that charge an annual
administrative fee.
Surrender fees decreased by 6%, or $5.0 million, to $75.3 million in
2003 compared to 2002. The decrease is primarily due to improving
equity markets in 2003. Surrender fees increased in 2002 compared to a
year ago, primarily due to higher lapse activity in individual
variable annuities and investment life insurance products as a result
of the sustained downturn in the equity markets and the competitive
environment in the marketplace.
Net investment income includes the investment income earned on
investments supporting fixed annuities, the medium-term note program
and certain life insurance products as well as invested assets not
allocated to product segments, net of related investment expenses. Net
investment income totaled $1.98 billion in 2003 compared to $1.84
billion and $1.72 billion in 2002 and 2001, respectively. These
increases were primarily due to increased invested assets supporting
growth in individual fixed annuity, allocations to the fixed option of
variable annuities, medium-term notes and fixed life insurance policy
reserves, partially offset by lower yields due to declining market
interest rates. General account assets supporting insurance products
are closely correlated to the underlying reserves on these products.
General account reserves supporting these products grew by $3.64
billion and $6.46 billion in 2003 and 2002, respectively, and totaled
$35.32 billion as of December 31, 2003. The growth in general account
reserves reflects increased customer preference for fixed products in
light of declining and volatile equity markets. The changes in net
investment income were also impacted by average yields on investments,
which decreased by 87 basis points and 81 basis points in 2003 in
2002, respectively, as a result of lower market interest rates.
The Company makes decisions concerning the sale of invested assets
based on a variety of market, business, tax and other factors. All
realized gains and losses generated by these sales, charges related to
other-than-temporary impairments of available-for-sale securities and
other investments and changes in valuation allowances on mortgage
loans on real estate are included as realized gains and losses on
investments, hedging instruments and hedged items. Also included are
changes in the fair value of derivatives qualifying as fair value
hedges and the recognized change in the fair value of the hedged
items, the ineffective, or excluded, portion of cash flow hedges and
changes in the fair value of derivatives not designated in hedging
relationships.
Net realized losses on investments, hedging instruments and hedged
items totaled $100.8 million, $84.4 million and $18.3 million in 2003,
2002 and 2001, respectively, and included other-than-temporary
impairments of $156.5 million, $120.3 million and $80.6 million in
2003, 2002 and 2001, respectively. Also, in third quarter 2003, the
Company refined its mortgage loan valuation allowance process by
incorporating more detailed in formation in the analysis. As a result,
the valuation allowance was reduced by $12.1 million. Please refer to
the table included under the - Corporate heading within this section
of the document for a detailed summary of the components of net
realized gains and losses on investments, hedging instruments and
hedged items.
Benefits and Expenses
Interest credited to policyholder account values totaled $1.30 billion
in 2003 and $1.24 billion in both 2002 and 2001 and principally
relates to fixed annuities, both individual and institutional, funding
agreements backing the Company's medium-term note program and certain
life insurance products. The increase in interest credited reflects an
increase in account values for these products as a result of strong
fixed annuity production and increased allocations of variable annuity
funds to the guaranteed fixed option, partially offset by lower
crediting rates in the Individual Annuity and Institutional Products
segments, on products where crediting rates have not already reached
guaranteed floors.
Other benefits and claims include policyholder benefits in excess of
policyholder account values for universal life and individual deferred
annuities and net claims and provisions for future policy benefits for
traditional life insurance products and immediate annuities. An
increase in other benefits and claims in 2003 compared to a year ago
reflects additional life insurance benefits reflecting growth in life
insurance in-force, an increase in GMDB costs due to a higher level of
claims and an increase in the provision for future policy benefits for
immediate annuities due to growth in new premium in 2003 compared to
2002. An increase in other benefits and claims in 2002 compared to
2001 reflects higher levels of GMDB claims from individual variable
annuity products and additional life insurance benefits reflecting
growth in life insurance in-force.
Amortization of DAC decreased by $294.2 million to $375.9 million in
2003 compared to $670.1 million in 2002. The substantial increase in
DAC amortization in 2002 reflects an acceleration of DAC amortization
recorded in the third quarter of 2002. As part of the regular
quarterly analysis of DAC, at the end of the third quarter of 2002,
the Company determined that using actual experience to date and
assumptions consistent with those used in the second quarter of 2002,
its individual variable annuity DAC balance would be outside a pre-set
parameter of acceptable results. The Company also determined that it
was not reasonably possible that the DAC would return to an amount
within the acceptable parameter within a prescribed period of time.
Accordingly, the Company unlocked its DAC assumptions for individual
variable annuities and reduced the DAC asset to the amount calculated
using the revised assumptions. Because the Company unlocked the net
separate account growth rate assumption for individual variable
annuities for the three-year reversion period, the Company unlocked
that assumption for all investment products and variable universal
life insurance products to be consistent across product lines.
Therefore, in 2002 the Company recorded an acceleration of DAC
amortization totaling $347.1 million before tax, or $225.6 million,
net of $121.5 million of tax benefit, which has been reported in the
following segments in the amounts indicated, net of tax: Individual
Annuity - $213.4 million, Institutional Products - $7.8 million and
Life Insurance - $4.4 million. The acceleration of DAC amortization
was the result of unlocking certain assumptions underlying the
calculation of DAC for investment products and variable universal life
insurance products. The most significant assumption changes were the
resetting of the Company's anchor date for reversion to the mean
calculations to September 30, 2002, resetting the assumption for
annual net separate account growth to 8 percent during the three-year
reversion period for all investment products and variable life
insurance products and increasing future lapses and costs related to
GMDB on variable annuity contracts. These adjustments were primarily
driven by the sustained downturn in the equity markets.
Excluding the accelerated DAC amortization in 2002, amortization of
DAC increased 16% in 2003 compared to 2002. The increase in DAC
amortization expense, excluding the accelerated DAC amortization, was
attributable to the Individual Annuity and Life Insurance segments as
a result of a growing book of business and the surrender of a large
corporate-owned life insurance (COLI) contract in second quarter 2003.
The increase in interest expense on debt in 2003 relates to the
issuance of $300 million of surplus notes to NFS in both December 2001
and June 2002 and the issuance of a $100 million surplus note in
December 2003. During 2003 there was also an increased utilization of
commercial paper.
Operating expenses were $533.7 million in 2003, a 5% increase from
2002 operating expenses of $508.6 million. Operating expenses were
$439.3 million in 2001. The increase in 2003 reflects higher employee
benefits, pension and insurance costs, partially offset by
management's efforts to manage expenses in response to the challenging
market conditions. The increase in 2002 reflects a growing customer
base, higher employee benefits, pension and insurance costs and
increased spending on projects focused on improving producer and
customer support.
Federal income tax expense from continuing operations was $96.2
million, representing an effective tax rate of 22.1% for 2003. Federal
income tax expense in 2002 and 2001 was $8.7 million and $161.2
million, respectively, representing effective rates of 5.1% and 25.6%.
The tax benefit of $121.5 million associated with the $347.1 million
of accelerated DAC amortization in third quarter 2002 was calculated
at the U.S. federal corporate income tax rate of 35%, which
substantially impacts in what would normally be expected to be
reported as an effective tax rate. The effective tax rate for 2002 was
25.2%, excluding the accelerated DAC amortization and related tax
benefit. The decrease in effective rates in 2003, using this basis, is
due to an increase in tax-exempt income and credits from affordable
housing partnership investments. Using this same basis, the effective
rate for 2002 was lower than 2001 due to an increase in tax credits
from affordable housing partnership investments and the elimination of
non-deductible goodwill amortization expense in 2002, partially offset
by lower tax-exempt income.
Discontinued Operations
On June 27, 2002, NLIC paid a dividend to NFS consisting of its shares
of common stock of Nationwide Securities, Inc. (NSI), a wholly owned
broker/dealer subsidiary. This is a transaction between related
parties and therefore was recorded at carrying value, $10.0 million,
of the underlying components of the transaction rather than fair
value.
As a result of this transaction, the Company is no longer engaged in
asset management operations and the underlying results of NSI have
been reported as discontinued operations. Also, effective in second
quarter 2002, the structured products transactions, previously
reported in the Corporate segment, are reported in the Institutional
Products segment. All periods presented have been revised to reflect
these changes.
Income from discontinued operations, net of tax, for 2002 and 2001 was
$0.7 million and $1.2 million, respectively.
Sales Information
The Company regularly monitors and reports a production volume metric
titled sales. Sales or similar measures are commonly used in the
insurance industry as a measure of the volume of new and renewal
business generated in a period.
Sales should not be viewed as a substitute for any financial measure
determined in accordance with GAAP, including "sales" as it relates to
non-insurance companies, and the Company's definition of sales might
differ from that used by other companies. As used in the insurance
industry, sales, or similarly titled measures, generate customer funds
managed and administered, which ultimately drive revenues.
As calculated and analyzed by the Company, statutory premiums and
deposits on individual and group annuities and life insurance products
calculated in accordance with accounting practices prescribed or
permitted by regulatory authorities and deposits on
administration-only group pension plans and the advisory services
program are adjusted as described below to arrive at sales.
Sales, as reported by the Company, are stated net of internal
replacements, which in the Company's opinion provides a more
meaningful disclosure of production in a given period. In addition,
the Company's definition of sales excludes: funding agreements issued
under the Company's medium-term note program; large case bank-owned
life insurance (BOLI); large case pension plan acquisitions; and
deposits into Nationwide employee and agent benefit plans. Although
these products contribute to asset and earnings growth, they do not
produce steady production flow that lends itself to meaningful
comparisons and are therefore excluded from sales.
The Company believes that the presentation of sales as measured for
management purposes enhances the understanding of the Company's
business and helps depict longer-term trends that may not be apparent
in the results of operations due to differences between the timing of
sales and revenue recognition.
The Company's flagship products are marketed under The BEST of AMERICA
brand, and include individual variable and group annuities, group
private sector pension plans and variable life insurance. The BEST of
AMERICA products allow customers to choose from investment options
managed by premier mutual fund managers. The Company has also
developed private label variable and fixed annuity products in
conjunction with other financial services providers that allow those
providers to sell products to their own customer bases under their own
brand name.
The Company also markets group deferred compensation retirement plans
to employees of state and local governments for use under IRC Section
457. The Company utilizes its sponsorship by the National Association
of Counties and The United States Conference of Mayors, and the
International Association of Firefighters when marketing IRC Section
457 products.
Sales by product and segment for each of the last three years are as
follows:
(in millions) 2003 2002 2001
============================================================================================================
============================================================================================================
The BEST of AMERICA products $ 3,799.6 $ 3,506.9 $ 3,927.1
Private label annuities 659.3 795.3 1,398.3
Income products 13.7 - 2.8
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Total individual variable annuity sales 4,472.6 4,302.2 5,328.2
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Deferred fixed annuities 1,698.5 2,528.3 1,874.4
Income products 124.8 133.0 127.8
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Total individual fixed annuity sales 1,823.3 2,661.3 2,002.2
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Total individual annuity sales 6,295.9 6,963.5 7,330.4
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
The BEST of AMERICA products 2,034.9 2,611.2 3,067.6
Other 31.1 46.5 56.9
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Total private sector pension plan sales 2,066.0 2,657.7 3,124.5
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Total public sector pension plan sales -
IRC Section 457 annuities 1,442.4 1,375.6 1,521.2
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Total institutional products sales 3,508.4 4,033.3 4,645.7
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
The BEST of AMERICA variable life series 435.4 518.2 552.4
Corporate-owned life insurance 545.0 657.5 742.3
Traditional/Universal life insurance 299.8 244.8 245.9
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Total life insurance sales 1,280.2 1,420.5 1,540.6
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Corporate - Advisory services program sales 25.7 - -
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Total sales $ 11,110.2 $ 12,417.3 $13,516.7
============================================================================================================
============================================================================================================
The Company sells its products through a diverse distribution network.
Unaffiliated entities that sell the Company's products to their own
customer base include independent broker/dealers, wirehouse and
regional firms, financial institutions, pension plan administrators,
life insurance specialists and representatives of certain CPA firms.
Representatives of affiliates who market products directly to a
customer base include NRS, TBG Financial and Nationwide Provident
agents. The Company also distributes life and retirement savings
products through the agency distribution force of its ultimate parent
company, NMIC.
Sales by distribution channel for each of the last three years are
summarized as follows:
(in millions) 2003 2002 2001
==============================================================================================================
NON-AFFILIATED:
Independent broker/dealers $ 3,045.9 $ 3,326.3 $ 3,977.4
Financial institutions 3,037.0 3,421.4 3,202.9
Wirehouse and regional firms 1,671.5 2,050.4 2,332.0
Pension plan administrators 513.4 709.6 959.7
Life insurance specialists 387.5 510.6 508.6
CPA channel 14.4 - -
AFFILIATED:
Nationwide Retirement Solutions 1,474.9 1,426.9 1,591.7
Nationwide Provident 145.4 98.9 -
Nationwide agents 659.3 726.3 710.6
TBG Financial 160.9 146.9 233.8
- - --------------------------------------------------------------------------------------------------------------
Total sales $11,110.2 $ 12,417.3 $ 13,516.7
==============================================================================================================
The 8% decrease in sales in the independent broker/dealer channel in
2003 reflects primarily lower demand for variable annuities and
variable life insurance in light of depressed equity markets in early
2003. Total sales through this channel were down 16% in 2002,
reflecting lower demand for variable annuities due to declining and
volatile equity markets. Also contributing to the decline in 2002 were
lower private sector group pension sales due to decreases in the
average takeover case size reflecting the depressed equity markets and
number of new plans sold in light of the economic slowdown.
Sales generated by financial institutions declined 11% in 2003 as a
result of efforts focused on pricing discipline and planned reduction
in fixed annuity sales, while private sector pension plan and variable
annuity sales were higher in 2003. Sales through financial
institutions grew 7% in 2002, driven mainly by increased fixed annuity
sales, partially offset by lower production of variable annuities.
Sales generated by wirehouse and regional firms decreased 18% in 2003
due to lower sales of individual annuity and private sector pension
sales. Sales in this channel in 2002 decreased 12% in 2002 to $2.05
billion compared to $2.33 billion in 2001, primarily reflecting lower
sales from the Waddell & Reed Financial, Inc. relationship, partially
offset by growth from other firms
As the Company's private sector pension business model continues to
evolve, direct production through the pension plan administrators
channel is expected to decline, as more new business opportunities are
being created in conjunction or in partnership with the independent
broker/dealers, wirehouse and regional firms and financial
institutions. This is evidenced by the 28% and 26% declines in 2003
and 2002, respectively.
Sales generated by life insurance specialists declined 24% in 2003
compared to 2002 and were flat in 2002 compared to 2001 due to the
current unfavorable environment for COLI and executive deferred
compensation programs. The sluggish equity markets in 2002 and 2001,
the weak economy, unfavorable press regarding COLI and executive
deferred compensation plans and proposed legislation which could
adversely impact the tax benefits of COLI all negatively impacted
sales and new business opportunities.
The 3% increase in sales is due to ongoing sales activities relating
to enrolling new employees and actively working with existing
participants to increase their contributions and transfer in assets
from other qualified plans.
Sales generated by Nationwide Provident increased significantly in
2003. This increase is primarily due to the acquisition that NFS
closed on October 1, 2002.
Sales generated by Nationwide agents declined 9% in 2003 compared to
2002 due to lower fixed annuity sales resulting from an intentional
slow down in sales and commission reductions.
Sales through TBG Financial increased 10% in 2003 compared to 2002,
primarily due to the sale of a single large case. This increase was
partially offset by a decline in sales due to the unfavorable
environment for COLI and executive deferred compensation plans. Sales
decreased 37% in 2002 compared to 2001, primarily due to the the
sluggish equity markets in 2002 and 2001, the weak economy,
unfavorable press regarding COLI and executive deferred compensation
plans and proposed legislation which could adversely impact the tax
benefits of COLI all negatively impacted sales and new business
opportunities.
BUSINESS SEGMENTS
The Company reports three product segments: Individual Annuity,
Institutional Products and Life Insurance. In addition, the Company
reports certain other revenues and expenses in a Corporate segment.
The following table summarizes pre-tax operating earnings (loss) for
the Company's business segments for each of the last three years.
(in millions) 2003 2002 2001
=============================================================================================================
Individual Annuity $ 170.7 $ (122.8) $ 231.4
Institutional Products 209.0 203.4 211.3
Life Insurance 150.0 171.5 189.7
Corporate 5.5 1.8 16.7
- - -------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings1 $ 535.2 $ 253.9 $ 649.1
=============================================================================================================
__________
1 Excludes net realized gains and losses on investments not related
to securitizations, hedging instruments and hedged items,
discontinued operations and cumulative effect of adoption of
accounting principles.
Individual Annuity
The Individual Annuity segment consists of individual The BEST of
AMERICA and private label deferred variable annuity products, deferred
fixed annuity products and income products. Individual deferred
annuity contracts provide the customer with tax-deferred accumulation
of savings and flexible payout options including lump sum, systematic
withdrawal or a stream of payments for life. In addition, variable
annuity contracts provide the customer with access to a wide range of
investment options and asset protection in the event of an untimely
death, while fixed annuity contracts generate a return for the
customer at a specified interest rate fixed for prescribed periods.
The following table summarizes selected financial data for the
Company's Individual Annuity segment for the years indicated.
(in millions) 2003 2002 2001
=============================================================================================================
INCOME STATEMENT DATA
Revenues:
Policy charges $ 428.0 $ 456.8 $ 495.1
Net investment income 807.9 668.5 534.7
Premiums on immediate annuities 89.7 69.4 60.9
- - -------------------------------------------------------------------------------------------------------------
Total operating revenues 1,325.6 1,194.7 1,090.7
- - -------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account values 602.5 505.9 433.2
Other benefits 137.3 99.5 68.7
Amortization of DAC 228.4 528.2 220.0
Other operating expenses 186.7 183.9 137.4
- - -------------------------------------------------------------------------------------------------------------
Total benefits and expenses 1,154.9 1,317.5 859.3
- - -------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings (loss) $ 170.7 $ (122.8)$ 231.4
=============================================================================================================
OTHER DATA
Sales:
Individual variable annuities $ 4,472.6 $ 4,302.2 $ 5,328.3
Individual fixed annuities 1,823.3 2,661.3 2,002.2
- - -------------------------------------------------------------------------------------------------------------
Total individual annuity sales $ 6,295.9 $ 6,963.5 $ 7,330.5
=============================================================================================================
Average account values:
General Account $ 13,815.3 $ 10,163.8 $ 7,619.7
Separate Account 28,224.0 29,750.3 33,419.0
- - -------------------------------------------------------------------------------------------------------------
Total average account values $ 42,039.3 $ 39,914.1 $ 41,038.7
=============================================================================================================
Account values as of period end:
Individual variable annuities $ 37,291.4 $ 30,611.4 $ 36,020.9
Individual fixed annuities 9,263.6 8,020.8 5,756.6
- - -------------------------------------------------------------------------------------------------------------
Total account values $ 46,555.0 $ 38,632.2 $ 41,777.5
=============================================================================================================
GMDB - Net amount at risk, net of reinsurance $ 982.9 $ 2,961.9 $ 1,295.9
GMDB - Reserves, net of reinsurance $ 21.8 $ 13.7 $ 10.8
Pre-tax operating earnings (loss) to average account values 0.41% (0.31%) 0.56%
- - -------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings totaled $170.7 million in 2003 compared to
a loss of $122.8 million in 2002 and earnings of $231.4 million in
2001. Excluding $328.3 million of accelerated DAC amortization, the
lower 2003 earnings were primarily driven by lower policy charges and
higher policy benefits primarily related to GMDB expenses, partially
offset by an increase in interest spread income.Excluding the
accelerated DAC amortization, the lower 2002 earnings compared to 2001
were driven by lower policy charges and higher policy benefits and
operating expenses, offset by growth in interest spread income.
Asset fees were $362.5 million in 2003 down 3% from $373.3 million in
2002 and totaled $420.8 million in 2001. Asset fees are calculated and
assessed daily as a percentage of separate account values. The
fluctuations in asset fees are primarily due to changes in the market
value of the investment options underlying the account values, which
have followed the general trends of the equity markets. Average
separate account values decreased 5% in 2003 to $28.22 billion
following a 11% decrease in 2002.
Surrender fees decreased by $6.3 million to $54.1 million in 2003
compared to $60.4 million in 2002 and $55.7 million in 2001. The
decrease in 2003 is due in part to positive equity market returns in
the period, while the increase in 2002 was primarily due to the
competitive market place and sustained downturn in the equity markets.
Lower surrender fees in 2001 were the result of the successful
implementation of customer retention programs in the individual
variable annuity business during the year.
Premiums on immediate annuities increase by $20.3 million in 2003 over
2002, following an $8.5 million increase in 2002. The increase
reflects increased sales efforts and growth in the number of firms and
distributors selling income products.
Other benefits reflect increased GMDB and immediate annuity costs in
2003. GMDB exposure, as measured by the difference between the current
contractual death benefit and account value, net of reinsurance,
decreased to $0.98 billion at the end of 2003 from $2.96 billion at
the end of 2002. As a result of first quarter 2003 increases in GMDB
exposure and claims activity, the Company strengthened reserves by
$11.9 million in first quarter 2003 to meet the current estimate of
future net claims in excess of fees. During 2002, the Company
strengthened its reserve for GMDB claims by $10.5 million to meet the
then current estimate of future net GMDB claims in excess of fees. The
Company's reserve for GMDB claims was $21.8 million and $13.7 million
as of December 31, 2003 and 2002, respectively. The growth in other
benefits also reflects increased provision for future policy benefits
for immediate annuities consistent with the growth in premium income.
Amortization of DAC decreased by $299.8 million to $228.4 million in
2003, compared to $528.2 million in 2002. Excluding the $328.3 million
of accelerated DAC amortization in 2002, amortization of DAC increased
14% to $228.4 million in 2003 reflecting higher estimated gross
profits on the underlying business following a 9% decrease in 2002,
reflecting lower estimated gross profits.
Operating expenses were $186.7 million in 2003, a slight increase over
2002. The increase reflects growth in the number of contracts
in-force, an increase in employee benefit, pension and insurance
costs, partially offset by expense management efforts in response to
the challenging equity markets and interest rate environments.
Operating expenses were $183.9 million in 2002, an increase of 34%
over 2001. The increase reflects growth in the number of contracts
in-force, an increase in employee benefits costs and projects focused
on improving producer and customer support.
Interest spread income is comprised of net investment income, net of
capital charges, less interest credited to policyholder account
values. Interest spread income can vary depending on crediting rates
offered by the Company, performance of the investment portfolio,
including the rate of prepayments, changes in market interest rates,
the competitive environment and other factors.
Interest spread income grew 16% in 2003 to $231.0 million from $198.9
million a year ago, while the growth was 37% during 2002 compared to
the same period a year ago. The growth was driven by 36% and 33%
increases in average general account assets for these same comparative
periods, respectively, the result of growth in the individual fixed
annuity business and increased customer allocations to the guaranteed
fixed options on individual annuities. Allocations to the guaranteed
fixed option related to new domestic individual variable annuity sales
during 2003 and 2002 totaled 39% and 43%, respectively.
The following table depicts the interest spread on average general
account values in the Individual Annuity segment for the years
ended December 31:
2003 2002 2001
=============================================================================================================
Net investment income 6.03% 6.93% 7.58%
Interest credited 4.36% 4.98% 5.69%
- - -------------------------------------------------------------------------------------------------------------
Interest spread on average general account values 1.67% 1.95% 1.89%
=============================================================================================================
Although interest spread income was higher, interest spread margins
compressed to 167 basis points in 2003. A one year enhanced crediting
rate special offered in the fourth quarter 2002 coupled with new
crediting rates at or near contractual minimum rates and a jump in
prepayments of higher yielding investments created pressure on
interest spread on average general account values in 2003. Interest
spread on average general account values increased 6 basis points in
2002 compared to 2001. The improvement was due to the Company's
ability to lower renewal crediting rates more quickly than investment
portfolio rates have declined as a result of lower market interest
rates. Included in the current year were 6 basis points, or $7.9
million of prepayment income on mortgage loans and bonds compared to 6
basis points, or $6.0 million, a year ago and 7 basis points, or $5.7
million in 2001. The current interest rate environment has limited the
ability to adjust crediting rates to the extent of declines in
investment yields due to the interest rate floors contained in annuity
contracts.
The Company has taken actions to address the current low interest rate
environment and the impact on interest spread margins. In 2003, the
Company lowered commission rates for individual fixed annuities and
the Company began invoking contractual provisions during second
quarter 2003 that have limited the amount of variable annuity deposits
allocated to the guaranteed fixed option. Furthermore, the Company
introduced new products and has begun issuing contracts with lower
floor guarantees.
Account values ended 2003 at $46.56 billion, up $7.92 billion from the
end of 2002 of $38.63 billion, which was down $3.14 billion from the
end of 2001. Net flows, which consists of deposits less withdrawals,
of $1.62 billion and $1.98 billion in 2003 and 2002, respectively,
were affected by market appreciation (depreciation) of variable
annuities of $7.02 billion and $(4.48) billion in 2003 and 2002,
respectively. The decrease in net flows is attributable to the decline
in fixed annuity sales combined with an increase in variable annuity
surrenders which we attribute primarily to continued losses in the
equity markets.
In addition, a number of the Company's competitors offer variable
annuities with more robust living benefits (including income benefits
and withdrawal benefits) than the Company offers. The Company has
elected to offer more limited living benefit features that meet the
Company's risk/return profile. During 2003, the Company discontinued
offering products with guaranteed minimum income benefits. Also in
2003, the Company began offering products with guaranteed minimum
accumulation benefits. See note 5 to the consolidated financial
statements included in the F pages of this report.
Individual Annuity segment sales, which exclude internal replacements,
during 2003 were $6.30 billion, down 10% from $6.96 billion a year
ago. A sharp drop-off in fixed annuities, the result of actions
described above, which were intended to reduce the level of new
individual fixed annuity business, drove segment sales lower compared
to 2002. Fixed annuity sales were $1.82 billion, down 31% compared to
$2.66 billion in 2002. Fixed annuity sales were up 33% in 2002 from
$2.00 billion in 2001. Variable annuity sales were $4.47 billion in
2003, up 4% compared to $4.30 million in 2002. Sales of variable
annuities were down 19% in 2002 compared to 2001. In 2002, the
sustained weakness in the equity markets reduced demand for variable
products and drove consumer interest in fixed products. According to
the Variable Annuity Research & Data Service (VARDS), the Company was
ranked 9th in total variable annuity sales in 2003.
The decrease in pre-tax operating earnings to average account values,
excluding the $328.3 million of accelerated DAC amortization in 2002,
in 2003 compared to 2002 is primarily a result of lower interest
spread margins and increased GMDB costs.
The following table provides selected information about the Company's
deferred individual fixed annuities as of December 31, 2003:
WTD. AVG.
ACCOUNT CREDITING
(in millions) VALUE RATE
============================================================================================================
Minimum interest rate of 3.50% or greater $ 835.5 3.60%
Minimum interest rate of 3.00% to 3.49% 10,477.7 3.89%
Minimum interest rate lower than 3.00% 667.9 3.11%
MVA with no minimum interest rate guarantee 851.5 3.60%
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Total deferred individual fixed annuities $12,832.6 3.81%
============================================================================================================
Institutional Products
The Institutional Products segment is comprised of the Company's
private and public sector group retirement plans, medium-term note
program and structured products initiatives. The private sector
includes the 401(k) business generated through fixed and variable
annuities. The public sector includes the IRC Section 457 business in
the form of fixed and variable annuities.
Institutional Products segment sales data presented on the following
table do not include business generated through the Company's
medium-term note program, large case pension plan acquisitions and
Nationwide employee and agent benefit plans, however the income
statement data does reflect this business.
The following table summarizes selected financial data for the
Company's Institutional Products segment for the years indicated.
(in millions) 2003 2002 2001
=============================================================================================================
INCOME STATEMENT DATA
Revenues:
Policy charges $ 149.8 $ 169.8 $ 205.9
Net investment income 787.7 800.2 847.5
Other income 12.5 8.1 3.5
- - -------------------------------------------------------------------------------------------------------------
Total operating revenues 950.0 978.1 1,056.9
- - -------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account values 512.3 548.9 627.8
Amortization of DAC 45.6 53.7 47.6
Other operating expenses 183.1 172.1 170.2
- - -------------------------------------------------------------------------------------------------------------
Total benefits and expenses 741.0 774.7 845.6
- - -------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings $ 209.0 $ 203.4 $ 211.3
=============================================================================================================
OTHER DATA
Sales:
Private sector pension plans $ 2,066.0 $ 2,657.7 $ 3,124.5
Public sector pension plans 1,442.4 1,375.6 1,521.2
- - -------------------------------------------------------------------------------------------------------------
Total institutional products sales $ 3,508.4 $ 4,033.3 $ 4,645.7
=============================================================================================================
Average account values:
Separate account $ 17,692.5 $ 19,261.4 $ 23,149.9
General Account 13,771.1 12,657.2 11,528.3
- - -------------------------------------------------------------------------------------------------------------
Total average account values $ 31,463.6 $ 31,918.6 $ 34,678.2
=============================================================================================================
Account values as of period end:
Private sector pension plans $ 14,992.8 $ 13,797.2 $ 16,405.5
Public sector pension plans 13,916.9 12,065.1 14,288.8
Funding agreements backing medium-term notes 4,606.3 4,273.6 3,128.1
- - -------------------------------------------------------------------------------------------------------------
Total account values $ 33,516.0 $ 30,135.9 $ 33,822.4
=============================================================================================================
Pre-tax operating earnings to average account values1 0.66% 0.64% 0.61%
- - -------------------------------------------------------------------------------------------------------------
______
1 Excludes pre-tax operating earnings from structured products as
there are no account values associated with structured products.
Pre-tax operating earnings totaled $209.0 million in 2003, up 3%
compared to $203.4 million in 2002, which was down 4% from 2001. The
increase in 2003 was the result of increased interest spread income
driven primarily by prepayment income, and other income were partially
offset by lower policy charges and higher operating expenses.
Excluding the accelerated DAC amortization, pre-tax operating earnings
increased 2% in 2002 compared to 2001. The increase is due to growth
in interest spread income and other income, which more than offset
lower policy charges as a result of depressed equity markets and a
shift in product mix to non-annuity products.
Asset fees declined 8% to $134.8 million in 2003 compared to $147.3
million in 2002 and totaled $176.7 million in 2001. The declines were
driven by a 8% decrease in average separate account assets in 2003
following a decrease of 17% in 2002 as a result of experiencing in the
equity markets and a shift in product mix from annuities to
administration-only products.
Administrative fees declined by $6.3 million or 40% in 2003 compared
to 2002, primarily due $3.6 million of fees related to a terminated
case in the first quarter of 2002.
Other income increased 54% to $12.5 million in 2003 compared to $8.1
million in 2002. The increase was primarily due to an increase in fees
from structured product transactions.
Interest spread income is comprised of net investment income less
interest credited to policyholder account values. Interest spreads
vary depending on crediting rates offered by the Company, performance
of the investment portfolio, including the rate of prepayments,
changes in market interest rates, the competitive environment and
other factors.
Interest spread income was $24.1 million higher in 2003 compared to
2002, which was $31.6 million higher than 2001 driven by higher
prepayment income and higher average general account values. The
increase in average general account values was led by the growth in
the medium-term note program and an increase in participant
allocations to the fixed option of the Company's retirement plan
offerings.
The following table depicts the interest spread on average general
account values in the Institutional Products segment for the years
ended December 31:
2003 2002 2001
==================================================================================================================
Net investment income 5.72% 6.32% 7.35%
Interest credited 3.72% 4.34% 5.44%
- - ------------------------------------------------------------------------------------------------------------------
Interest spread on average general account values 2.00% 1.98% 1.91%
==================================================================================================================
Interest spread improved to 200 basis points in 2003 compared to 198
basis points in 2002. Included in 2003 were 20 basis points, or $27.1
million, of prepayment income on mortgage loans and bonds compared to
9 basis points, or $10.8 million in 2002 and 12 basis points, or $14.4
million in 2001, respectively.
Excluding the $12.0 million of accelerated DAC amortization in 2002,
amortization of DAC increased 9% in 2003, following a comparative 12%
decrease in 2002. The changes are reflection of fluctuations in the
gross margins of the underlying business, which is driven in part by
equity market activity.
Other operating expenses in 2003 increased 6% to $183.1 million,
compared to a slight increase in 2002. The 2003 increase reflects
increased costs related to an initiative aimed at expanding the sales
and service capabilities in the Company's private sector pension
business, an increase in participants in public sector pension plans
and increased employee benefit, pension and insurance costs. The
increase in 2002 reflects the growth in the number of cases being
administered and an increase in employee benefit costs.
Account values ended 2003 at $33.52 billion, up $3.38 billion from
$30.14 billion at the end of 2002, which were down $3.69 billion
compared to $33.82 billion at the end of 2001. The 2003 increase is
due in part to positive equity market returns in the period. In 2002,
the impact of market depreciation resulting from depressed equity
markets in both 2001 and 2002 was partially offset by the addition of
the California Savings Plus Program in 2001 which added $4.77 billion
in administration-only account values, and new issues of medium-term
notes in both years. Net flows, which consists of deposits less
withdrawals, were $935.0 million in 2003, compared to $1.06 billion
and $1.95 billion in 2002 and 2001, respectively.
Institutional Products segment sales during 2003 totaled $3.51 billion
compared to $4.03 billion in 2002 and $4.65 in 2001. Private sector
pension sales in 2003 totaled $2.07 billion, a decrease of 22% from
2002 compared to a decrease of 15% from 2001. The decrease reflects a
strategy of writing new business with Nationwide Trust Company. In
addition, during 2003 there was a trend of the existing block of
business to convert to Nationwide Trust Company products at renewal.
Public sector pension sales in 2003 totaled $1.44 billion, 5% higher
compared to $1.38 billion in 2002, which was a decline of 10%, from
the $1.52 billion reported in 2001. The increased sales reflect
increased rollover activity from existing participants' previous
employer sponsored plans into existing accounts, as recent pension
reform legislation implemented has expanded the portability of public
plan assets and the addition of deposits into the newly acquired State
of New York defined contribution plan.
Institutional Products segment deposits in 2003 of $4.54 billion
offset by participant withdrawals and surrenders totaling $3.61
billion generated net flows from participant activity of $935.0
million, a 12% decrease over 2002, which reflected a 46% decrease from
2001 net flows. An increase in surrender activity, offset by deposits
to Nationwide employee and agent benefit plans, deferrals into newly
acquired plans, rollover activity into existing participant accounts
drove the, 2003 decrease. The decline in 2002 was driven by an
increase in withdrawals from public sector cases increased in early
2002, as participants took advantage of the new portability provisions
and rolled over funds to other companies.
Life Insurance
The Life Insurance segment consists of investment life products,
including individual variable life and COLI products, traditional life
insurance products and universal life insurance. Life Insurance
segment products provide a death benefit and generally also allow the
customer to build cash value on a tax-advantaged basis.
The following table summarizes certain selected financial data for the
Company's Life Insurance segment for the years indicated.
(in millions) 2003 2002 2001
=============================================================================================================
INCOME STATEMENT DATA
Revenues:
Policy charges $ 346.2 $ 347.2 $ 316.2
Net investment income 324.3 328.6 323.3
Other income 190.0 190.5 195.3
- - -------------------------------------------------------------------------------------------------------------
Total operating revenues 860.5 866.3 834.8
- - -------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Life benefits and policyholder dividends 451.3 458.2 431.1
Amortization of DAC 101.9 88.2 80.3
Other operating expenses 157.3 148.4 133.7
- - -------------------------------------------------------------------------------------------------------------
Total benefits and expenses 710.5 694.8 645.1
- - -------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings $ 150.0 $ 171.5 $ 189.7
=============================================================================================================
OTHER DATA
Sales:
The BEST of AMERICA variable life series $ 435.4 $ 518.2 $ 552.4
Corporate-owned life insurance 545.0 657.5 742.3
Traditional/Universal life insurance 299.8 244.8 245.9
- - -------------------------------------------------------------------------------------------------------------
Total life insurance sales $ 1,280.2 $ 1,420.5 $ 1,540.6
=============================================================================================================
Policy reserves as of period end:
Individual investment life insurance $ 2,698.7 $ 2,121.6 $ 2,203.7
Corporate investment life insurance 4,401.5 3,652.8 3,236.8
Traditional life insurance 2,046.4 1,937.1 1,873.4
Universal life insurance 886.0 830.5 785.3
- - -------------------------------------------------------------------------------------------------------------
Total policy reserves $ 10,032.6 $ 8,542.0 $ 8,099.2
=============================================================================================================
Life insurance in-force as of period end:
Individual investment life insurance $ 35,065.8 $ 33,536.9 $ 30,641.0
Corporate investment life insurance 9,263.3 8,387.1 7,727.6
Traditional life insurance 23,262.7 24,046.9 24,276.7
Universal life insurance 8,250.0 7,804.2 7,806.3
- - -------------------------------------------------------------------------------------------------------------
Total insurance in-force $ 75,841.8 $ 73,775.1 $ 70,451.6
=============================================================================================================
Life Insurance segment pre-tax operating earnings decreased 13% to
$150.0 million in 2003, down from $171.5 million in 2002 while
earnings in 2002 declined from $189.7 million in 2001. Excluding $6.8
million accelerated DAC amortization in third quarter 2002, pre-tax
operating earnings totaled $178.3 million in 2002. Higher general
operating expenses and DAC amortization on COLI, primarily the result
of the surrender of a single large case, contributed to the decline in
2003. In both 2003 and 2002, increased cost of insurance charges were
offset by higher policy benefits and operating expenses and DAC.
Policy charges decreased slightly to $346.2 million in 2003, following
a 10% increase to $347.2 million in 2002. Cost of insurance charges,
which are assessed on the amount of insurance in-force in excess of
the related policyholder account value, increased 6% and 17% in 2003
and 2002, respectively, and reflect a growing block of investment life
business, as insurance in-force increased 3% to $75.84 billion at 2003
compared to $73.78 billion at 2002. The growth in insurance in-force
reflects both the impact of new sales as well as high persistency of
in-force contracts. Administrative fees were $61.1 million or 24%
lower in 2003 and 9% lower in 2002 compared to 2001. Growth in fees
assessed on policies in-force offset lower fees assessed on premiums
and deposits due to the decline in sale of investment life products.
Life benefits and policyholder dividends decreased slightly to $451.3
million in 2003 following a 6% increase in 2002. The growth in 2002
reflects the growth in insurance in-force and higher mortality
experience.
Amortization of DAC increased $13.7 million in 2003 following a $7.9
million increase in 2002, including $6.8 million of accelerated DAC
amortization. Excluding the $6.8 million accelerated DAC amortization
in third quarter 2002 resulted in increases in DAC amortization of
$20.5 million in 2003 and a slight increase in 2002. The increase in
2003 primarily reflects the DAC amortization as a result of the
surrender of a large COLI case and the near certain lapse of a second
large COLI case. In addition, during 2003 mortality experience was
more favorable than expected and there was an increase in estimated
gross profits on the in-force variable business. The slight increase
in 2002 is due to an increase in estimated gross profits on the
in-force variable business.
Other operating expenses increased to $157.3 million in 2003 a 6%
increase compared to 2002, primarily due to higher employee benefit,
pension and insurance costs.
Total Life Insurance segment sales in 2003 decreased 10% to $1.28
billion compared to $1.42 billion in 2002. Variable life sales in 2003
declined 16% as individual variable life production continues to be
adversely impacted by consumer preference for fixed products. COLI
sales in 2003 declined 17% from the prior year due to the current
unfavorable environment for COLI and executive deferred compensation
programs.
Strong fixed life growth was substantially offset as individual
variable life sales continue to be adversely impacted by the sluggish
equity markets, concern over the potential for adverse tax legislation
and consumer preference for fixed products. According to the December
31, 2003 Tillinghast-Towers Perrin Value Variable Life Survey, the
Company was ranked 4th in total variable life sales in 2003, compared
to 3rd in 2002 and 6th in 2001. In 2002, our efforts to expand sales
to new channels drove sales through the wirehouse and regional firms
and financial institutions up 37% and 30%, respectively, from 2001.
COLI sales were negatively impacted throughout 2002 by the sluggish
economy, depressed equity markets, unfavorable press regarding COLI
and executive deferred compensation plans and proposed legislation
which could adversely impact the tax benefits of COLI. First year
premiums for fixed life were up from a year ago due to increased
universal life and term life sales. Total life insurance sales of
$1.42 billion in 2002 declined 8% compared to 2001 sales of $1.54
billion. Individual variable universal life sales were adversely
impacted by the phase out of the estate tax, uncertainty surrounding
the taxation of split dollar plans and the volatile stock market.
Sales of new COLI cases in 2002 were down given the depressed economic
conditions where corporations were not forming new executive benefit
plans and existing plans were being funded at lower levels.
Corporate
The Corporate segment consists of net investment income not allocated
to the three product segments, interest expense on debt and
unallocated expenses.
The following table summarizes selected financial data for the
Company's Corporate segment for the years indicated.
(in millions) 2003 2002 2001
============================================================================================================
============================================================================================================
INCOME STATEMENT DATA
Operating revenues $ 60.5 $ 41.9 $ 20.8
Interest expense on debt (48.4) (36.0) (6.2)
Other operating expenses (6.6) (4.1) 2.1
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Pre-tax operating income 1 5.5 1.8 16.7
Net realized losses on investments, (100.8) (84.4) (20.2)
hedging instruments and hedged items not
related to securitizations
- - ------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------
Loss from continuing operations before federal income taxes $ (95.3) $ (82.6) $ (3.5)
============================================================================================================
============================================================================================================
---------
1 Excludes net realized gains and losses on investments not
related to securitizations, hedging instruments and hedged
items, discontinued items and cumulative effect of adoption
of accounting principles.
The increase in operating revenues in 2003 reflects an increase in net
investment income primarily attributable to income earned on the
proceeds from the $200.0 million capital contribution from NFS in
February 2003. The increase in revenues in 2002 reflects an increase
in net investment income primarily attributable to income earned on
the proceeds from the surplus note offerings completed in December
2001 and June 2002, less the impact of lower investment income as a
result of dividends paid to NFS and lower yields. The 34% increase in
interest expense in 2003 compared to 2002 is due to the surplus notes
issued in 2002 and the increased utilization of commercial paper in
2003. The additional interest expense in 2002 reflects the surplus
note offerings mentioned above, offset by lower utilization of
commercial paper borrowings. The decline in revenues in 2001 reflects
a decrease in net investment income on real estate investments, higher
passive losses from affordable housing partnership investments, lower
investment yields from declining interest rates and fewer investments
retained in the Corporate segment as more capital and the related
investment earnings were allocated to the product segments to support
growth.
In addition to these operating revenues and expenses, the Company also
reports net realized gains and losses on investments, hedging
instruments and hedged items in the Corporate segment. Net realized
losses on investments, hedging instruments and hedged items totaled
$100.8 million in 2003, compared to net realized losses of $84.4
million in 2002 and $18.3 million in 2001, respectively, and included
other-than-temporary impairments of $156.5 million, $120.3 million and
$80.6 million in 2003, 2002 and 2001, respectively. Included in 2003
net realized losses are $13.0 million, net of tax of other than
temporarily impairments related to Parmalat, leaving $5.0 million of
gross exposure. Also, in third quarter 2003, the Company refined its
mortgage loan valuation allowance process by incorporating more
detailed information in the analysis. As a result, the valuations
allowance was reduced by $12.1 million. The table below provides a
detailed summary of the components of net realized gains and losses on
investments, hedging instruments and hedged items.
An analysis of net realized (losses) gains on investments, hedging
instruments and hedged items, by source and investment type follows:
(in millions) 2003 2002 2001
===============================================================================================================
UNRELATED PARTIES:
Realized gains on sales, net of hedging losses:
Fixed maturity securities, available-for-sale $ 98.5 $ 42.0 $ 30.1
Hedging losses on fixed maturity sales (42.4) (36.2) (1.5)
Equity securities, available-for-sale 5.5 - 1.2
Real estate 4.2 14.0 3.3
Mortgage loans on real estate 3.0 3.2 11.2
Mortgage loan hedging losses (2.4) (1.2) (8.1)
Other - 0.1 1.2
- - ---------------------------------------------------------------------------------------------------------------
- - ---------------------------------------------------------------------------------------------------------------
Total realized gains on sales - unrelated parties 66.4 21.9 37.4
- - ---------------------------------------------------------------------------------------------------------------
Realized losses on sales, net of hedging gains:
Fixed maturity securities, available-for-sale (27.2) (15.7) (9.3)
Hedging gains on fixed maturity sales 9.2 10.7 0.1
Equity securities, available-for-sale (0.4) (0.9) (0.8)
Real estate (0.3) (3.0) (1.4)
Mortgage loans on real estate (5.0) (3.3) (0.6)
Mortgage loan hedging gains 0.5 0.9 -
Other (2.0) (1.0) (7.7)
- - ---------------------------------------------------------------------------------------------------------------
Total realized losses on sales - unrelated parties (25.2) (12.3) (19.7)
- - ---------------------------------------------------------------------------------------------------------------
Other-than-temporary and other investment impairments
Fixed maturity securities, available-for-sale (159.4) (111.6) (66.1)
Equity securities, available-for-sale (8.0) - (13.8)
Real estate (0.8) (2.4) -
Mortgage loans on real estate 11.7 (6.3) (0.7)
- - ---------------------------------------------------------------------------------------------------------------
Total other-than-temporary and other investment impairments (156.5) (120.3) (80.6)
- - ---------------------------------------------------------------------------------------------------------------
Credit default swaps 13.3 (6.4) (0.5)
Derivatives, excluding hedging gains and losses on 1.2 9.5 0.7
sales, and credit default swaps
- - ---------------------------------------------------------------------------------------------------------------
Total unrelated parties (100.8) (107.6) (62.7)
Gain on sale of limited partnership - related parties - 23.2 44.4
- - ---------------------------------------------------------------------------------------------------------------
- - ---------------------------------------------------------------------------------------------------------------
Net realized losses on investments, $ (100.8) $ (84.4) $ (18.3)
hedging instruments and hedged items
===============================================================================================================
RELATED PARTY TRANSACTIONS
In the normal course of business, the Company has entered into a
number of related party transactions. Descriptions of these
transactions are provided in note 15 to the consolidated financial
statements included in the F pages to this report and are hereby
incorporated by reference.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following table summarizes the Company's contractual obligations
and commitments as of December 31, 2003 due in each period presented.
Payments due in
------------------------------------------------------
------------------------------------------------------
(in millions) Total 2004 2005 - 2006 2007 - 2008 Thereafter
==========================================================================================================================
==========================================================================================================================
Short-term debt $ 199.8 $ 199.8 $ - $ - $ -
Long-term debt, payable to NFS 700.0 - - - 700.0
Funding agreements backing medium-term notes 4,606.3 1,116.8 2,489.8 745.8 253.9
Purchase and lending commitments:
Fixed maturity securities 110.3 110.3 - - -
Commercial mortgage loans 391.8 351.3 40.5 - -
Limited partnerships 1 45.4 45.4 - - -
- - --------------------------------------------------------------------------------------------------------------------------
- - --------------------------------------------------------------------------------------------------------------------------
Total $ 6,053.6 $1,823.6 $ 2,530.3 $ 745.8 $ 953.9
==========================================================================================================================
==========================================================================================================================
_______
1 Purchase commitments for limited partnership interests
related to low income housing tax credit investments that
may be exercised by the respective partnerships as needed.
As a result, the purchase of all such interests may not be
required in the next year, but have been reflected in the
2004 column because their exercise are controlled by the
partnerships and not the Company.
OFF-BALANCE SHEET TRANSACTIONS
Under the medium-term note program, NLIC issues funding agreements,
which are insurance obligations, to an unrelated third-party trust to
secure notes issued to investors by the trust. The funding agreements
are recorded as a component of future policy benefits and claims on
the consolidated balance sheets. Because the Company is not the
primary beneficiary of, and has no ownership interest in, or control
over, the third-party trust that issues the notes, the Company does
not include the trust in its consolidated financial statements and
therefore, such notes are not reflected in the consolidated financial
statements of the Company. Because the notes issued by the trust have
a secured interest in the funding agreements issued by the Company,
Moody's and S&P, assign the same ratings to the notes as the insurance
financial strength ratings of NLIC.
To date, the Company has sold $290.1 million of credit enhanced equity
interests in Tax Credit Funds to unrelated third parties. The Company
has guaranteed cumulative after-tax yields to third party investors
ranging from 5.10% to 5.25% and as of December 31, 2003 held guarantee
reserves totaling $2.9 million on these transactions. These guarantees
are in effect for periods of approximately 15 years each. The Tax
Credit Funds provide a stream of tax benefits to the investors that
will generate a yield and return of capital. To the extent that the
tax benefits are not sufficient to provide these cumulative after-tax
yields, then the Company must fund any shortfall, which is mitigated
by stabilization collateral set aside by the Company at the inception
of the transactions.
The maximum amount of undiscounted future payments that the Company
could be required to pay the investors under the terms of the
guarantees is $824.2 million. The Company does not anticipate making
any payments related to the guarantees.
At the time of the sales, $4.3 million of net sale proceeds were set
aside as collateral for certain properties owned by the Tax Credit
Funds that had not met all of the criteria necessary to generate tax
credits. Such criteria include, but are not limited to, completion of
construction and the leasing of each unit to a qualified tenant.
Properties meeting the necessary criteria are considered to have
"stabilized." The properties are evaluated regularly and upon
stabilizing, the collateral is released. During 2003 and 2002, $3.1
million and $0.5 million of stabilization collateral had been released
into income, respectively.
To the extent there are cash deficits in any specific property owned
by the Tax Credit Funds, property reserves, property operating
guarantees and reserves held by the Tax Credit Funds are exhausted
before the Company is required to perform under its guarantees. To the
extent the Company is ever required to perform under its guarantees,
it may recover any such funding out of the cash flow distributed from
the sale of any and/or all of the underlying properties of the Tax
Credit Funds. This cash flow distribution would be paid to the Company
prior to any cash flow distributions to unrelated third party
investors.
As of December 31, 2003, NLIC had received $976.6 million of cash
collateral on securities lending and invested the proceeds in
short-term investments, which are reflected on the balance sheet, and
a corresponding liability is established to reflect the return of the
collateral. Also, NLIC has received $544.5 million of cash for
derivative collateral, which has been invested in short-term
investments and a corresponding liability has been recorded in other
liabilities. The Company also held $163.0 million and $25.9 million of
securities as off-balance sheet collateral on derivative transactions
as of December 31, 2003 and 2002, respectively.
ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
MARKET RISK SENSITIVE FINANCIAL INSTRUMENTS
The Company is subject to potential fluctuations in earnings and the
fair value of certain of its assets and liabilities, as well as
variations in expected cash flows due to changes in market interest
rates and equity prices. The following discussion focuses on specific
exposures the Company has to interest rate and equity price risk and
describes strategies used to manage these risks. The discussion is
limited to financial instruments subject to market risks and is not
intended to be a complete discussion of all of the risks to which the
Company is exposed to.
Interest Rate Risk
Fluctuations in interest rates can impact the Company's earnings, cash
flows and the fair value of its assets and liabilities. In a declining
interest rate environment, the Company may be required to reinvest the
proceeds from maturing and prepaying investments at rates lower than
the overall yield of the portfolio, which could reduce future interest
spread income. In addition, minimum guaranteed crediting rates
(ranging from 3.0% to 3.5% for a majority of the individual annuity
contracts in-force) on certain individual annuity contracts could
prevent the Company from lowering its interest crediting rates to
levels commensurate with prevailing market interest rates resulting in
a reduction of the Company's interest spread income in the event
market interest rates remain at, or decline further from December 31,
2003 levels. The average crediting rate of fixed annuity products
during 2003 was 4.36% and 3.72% for the Individual Annuity and
Institutional Products segments, respectively, well in excess of the
guaranteed rates.
The Company mitigates this risk by managing the maturity and
interest-rate sensitivities of the assets to be consistent with those
of the liabilities. During 2003, in response to the low interest rate
environment, the Company reduced commissions on fixed annuity sales,
launched new products with new guaranteed rates, discontinued the sale
of its leading annual reset fixed annuities and implemented limits on
variable annuity allocations to the guaranteed fixed option.
Conversely, a rising interest rate environment could result in a
reduction of interest spread income or an increase in policyholder
surrenders. Existing general account investments supporting annuity
liabilities have a weighted average maturity of approximately 4.9
years as of December 31, 2003 and therefore, the change in yield of
the portfolio will lag changes in market interest rates. This lag is
increased if the rate of prepayments of securities slows. To the
extent the Company sets renewal rates based on current market rates,
this will result in reduced interest spreads. Alternatively, if the
Company sets renewal crediting rates while attempting to maintain a
desired spread from the portfolio yield, the rates offered by the
Company may be less than new money rates offered by competitors. This
difference could result in an increase in surrender activity by
policyholders. If the Company were unable to fund the surrenders with
its cash flow from operations, the Company may need to sell assets,
which likely would have declined in value due to the increase in
interest rates. The Company mitigates this risk by offering products
that assess surrender charges and/or market value adjustments at the
time of surrender, and by managing the maturity and interest-rate
sensitivities of the assets to be consistent with those of the
liabilities
Asset/Liability Management Strategies to Manage Interest Rate Risk
The Company employs an asset/liability management approach tailored to
the specific requirements of each of its products. Each product line
has an investment policy based on its specific characteristics. The
policy establishes asset maturity and duration, quality and other
guidelines
The Company employs cash flow testing techniques in its
asset/liability management process because the timing of the payment
of future benefits on the majority of the Company's business can be
changed by the policyholder. In addition, each year the Company's
annuity and insurance business is analyzed to determine the adequacy
of the reserves supporting such business. This analysis is
accomplished by projecting the anticipated cash flows from such
business and the assets required to support such business under a
number of possible future interest rate scenarios. The first seven of
these scenarios are required by state insurance regulation.
Projections are also made using 12 additional scenarios, which involve
more extreme fluctuations in future interest rates and equity markets.
Finally, to get a statistical analysis of possible results and to
minimize any bias in the 19 predetermined scenarios, additional
projections are made using 100 randomly generated interest rate
scenarios. For the Company's 2003 cash flow testing process, interest
rates for 90-day treasury bills ranged from 0.10% to 9.08% under the
19 predetermined scenarios and 0.45% to 20.47% under the 100 random
scenarios. Interest rates for longer maturity treasury securities had
comparable ranges. The values produced by each projection are used to
determine future gains or losses from the Company's annuity and
insurance business, which, in turn, are used to quantify the adequacy
of the Company's statutory-basis reserves over the entire projection
period. The results of the Company's cash flow testing indicated that
the Company's reserves were adequate as of December 31, 2003.
Use of Derivatives to Manage Interest Rate Risk
The Company is exposed to changes in the fair value of fixed rate
investments (e.g. commercial mortgage loans and corporate bonds) due
to changes in interest rates. To manage this risk, the Company enters
into various types of derivative instruments to minimize fluctuations
in fair values resulting from changes in interest rates. The Company
principally uses interest rate swaps and short Euro futures to manage
this risk.
Under interest rate swaps, the Company receives variable interest rate
payments and makes fixed rate payments, thereby creating floating rate
investments.
Short Euro futures change fixed rate cash flow exposure to variable
rate. With short Euro futures, if interest rates rise (fall), the
gains (losses) on the futures adjust the fixed rate income on the
investments, thereby creating floating rate investments.
As a result of entering into commercial mortgage loan and private
placement commitments, the Company is exposed to changes in the fair
value of the commitment due to changes in interest rates during the
commitment period. To manage this risk, the Company enters into short
Treasury futures.
With short Treasury futures, if interest rates rise (fall), the gains
(losses) on the futures will offset the change in fair value of the
commitment.
Floating rate investments (commercial mortgage loans and corporate
bonds) expose the Company to fluctuations in cash flow and investment
income due to changes in interest rates. To manage this risk, the
Company enters into receive fixed, pay variable over-the-counter
interest rate swaps or long Euro futures strips to convert the
variable rate investments to a fixed rate.
In using interest rate swaps, the Company receives fixed interest rate
payments and makes variable rate payments; thereby creating fixed rate
assets.
Long Euro futures change the variable rate cash flow exposure to fixed
rate cash flows. With long Euro futures, if interest rates rise
(fall), the losses (gains) on the futures to reduce (increase) the
variable rate income on the investments, thereby creating fixed rate
investments.
Foreign Currency Risk Management
In conjunction with the Company's medium-term note program, from time
to time, the Company issues both fixed and variable rate liabilities
denominated in foreign currencies. As a result, the Company is exposed
to changes in fair value of the liabilities due to changes in foreign
currency exchange rates and interest rates. To manage these risks, the
Company enters into cross-currency swaps to convert these liabilities
to a U.S. dollar rate.
For a fixed rate liability, the cross-currency interest rate swap is
structured to receive a fixed rate, in the foreign currency, and pay a
variable U.S. dollar rate, generally 3-month libor. For a variable
rate foreign liability, the cross-currency interest rate swap is
structured to receive a variable rate, in the foreign currency, and
pay a variable U.S. dollar rate, generally 3-month libor.
The Company is exposed to changes in fair value of fixed rate
investments denominated in a foreign currency due to changes in
foreign currency exchange rates and interest rates. To manage this
risk, the Company uses cross-currency interest rate swaps to convert
these assets to variable U.S. dollar rate instruments. Cross-currency
interest rate swaps on assets are structured to pay a fixed rate, in
the foreign currency, and receive a variable U.S. dollar rate,
generally 3-month libor.
Cross-currency interest rate swaps in place against each foreign
currency obligation or investment hedge the Company against adverse
currency movements with respect to both period interest payments and
principal repayment.
Characteristics of Interest Rate Sensitive Financial Instruments
The following table provides information about the Company's financial
instruments as of December 31, 2003 that are sensitive to changes in
interest rates. Insurance contracts that subject the Company to
significant mortality risk, including life insurance contracts and
life-contingent immediate annuities, do not meet the definition of a
financial instrument and are not included in the table.
There-
(in millions) 2004 2005 2006 2007 2008 after Total
- - ---------------------------------------------------------------------------------------------------------------------
ASSETS
Fixed maturity securities:
Corporate bonds:
Principal $1,349.7 $1,806.9 $2,707.7 $1,911.7 $ 1,510.1 $7,168.1 $16,454.2
Weighted average interest rate 6.97% 6.90% 7.30% 6.63% 5.93% 6.58% 6.71%
Mortgage and other asset- backed
securities:
Principal $1,280.1 $1,210.0 $1,176.7 $1,052.4 $ 972.9 $2,442.0 $8,134.1
Weighted average interest rate 5.31% 5.51% 5.34% 4.90% 4.44% 5.48% 5.25%
Other fixed maturity securities:
Principal $ 39.1 $ 27.0 $ 127.0 $ 39.7 $ 69.4 $ 959.7 $1,261.9
Weighted average interest rate 6.11% 5.90% 4.54% 5.30% 4.98% 5.47% 5.37%
Mortgage loans on real estate:
Principal $ 406.5 $ 718.3 $ 705.0 $ 673.3 $ 634.9 $5,163.7 $8,301.7
Weighted average interest rate 6.75% 6.90% 6.46% 5.44% 5.43% 6.74% 6.52%
LIABILITIES
Individual deferred fixed annuities:
Principal $1,492.5 $1,568.7 $2,003.4 $1,880.3 $ 1,264.8 $4,908.8 $13,118.5
Weighted average crediting rate 3.74% 3.61% 3.37% 3.08% 2.98% 3.01% 3.23%
Group pension deferred fixed annuities:
Principal $1,252.7 $1,090.7 $ 968.9 $ 841.2 $ 718.2 $4,531.1 $9,402.7
Weighted average crediting rate 4.24% 3.90% 3.62% 3.43% 3.31% 3.22% 3.50%
Funding agreements backing MTNs
Principal $1,341.7 $1,722.0 $ 969.4 $ 625.7 $ 270.3 $ 305.4 $5,234.4
Weighted average crediting rate 2.40% 2.62% 2.69% 2.73% 2.72% 2.72% 2.60%
Immediate annuities:
Principal $ 50.0 $ 44.2 $ 39.0 $ 33.8 $ 29.4 $ 203.5 $ 399.8
Weighted average crediting rate 7.03% 7.05% 7.08% 7.10% 7.13% 7.16% 7.12%
Short-term debt:
Principal $ 199.8 $ - $ - $ - $ - $ - $ 199.8
Weighted average interest rate 1.07% - - - - - 1.07%
Long-term debt, payable to NFS
Principal $ - $ - $ - $ - $ - $ 700.0 $ 700.0
Weighted average interest rate - - - - - 7.67% 7.67%
2003 2002
FAIR Fair
(in millions) VALUE Value
- - -------------------------------------------------------------
ASSETS
Fixed maturity securities:
Corporate bonds:
Principal $17,375.5 $14,961.4
Weighted average interest rate
Mortgage and other asset- backed
securities:
Principal $8,253.3 $8,305.3
Weighted average interest rate
Other fixed maturity securities:
Principal $1,318.0 $ 902.3
Weighted average interest rate
Mortgage loans on real estate:
Principal $8,830.0 $8,536.4
Weighted average interest rate
LIABILITIES
Individual deferred fixed annuities:
Principal $12,946.1 $10,214.9
Weighted average crediting rate
Group pension deferred fixed annuities:
Principal $9,287.4 $8,745.0
Weighted average crediting rate
Funding agreements backing MTNs
Principal $4,606.3 $4,272.2
Weighted average crediting rate
Immediate annuities:
Principal $ 400.0 $ 402.0
Weighted average crediting rate
Short-term debt:
Principal $ 199.8 $ -
Weighted average interest rate
Long-term debt, payable to NFS
Principal $ 803.7 $ 728.5
Weighted average interest rate
2003 2002
There- FAIR Fair
(in millions) 2004 2005 2006 2007 2008 after Total VALUE Value
- -
- ------------------------------------------------------------------------------------------------------------------------------------
DERIVATIVE FINANCIAL INSTRUMENTS
Interest rate swaps:
Pay fixed/receive variable
Notional value $ 221.8 $ 355.8 $ 534.9 $ 364.1 $ 252.6 $ 721.5 $2,450.7 $ (200.4) $
(155.5)
Weighted average pay rate 5.7% 5.7% 4.8% 5.2% 5.6% 5.6% 5.4%
Weighted average receive rate 1 1.2% 1.2% 1.2% 1.2% 1.2% 1.4% 1.2%
Pay variable/receive fixed
Notional value $ 320.4 $ 610.3 $ 552.7 $ 566.7 $ 281.4 $ 264.3 $2,595.8 $ 640.6 $ 250.1
Weighted average pay rate 1 1.5% 1.5% 1.6% 1.6% 1.6% 1.7% 1.6%
Weighted average receive rate 3.0% 4.2% 4.3% 5.3% 5.0% 6.2% 4.6%
Pay variable/receive variable
Notional value $ 239.1 $ 769.1 $ 102.6 $ - $ - $ - $1,110.8 $ 99.6 $ 95.6
Weighted average pay rate 1 1.4% 1.5% 1.6% - - - 1.5%
Weighted average receive rate 1 2.4% 1.3% 3.6% - - - 1.7%
Pay fixed/receive fixed
Notional value $ - $ 35.5 $ 26.8 $ 44.0 $ 16.8 $ 170.8 $ 293.9 $ (49.4) $
(0.9)
Weighted average pay rate - 2.9% 5.7% 6.0% 5.8% 5.3% 5.2%
Weighted average receive rate - 4.9% 3.3% 3.4% 4.0% 4.6% 4.3%
Convertible asset swap
Notional value $ 10.0 $ - $ - $ - $ - $ - $ 10.0 $ (1.1) $
(3.0)
Weighted average pay rate - - - - - - -
Weighted average receive rate 2.8% - - - - - 2.8%
Credit default swaps sold
Notional value $ 115.0 $ 98.0 $ 199.0 $ 247.0 $ 137.0 $ 4.5 $ 800.5 $ 10.0 $
(2.7)
Weighted average pay rate 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
Weighted average receive rate 1.1% 1.5% 1.1% 1.0% 0.6% 0.8% 1.0%
Credit default swap purchased
Notional value $ - $ - $ 5.0 $ - $ 7.0 $ - $ 12.0 $ 0.4 $ -
Weighted average pay rate - - 5.0% - 1.0% - 2.7%
Weighted average receive rate - - - - - - 0.0%
Embedded derivative
Notional value $ - $ - $ - $ - $ - $ 20.0 $ 20.0 $ 4.6 $ -
Futures contracts:
Longs
Contract amount/notional value $ 4.0 $ 1.0 $ - $ - $ - $ - $ 5.0 $ 0.1 $ 0.2
Weighted average settled price 92.4 92.3 - - - - 92.3
Shorts
Contract amount/notional value $1,132.8 $ 616.0 $ 370.0 $ 225.0 $ 143.0 $ 124.0 $2,610.8 $ (25.3) $
(45.6)
Weighted average settled price 96.5 93.3 93.1 93.1 92.9 92.6 94.6
- -
- ------------------------------------------------------------------------------------------------------------------------------------
--------
1 Variable rates are generally based on 1, 3 or 6-month libor,
and reflect the effective rate as of December 31, 2003.
Additional information about the characteristics of the financial
instruments and assumptions underlying the data presented in the table
above are as follows:
Mortgage-backed and asset-backed securities: The year of maturity is
determined based on the terms of the securities and the current rate
of prepayment of the underlying pools of mortgages or assets. The
Company limits its exposure to prepayments by purchasing less volatile
types of MBSs and ABSs (see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Investments - Fixed
Maturity Securities").
Corporate bonds and other fixed maturity securities and mortgage loans
on real estate: The maturity year is that of the security or loan.
Individual deferred fixed annuities: The maturity year is based on the
expected date of policyholder withdrawal, taking into account actual
experience, current interest rates and contract terms. Individual
deferred fixed annuities are certain individual annuity contracts,
which are also subject to surrender charges calculated as a percentage
of the deposits made and assessed at declining rates during the first
seven years after a deposit is made. As of December 31, 2003,
individual annuity general account liabilities totaling $7.34 billion
were in contracts where the crediting rate is reset periodically, with
portions resetting in each calendar quarter and $1.10 billion that
reset annually. Individual fixed annuity policy reserves of $3.23
billion are in contracts that adjust the crediting rate every five
years. Individual fixed annuity policy reserves of $458.6 million are
in contracts that adjust the crediting rate every three years. The
average crediting rate is calculated as the difference between the
projected yield of the assets backing the liabilities and a targeted
interest spread. However, for certain individual annuities the
credited rate is also adjusted to partially reflect current new money
rates.
Group pension deferred fixed annuities: The maturity year is based on
the expected date of policyholder withdrawal, taking into account
actual experience, current interest rates and contract terms. Included
are group annuity contracts representing $8.93 billion of general
account liabilities as of December 31, 2003, which are generally
subject to market value adjustment upon surrender and which may also
be subject to surrender charges. Of the total group annuity
liabilities, $6.23 billion were in contracts where the crediting rate
is reset quarterly, $1.15 billion were in contracts that adjust the
crediting rate on an annual basis with portions resetting in each
calendar quarter and $1.55 billion were in contracts where the
crediting rate is reset annually on January 1.
Funding agreements backing MTNs: Fixed annuity policy reserves of
$4.61 billion relate to funding agreements issued in conjunction with
the Company's medium-term note program where the crediting rate is
either fixed for the term of the contract or variable, based on an
underlying index.
Immediate annuities: Included are non-life contingent contracts in
payout status where the Company has guaranteed periodic, typically
monthly, payments. The maturity year is based on the terms of the
contract.
Short-term debt and long-term debt: The maturity year is the stated
maturity date of the obligation.
Derivative financial instruments: The maturity year is based on the
terms of the related contracts. Interest rate swaps include
cross-currency interest rate swaps that eliminate all foreign currency
exposure the Company has with existing assets and liabilities.
Cross-currency interest rate swaps in place against each foreign
currency obligation hedge the Company against adverse currency
movements with respect to both period interest payments and principal
repayment. Underlying details by currency have therefore been omitted.
Variable swap rates and settlement prices reflect rates and prices in
effect as of December 31, 2003.
Equity Market Risk
Asset fees calculated as a percentage of the separate account assets
are a significant source of revenue to the Company. As of December 31,
2003, approximately 80% of separate account assets were invested in
equity mutual funds. Gains and losses in the equity markets will
result in corresponding increases and decreases in the Company's
separate account assets and the reported asset fee revenue. In
addition, a decrease in separate account assets may decrease the
Company's expectations of future profit margins due to a decrease in
asset fee revenue and/or an increase in GMDB claims, which may require
the Company to accelerate the amortization of deferred policy
acquisition costs. The Company's long-term assumption for net separate
account returns is 8% annual growth, earned evenly throughout the
year.
Many of the Company's individual variable annuity contracts offer
guaranteed minimum death benefit (GMDB) features. A GMDB generally
provides a benefit if the annuitant dies and the contract value is
less than a contractually defined amount. Such specified amounts vary
from contract to contract based on the date the contract was entered
into as well as the GMDB feature elected. A decline in the stock
market may cause the contract value to fall below this specified
amount, and the net amount at risk to increase. The net amount at risk
is the amount by which the GMDB exceeds the contract value at any
given time and is a primary indicator of potential future GMDB claims.
As of December 31, 2003, the net amount at risk, net of amounts
reinsured, was $982.9 million. To manage this risk, the Company has
implemented a GMDB hedging program for certain new and existing
business. The program, which is an economic hedge but does not qualify
for hedge accounting under FAS 133, is designed to offset a specified
portion of changes in the value of the GMDB obligation. Currently the
program shorts S&P 500 index futures, which in turn provides a partial
offset to changes in the value of the designated obligation. Prior to
implementation of the GMDB hedging program in 2003, the Company
managed the risk of these benefits by entering into reinsurance
arrangements.
The Company also offers certain variable annuity products with a
guaranteed minimum accumulation benefit (GMAB) rider. The GMAB
provides the contract holder with a guaranteed return of premium,
adjusted proportionately for withdrawals, after a specified period of
time, 5, 7 or 10 years, selected by the contract holder at the
issuance of the variable annuity contract. In some cases, the contract
holder also has the option, after a specified period of time, to drop
the rider and continue the variable annuity contract without the GMAB.
The GMAB is an embedded derivative, and as such, the equity exposure
in this product is recognized at fair value, separately from the
annuity contract, with changes in fair value recognized in the income
statement. The Company is exposed to equity market risk to the extent
that the underlying investment options, which can include fixed and
variable components, selected by the contract holder do not generate
enough earnings over the life of the contract to at least equal the
adjusted premiums. The Company is economically hedging the GMAB
exposure for those risks that exceed a level considered acceptable by
purchasing interest rate futures and shorting S&P 500 futures. The
GMAB economic hedge does not qualify for hedge accounting under FAS
133. Upon reaching scale, the Company anticipates the purchase of S&P
500 index put options and over-the-counter basket put options, which
are constructed such that they minimize the tracking error of the
hedge and the GMAB exposure. See notes 5, 8 and 12 to the consolidated
financial statements included in the F pages of this report for
additional disclosure about GMAB rates.
INFLATION
The rate of inflation did not have a material effect on the revenues
or operating results of the Company during 2003, 2002 or 2001.
ITEM 8 CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements of Nationwide Life Insurance
Company and Subsidiaries are indexed in , Item 5 - Exhibits,
Financial Statement Schedule, and Reports on Form 8-K, and included in
the F pages to this report.
Semi-annual and annual reports are sent to contract owners of the
variable annuity and life insurance contracts issued through
registered separate accounts of the Company.
ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
None.
ITEM 9A CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Chief Financial Officer have
evaluated the effectiveness of the Company's disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act). Based on such evaluation, such officers have
concluded that the Company's disclosure controls and procedures are
effective as of the end of the period covered by this Annual Report.
There have been no changes during the Company's fourth fiscal quarter
in our internal control over financial reporting that have materially
affected, or are reasonably likely to materially affect, the Company's
internal control over financial reporting.
PART III
ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Omitted due to reduced disclosure format.
ITEM 11 EXECUTIVE COMPENSATION
Omitted due to reduced disclosure format.
ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED SHAREHOLDER MATTERS
Omitted due to reduced disclosure format.
ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Omitted due to reduced disclosure format.
ITEM 14 PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table presents fees for services rendered by KPMG LLP
for the audits of the consolidated financial statements for NFS and
its subsidiaries, including the consolidated financial statements of
NLIC and consolidated or individual audits of other NFS subsidiaries
financial statements, where appropriate, for each of the years ended
December 31, 2003 and 2002 and the reviews of the consolidated
financial statements included in the Forms 10-Q for the NFS and NLIC
during each year indicated and fees billed for other services rendered
by KPMG LLP.
PRINCIPAL ACCOUNTANT FEES AND SERVICES TABLE
(IN 000'S) 2003 2002
- - --------------------------------------------------------------------------------------------
Audit Fees $3,035,781 $2,436,687
Audit Related Fees1 611,966 440,100
Tax Fees2 35,700 351,600
All Other Fees3 - 17,369
- - --------------------------------------------------------------------------------------------
Total Fees $3,683,447 $3,245,756
============================================================================================
----------
1 Audit related fees were principally for reports on internal
controls (SAS 70), financial statement audits of employee
benefit plans, consultations with management regarding the
accounting treatment of transactions or potential impact of
rulings prescribed by the SEC, FASB, or other accounting
standard setting bodies and other audit related agreed upon
procedures reports.
2 Tax fees were for tax consultation of Federal tax issues
resulting from IRS examination, assistance with IRS or other
taxing authority audits, and activities such as preparing
tax returns to be filed with various taxing authorities.
3 All other fees include services related to the transition of
the audits of specified mutual funds to another auditing
firm in accordance with AU Section 315, Communications
Between Predecessor and Successor Auditors.
The Audit Committee of the Board of Directors considered whether the
provision of the services covered under "All Other Fees" above is
compatible with maintaining the independence of KPMG LLP.
None of the above fees fall under the de minimis exception to the
pre-approval rules.
The Nationwide Life Insurance Company Audit Committee (on behalf of
Nationwide Life Insurance Company and its subsidiary) has adopted
pre-approval policies and procedures for services provided by the
independent auditors. The Audit Committee approves four categories of
services: audit, audit related, tax and non-audit services. Each year
the independent auditor submits to the Audit Committee a list of
services and a fee is estimated and presented to the Audit Committee
for approval. The Audit Committee pre-approves both the services and
the related fees. Requests for the independent auditors to provide any
additional services or to increase the budget for approved services
during the course of the year must also be pre-approved by the Audit
Committee. Such specific pre-approval may be provided at a meeting of
the Audit Committee or, between meetings, as necessary, by the
Chairman of the Audit Committee to whom pre-approval has been
delegated. The Chairman will update the full Audit Committee at the
next Audit Committee meeting for any interim approvals granted. The
Audit Committee periodically monitors the services rendered by and
actual fees paid to the independent auditors to ensure that such
services are within the parameters it pre-approved.
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
Page
--------
CONSOLIDATED FINANCIAL STATEMENTS:
Independent Auditors' Report F-1
Consolidated Statements of Earnings for the years ended
December 31, 2003, 2002 and 2001 F-2
Consolidated Balance Sheets as of December 31, 2003 and 2002 F-3
Consolidated Statements of Shareholder's Equity for the
years ended December 31, 2003,
2002 and 2001 F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 F-5
Notes to Consolidated Financial Statements F-6
FINANCIAL STATEMENT SCHEDULES:
Schedule I Consolidated Summary of Investments - Other Than Investments in
Related Parties as of December 31, 2003 F-54
Schedule III Supplementary Insurance Information as of December 31, 2003, 2002 and
2001 and for each of the years then ended F-55
Schedule IV Reinsurance as of December 31, 2003, 2002 and 2001 and for each of the
years then ended F-56
Schedule V Valuation and Qualifying Accounts for the years ended December 31,
2003, 2002 and 2001 F-57
All other schedules are omitted because they are not applicable or
not required, or because the required information has been
included in the audited consolidated financial statements or notes
thereto.
EXHIBIT INDEX 43
REPORTS ON FORM 8-K:
On November 4, 2003, NLIC filed a Current Report on Form 8-K reporting
the condensed consolidated balance sheets as of September 30, 2003 and
December 31, 2002 and the condensed consolidated income statements for
the three and nine months ended September 30, 2003 and 2002.
On December 10, 2003, NLIC announced that Joseph J. Gasper, its
President and Chief Operating Officer and a member of its board of
directors, will be retiring effective at the next annual meeting of
shareholders in May 2004 and that its board has elected Mark R.
Thresher as his successor.
On December 17, 2003, NLIC filed a Current Report on Form 8-K
reporting that Fitch Ratings issued a press release announcing that
they had assigned an insurer financial strength rating of `AA-` with a
stable outlook to NLIC.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
NATIONWIDE LIFE INSURANCE COMPANY (Registrant)
By /s/ W.G. Jurgensen
-------------------
W.G. Jurgensen, Chief Executive Officer -
Nationwide Life Insurance Company
Date: March 11, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
/s/ Arden L. Shisler March 3, 2004 /s/ W.G. Jurgensen March 3, 2004
- - --------------------------------------------- ----------------------------------------------------------------
- -------------------
Arden L. Shisler, Chairman of the Board Date W.G. Jurgensen, Chief Executive Officer Date
and Director
/s/ Joseph J. Gasper March 8, 2004 /s/ Joseph A. Alutto March 3, 2004
- - --------------------------------------------- ----------------------------------------------------------------
- -------------------
Joseph J. Gasper, President, Date Joseph A. Alutto, Director Date
Chief Operating Officer and Director
/s/ James G. Brocksmith, Jr. March 3, 2004 /s/ Henry S. Holloway March 3, 2004
- - --------------------------------------------- ----------------------------------------------------------------
- -------------------
James G. Brocksmith, Jr., Director Date Henry S. Holloway, Director Date
/s/ Lydia M. Marshall March 3, 2004 /s/ Donald L. McWhorter March 3, 2004
- - --------------------------------------------- ----------------------------------------------------------------
- -------------------
Lydia M. Marshall, Director Date Donald L. McWhorter, Director Date
/s/ David O. Miller March 3, 2004 /s/ Martha Miller de Lombera March 3, 2004
- - --------------------------------------------- ----------------------------------------------------------------
- -------------------
David O. Miller, Director Date Martha Miller de Lombera, Director Date
/s/ James F. Patterson March 3, 2004 /s/ Gerald D. Prothro March 3, 2004
- - --------------------------------------------- ----------------------------------------------------------------
- -------------------
James F. Patterson, Director Date Gerald D. Prothro, Director Date
/s/ Alex Shumate March 3, 2004 /s/ Mark R. Thresher March 3, 2004
- - --------------------------------------------- ----------------------------------------------------------------
- -------------------
--------------------------------------------- -------------------
Alex Shumate, Director Date Mark R. Thresher, President and Chief Date
Operating Officer - Elect
and Chief Financial Officer
EXHIBIT INDEX
Exhibit
- - ----------
3.1 Amended Articles of Incorporation of Nationwide Life Insurance
Company, dated February 3, 2000 (previously filed as Exhibit 3.1
to Form 10-K, Commission File Number 2-64559, filed March 24,
2003, and incorporated herein by reference)
3.2 Form of Amended and Restated Code of Regulations of Nationwide
Life Insurance Company, dated May 7, 2002 (previously filed as
Exhibit 3.2 to Form 10-K, Commission File Number 2-64559, filed
March 24, 2003, and incorporated herein by reference)
10.1 Form of Tax Sharing Agreement dated as of October 1, 2002 among
Nationwide Financial Services, Inc. and any corporation that may
hereafter by a subsidiary of Nationwide Financial Services, Inc.
(previously filed as exhibit 10.2 to Form 10-K, Commission File
Number 1-12785, filed March 11, 2004 and incorporated herein by
reference)
10.2 Form of Tax Sharing Agreement dated as of October 1, 2002 among
Nationwide Life Insurance Company and any corporation that may
hereafter by a subsidiary of Nationwide Life Insurance Company.
(previously filed as exhibit 10.3 to Form 10-K, Commission File
Number 1-12785, filed March 11, 2004 and incorporated herein by
reference)
10.3 Form of Amended and Restated Cost Sharing Agreement among parties
named therein (previously filed as Exhibit 10.3 to Form 10-K,
Commission File Number 1-12785, filed March 14, 2003, and
incorporated herein by reference)
10.4 Modified Coinsurance Agreement between Nationwide Life Insurance
Company and Nationwide Mutual Insurance Company (previously filed
as Exhibit 10.4 to Form S-1, Registration Number 333-18527,
filed March 5, 1997, and incorporated herein by reference)
10.5 Five Year Credit Agreement, dated May 25, 2000, among Nationwide
Financial Services, Inc., Nationwide Life Insurance Company,
Nationwide Mutual Insurance Company, the banks named therein and
Bank One, NA, as agent (filed as Exhibit 10.5 to Form 10-K,
Commission File Number 1-12785, filed March 29, 2001, and
incorporated herein by reference)
10.5.1 Amendment No. 1 dated as of September 29, 2000 to the Five Year
Credit Agreement dated as of May 25, 2000 among Nationwide
Financial Services, Inc., Nationwide Life Insurance Company,
Nationwide Mutual Insurance Company, the banks party thereto and
Bank One, NA, as agent (filed as Exhibit 10.5.1 to Form 10-K,
Commission File Number 1-12785, filed March 29, 2001, and
incorporated herein
by reference)
10.5.2 Amendment No. 2 dated as of April 19, 2002 to the Five Year Credit
Agreement dated as of May 25, 2000 among Nationwide Financial
Services, Inc., Nationwide Life Insurance Company, Nationwide
Mutual Insurance Company, the banks party thereto and Bank One,
NA, as agent (previously filed as exhibit 10.8.2 to Form 10-K,
Commission File Number 1-12785, filed March 11, 2004 and
incorporated
herein by reference)
10.5.3 Amendment No. 3 dated as of May 22, 2002 to the Five Year Credit
Agreement dated as of May 25, 2000 among Nationwide Financial
Services, Inc., Nationwide Life Insurance Company, Nationwide
Mutual Insurance Company, the banks party thereto and Bank One,
NA, as agent (previously filed as exhibit 10.8.3 to Form 10-K,
Commission File Number 1-12785, filed March 11, 2004 and
incorporated herein
by reference)
10.5.4 Amendment No. 4 dated as of May 20, 2003 to the Five Year Credit
Agreement dated as of May 25, 2000 among Nationwide Financial
Services, Inc., Nationwide Life Insurance Company, Nationwide
Mutual Insurance Company, the banks party thereto and Bank One,
NA, as agent (previously filed as exhibit 10.8.4 to Form 10-K,
Commission File Number 1-12785, filed March 11, 2004 and
incorporated herein
by reference)
10.6 364-Day Credit Agreement, dated May 20, 2003, among Nationwide
Financial Services, Inc., Nationwide Life Insurance Company,
Nationwide Mutual Insurance Company, the banks named therein and
Bank One, NA, as agent (previously filed as exhibit 10.9 to Form
10-K, Commission File Number 1-12785, filed March 11, 2004 and
incorporated herein by reference)
10.7 Form of Lease Agreement between Nationwide Life Insurance Company
and Nationwide Mutual Insurance Company (previously filed as
Exhibit 10.7 to Form S-1, Registration Number 333-18527, filed
March 5, 1997, and incorporated herein by reference)
10.8 General Description of Nationwide Performance Incentive Plan
(filed as Exhibit 10.9 to Form 10-K, Commission File Number
1-12785, filed March 29, 2001, and incorporated herein by
reference)
Exhibit
- - ----------
- - ----------
10.9* Form of Amended and Restated Nationwide Office of Investment
Incentive Plan (filed as Exhibit 10.10 to Form 10-Q, Commission
File Number 1-12785, filed November 13, 2001, and incorporated
herein by reference)
10.10* Nationwide Insurance Excess Benefit Plan effective as of December
31, 1996 (previously filed as Exhibit 10.11 to Form S-1,
Registration Number 333-18527, filed March 5, 1997, and
incorporated herein by reference)
10.11 Restated Nationwide Insurance Retirement Plan effective as of
January 1, 2002 (previously filed as Exhibit 10.12 to Form 10-Q,
Commission File Number 1-12785, filed May 13, 2002, and
incorporated herein by reference)
10.12* Restated Nationwide Insurance Supplemental Retirement Plan
effective as of January 1, 2002 (previously filed as Exhibit 10.12
to Form S-1, Registration Number 333-18527, filed March 5,1997,
and incorporated herein by reference)
10.13 Nationwide Salaried Employees Severance Pay Plan (previously filed
as Exhibit 10.13 to Form S-1, Registration Number 333-18527, filed
March 5, 1997, and incorporated herein by reference)
10.14* Nationwide Insurance Supplemental Defined Contribution Plan
effective as of January 1, 1996 (previously filed as Exhibit 10.14
to Form S-1, Registration Number 333-18527, filed March 5, 1997,
and incorporated herein by reference)
10.15* General Description of Nationwide Insurance Individual Deferred
Compensation Program (previously filed as Exhibit 10.15 to Form
S-1, Registration Number 333-18527, filed March 5, 1997, and
incorporated herein by reference)
10.16* General Description of Nationwide Mutual Insurance Company
Directors Deferred Compensation Program (previously filed as
Exhibit 10.16 to Form S-1, Registration Number 333-18527, filed
March 5, 1997, and incorporated herein by reference)
10.17 Investment Agency Cost Allocation Agreement dated October 30, 2002
between Nationwide Life Insurance Company and Nationwide Cash
Management Company (previously filed as exhibit 10.22 to Form
10-K, Commission File Number 1-12785, filed March 11, 2004 and
incorporated herein by reference)
10.18 Master Repurchase Agreement between Nationwide Life Insurance
Company, Nationwide Life and Annuity Insurance Company, and
Nationwide Mutual Insurance Company and certain of its
subsidiaries and affiliates (previously filed as Exhibit 10.20 to
Form 10-K, Commission File Number 1-12785, filed March 29, 2000,
and incorporated herein by reference)
10.19 Form of Employment Agreement, dated January 1, 2000, between
Nationwide Mutual Insurance Company and John Cook (previously
filed as Exhibit 10.24 to Form 10-Q, Commission File Number
1-12785, filed August 14, 2000, and incorporated herein by
reference)
10.20 Form of Employment Agreement, dated January 1, 2000, between
Nationwide Mutual Insurance Company and Patricia Hatler
(previously filed as Exhibit 10.25 to Form 10-Q, Commission File
Number 1-12785, filed August 14, 2000, and incorporated herein by
reference)
10.21 Form of Employment Agreement, dated January 1, 2000, between
Nationwide Mutual Insurance Company and Richard Headley
(previously filed as Exhibit 10.26 to Form 10-Q, Commission File
Number 1-12785, filed August 14, 2000, and incorporated herein by
reference)
10.22 Form of Employment Agreement, dated January 1, 2000, between
Nationwide Mutual Insurance Company and Donna James (previously
filed as Exhibit 10.27 to Form 10-Q, Commission File Number
1-12785, filed August 14, 2000, and incorporated herein by
reference)
10.23 Form of Employment Agreement, dated January 1, 2000, between
Nationwide Mutual Insurance Company and Greg Lashutka (previously
filed as Exhibit 10.28 to Form 10-Q, Commission File Number
1-12785, filed August 14, 2000, and incorporated herein by
reference)
10.24 Form of Employment Agreement, dated January 1, 2000, between
Nationwide Mutual Insurance Company and Robert Oakley (previously
filed as Exhibit 10.29 to Form 10-Q, Commission File Number
1-12785, filed August 14, 2000, and incorporated herein by
reference)
10.24.1 Form of Amendment to Employment Agreement, effective August 29,
2002, between Nationwide Mutual Insurance Company and Robert
Oakley (previously filed as Exhibit 10.29.1 to Form 10-K,
Commission File Number 1-12785, filed March 14, 2003, and
incorporated herein by reference)
10.25 Form of Employment Agreement, dated August 11, 2000, between
Nationwide Mutual Insurance Company and Michael Helfer (previously
filed as Exhibit 10.31 to Form 10-Q, Commission File Number
1-12785, filed August 14, 2000, and incorporated herein by
reference)
Exhibit
- - -----------
- - -----------
10.26* Form of Employment Agreement, dated May 26, 2000, between
Nationwide Mutual Insurance Company and W.G. Jurgensen (previously
filed as Exhibit 10.32 to Form 10-Q, Commission File Number
1-12785, filed November 13, 2000, and incorporated herein by
reference)
10.27* Form of Employment Agreement, dated July 1, 2000, between
Nationwide Financial Services, Inc. and Joseph Gasper (previously
filed as Exhibit 10.33 to Form 10-Q, Commission File Number
1-12785, filed November 13, 2000, and incorporated herein by
reference)
10.27.1* Form of Amendment to Employment Agreement, effective August 28,
2002, between Nationwide Financial Services, Inc. and Joseph
Gasper (previously filed as Exhibit 10.33.1 to Form 10-K,
Commission File Number 1-12785, filed March 14, 2003, and
incorporated herein by reference)
10.27.2* Letter Agreement dated December 10, 2003 between Nationwide
Financial Services, Inc. and Joseph Gasper. (previously filed as
exhibit 10.37.2 to Form 10-K, Commission File Number 1-12785,
filed March 11, 2004 and incorporated herein by reference)
10.28* Form of Retention Agreement, dated July 1, 2000, between
Nationwide Financial Services, Inc. and Joseph Gasper (previously
filed as Exhibit 10.34 to Form 10-Q, Commission File Number
1-12785, filed November 13, 2000, and incorporated herein by
reference)
10.29 Form of Employee Leasing Agreement, dated July 1, 2000, between
Nationwide Mutual Insurance Company and Nationwide Financial
Services Inc. (previously filed as Exhibit 10.35 to Form 10-Q,
Commission File Number 1-12785, filed May 11,2001, and
incorporated herein by reference)
10.30 Form of Employment Agreement, dated June 4, 2001, between
Nationwide Mutual Insurance Company and Michael C. Keller
(previously filed as Exhibit 10.36 to Form 10-Q, Commission File
Number 1-12785, filed August 10, 2001, and incorporated herein by
reference)
10.31 Form of Employment Agreement between Nationwide Mutual Insurance
Company and Robert A. Rosholt (previously filed as Exhibit 10.30
to Form 10-Q, Commission File Number 1-12785, filed May 14, 2003,
and incorporated herein by reference).
10.32 Form of Surplus Note, dated December 17, 2001, between Nationwide
Financial Services, Inc. and Nationwide Life Insurance Company
(previously filed as Exhibit 10.32 to Form 10-K, Commission File
Number 2-64559, filed March 24, 2003, and incorporated herein by
reference)
10.33 Form of Surplus Note, dated June 26, 2002, between Nationwide
Financial Services, Inc. and Nationwide Life Insurance Company
(previously filed as Exhibit 10.32 to Form 10-K, Commission File
Number 2-64559, filed March 24, 2003, and incorporated herein by
reference)
10.34 Form of Surplus Note, dated December 23, 2003, between Nationwide
Financial Services, Inc. and Nationwide Life Insurance Company
18 Letter regarding change in accounting principle from KPMG LLP
(previously filed as Exhibit 18 to Form 10-Q, Commission File
Number 1-12785, filed November 12, 2003, and incorporated herein
by reference)
31.1 Certification of W.G. Jurgensen pursuant to 18 U.S.C. section
1350, as adopted pursuant to section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification of Mark R. Thresher pursuant to 18 U.S.C. section
1350, as adopted pursuant to section 302 of the Sarbanes-Oxley Act
of 2002.
32.1 Certification of W.G. Jurgensen pursuant to 18 U.S.C. section
1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act
of 2002 (this exhibit is intended to be furnished in accordance
with Regulation S-K, Item 601(b)(32)(ii) and shall not be deemed
"filed" for purposes of Section 18 of the Securities Exchange Act
of 1934 or incorporated by reference into any document filed under
the Securities Act of 1933, except as shall be expressly set forth
by specific reference to such filing)
32.2 Certification of Mark R. Thresher pursuant to 18 U.S.C. section
1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act
of 2002 (this exhibit is intended to be furnished in accordance
with Regulation S-K, Item 601(b)(32)(ii) and shall not be deemed
"filed" for purposes of Section 18 of the Securities Exchange Act
of 1934 or incorporated by reference into any document filed under
the Securities Act of 1933, except as shall be expressly set forth
by specific reference to such filing)
* Management Compensatory Plan
- - ------
All other exhibits referenced by Item 601 of Regulation S-K are not required
under the related instructions or are inapplicable and therefore have been
omitted.
EXHIBIT 31.1
CERTIFICATION
I, W.G. Jurgensen, Chief Executive Officer of Nationwide Life Insurance Company,
certify that:
1. I have reviewed this report on Form 10-K of Nationwide Life Insurance
Company;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
fourth fiscal quarter that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 11, 2004
/s/ W.G. Jurgensen
Name: W.G. Jurgensen
Title: Chief Executive Officer
EXHIBIT 31.2
CERTIFICATION
I, Mark R. Thresher, President and Chief Operating Officer - Elect and Chief
Financial Officer of Nationwide Life Insurance Company, certify that:
1. I have reviewed this report on Form 10-K of Nationwide Life Insurance
Company;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
(a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period in
which this report is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end
of the period covered by this report based on such evaluation; and
(c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the registrant's
fourth fiscal quarter that has materially affected, or is reasonably
likely to materially affect, the registrant's internal control over
financial reporting; and
5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
(a) All significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
control over financial reporting.
Date: March 11, 2004
/s/ Mark R. Thresher
Name: Mark R. Thresher
Title: President and Chief Operating Officer - Elect
and Chief Financial Officer
EXHIBIT 32.1
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Nationwide Life Insurance Company (the
"Company") on Form 10-K for the period ending December 31, 2003 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
W.G. Jurgensen, Chief Executive Officer of the Company, certify, pursuant to 18
U.S.C. ss. 1350, as adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of
2002, to the best of my knowledge, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
March 11, 2004
/s/ W.G. Jurgensen
Name: W.G. Jurgensen
Title: Chief Executive Officer
A signed original of this written statement required by Section 906 has been
provided to Nationwide Life Insurance Company and will be retained by Nationwide
Life Insurance Company and furnished to the Securities and Exchange Commission
or its staff upon request.
EXHIBIT 32.2
CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Nationwide Life Insurance Company (the
"Company") on Form 10-K for the period ending December 31, 2003 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Mark R. Thresher, President and Chief Operating Officer - Elect and Chief
Financial Officer of the Company, certify, pursuant to 18 U.S.C. ss. 1350, as
adopted pursuant to ss. 906 of the Sarbanes-Oxley Act of 2002, to the best of my
knowledge, that:
(1) The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material
respects, the financial condition and result of operations of the Company.
March 11, 2004
/s/ Mark R. Thresher
Name: Mark R. Thresher
Title: President and Chief Operating Officer - Elect
and Chief Financial Officer
A signed original of this written statement required by Section 906 has been
provided to Nationwide Life Insurance Company and will be retained by Nationwide
Life Insurance Company and furnished to the Securities and Exchange Commission
or its staff upon request.
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Nationwide Life Insurance Company:
We have audited the accompanying consolidated balance sheets of Nationwide Life
Insurance Company and subsidiaries (the Company) as of December 31, 2003 and
2002, and the related consolidated statements of earnings, shareholder's equity,
and cash flows for each of the years in the three-year period ended December 31,
2003. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Nationwide Life
Insurance Company and subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
As discussed in note 2 to the consolidated financial statements, the Company
changed its methods of accounting for derivative instruments and hedging
activities, and for purchased or retained interests in securitized financial
assets in 2001.
/s/ KPMG LLP
Columbus, Ohio
March 11, 2004
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES (a
wholly owned subsidiary of Nationwide Financial Services, Inc.)
Consolidated Statements of Earnings
(in millions)
YEARS ENDED DECEMBER
31,
- ---------------------------------------
2003 2002 2001
====================================================================================================================================
REVENUES:
Policy charges $ 924.1 $ 973.8 $1,017.3
Life insurance premiums 279.8 259.9 251.1
Net investment income 1,980.0 1,838.5 1,724.7
Net realized gains (losses) on investments, hedging instruments and hedged items:
Unrelated parties (100.8) (107.6)
(62.7)
Related parties - 23.2 44.4
Other income 12.7 8.8 8.2
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues 3,095.8 2,996.6 2,983.0
- -
- ------------------------------------------------------------------------------------------------------------------------------------
BENEFITS AND EXPENSES:
Interest credited to policyholder account values 1,300.4 1,241.2 1,238.7
Other benefits and claims 361.8 326.0 280.3
Policyholder dividends on participating policies 41.2 45.2 41.7
Amortization of deferred policy acquisition costs 375.9 670.1 347.9
Interest expense on debt, primarily with Nationwide Financial Services, Inc. (NFS) 48.4 36.0 6.2
Other operating expenses 533.7 508.6 439.3
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 2,661.4 2,827.1 2,354.1
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before federal income tax expense 434.4 169.5 628.9
Federal income tax expense 96.2 8.7 161.2
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 338.2 160.8 467.7
Income from discontinued operations, net of tax - 0.7 1.2
Cumulative effect of adoption of accounting principle, net of tax (0.6) -
(7.1)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Net income $ 337.6 $ 161.5 $ 461.8
====================================================================================================================================
See accompanying notes to consolidated financial statements, including note 15
which describes related party transactions.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Consolidated Balance Sheets
(in millions, except share amounts)
DECEMBER 31, December 31,
2003 2002
=============================================================================================================================
ASSETS:
Investments:
Securities available-for-sale, at fair value:
Fixed maturity securities (cost $25,850.2 in 2003; $23,134.3 in 2002) $ 26,946.8 $ 24,169.0
Equity securities (cost $74.0 in 2003; $85.1 in 2002) 85.6 84.3
Mortgage loans on real estate, net 8,345.8 7,923.2
Real estate, net 96.5 116.6
Policy loans 618.3 629.2
Other long-term investments 130.6 137.5
Short-term investments, including amounts managed by a related party 1,860.8 1,210.3
- - -----------------------------------------------------------------------------------------------------------------------------
Total invested assets 38,084.4 34,270.1
- - -----------------------------------------------------------------------------------------------------------------------------
Cash 0.1 0.9
Accrued investment income 367.1 328.7
Deferred policy acquisition costs 3,219.3 2,971.1
Other assets 1,815.5 1,243.6
Assets held in separate accounts 57,084.5 47,208.2
- - -----------------------------------------------------------------------------------------------------------------------------
Total assets $ 100,570.9 $ 86,022.6
=============================================================================================================================
LIABILITIES AND SHAREHOLDER'S EQUITY:
Future policy benefits and claims $ 35,322.3 $ 31,679.8
Short-term debt 199.8 -
Long-term debt, payable to NFS 700.0 600.0
Other liabilities 3,264.7 2,985.8
Liabilities related to separate accounts 57,084.5 47,208.2
- - -----------------------------------------------------------------------------------------------------------------------------
Total liabilities 96,571.3 82,473.8
- - -----------------------------------------------------------------------------------------------------------------------------
Shareholder's equity:
Capital shares, $1 par value. Authorized 5.0 million shares; 3.8 million shares issued 3.8 3.8
and outstanding
Additional paid-in capital 271.3 171.1
Retained earnings 3,257.2 2,979.6
Accumulated other comprehensive income 467.3 394.3
- - -----------------------------------------------------------------------------------------------------------------------------
Total shareholder's equity 3,999.6 3,548.8
- - -----------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholder's equity $ 100,570.9 $ 86,022.6
=============================================================================================================================
See accompanying notes to consolidated financial statements, including note 15
which describes related party transactions.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Consolidated Statements of Shareholder's Equity
Years Ended December 31, 2003, 2002 and 2001
(in millions)
ACCUMULATED
ADDITIONAL OTHER TOTAL
CAPITAL PAID-IN RETAINED COMPREHENSIVE
SHAREHOLDER'S
SHARES CAPITAL EARNINGS INCOME EQUTY
=================================================================================================================================
=================================================================================================================================
Balance as of January 1, 2001 $ 3.8 $ 646.1 $2,436.3 $ 116.7 $ 3,202.9
Comprehensive income:
Net income - - 461.8 - 461.8
Net unrealized gains on securities available-for-sale
arising during the period, net of tax - - - 98.2 98.2
Cumulative effect of adoption of accounting principles,
net of tax - - - (1.4) (1.4)
Accumulated net losses on cash flow hedges, net of tax - - - (8.8) (8.8)
---------------
Total comprehensive income 549.8
---------------
Dividend to NFS - - (35.0) - (35.0)
- - ---------------------------------------------------------------------------------------------------------------------------------
Balance as of December 31, 2001 $ 3.8 $ 646.1 $2,863.1 $ 204.7 $ 3,717.7
=================================================================================================================================
Comprehensive income:
Net income - - 161.5 - 161.5
Net unrealized gains on securities available-for-sale
arising during the period, net of tax - - - 178.6 178.6
Accumulated net gains on cash flow hedges, net of tax - - - 11.0 11.0
---------------
Total comprehensive income 351.1
---------------
Returns of capital to NFS - (475.0) - - (475.0)
Dividend to NFS - - (45.0) - (45.0)
- - ---------------------------------------------------------------------------------------------------------------------------------
Balance as of December 31, 2002 $ 3.8 $ 171.1 $2,979.6 $ 394.3 $ 3,548.8
=================================================================================================================================
Comprehensive income:
Net income - - 337.6 - 337.6
Net unrealized gains on securities available-for-sale
arising during the period, net of tax - - - 99.6 99.6
Accumulated net losses on cash flow hedges, net of tax - - - (26.6) (26.6)
---------------
Total comprehensive income 410.6
---------------
Capital contributed by NFS - 200.2 - - 200.2
Return of capital to NFS - (100.0) - - (100.0)
Dividend to NFS - - (60.0) - (60.0)
- - ---------------------------------------------------------------------------------------------------------------------------------
Balance as of December 31, 2003 $ 3.8 $ 271.3 $3,257.2 $ 467.3 $ 3,999.6
=================================================================================================================================
See accompanying notes to unaudited consolidated financial statements, including
note 15 which describes related party transactions.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Consolidated Statements of Cash Flows
(in millions)
YEARS ENDED DECEMBER 31,
----------------------------------------
2003 2002 2001
===========================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 337.6 $ 161.5 $ 461.8
Adjustments to reconcile net income to net cash provided by operating activities:
Income from discontinued operations - (0.7) (1.2)
Interest credited to policyholder account values 1,300.4 1,241.2 1,238.7
Capitalization of deferred policy acquisition costs (567.2) (648.2) (743.0)
Amortization of deferred policy acquisition costs 375.9 670.1 347.9
Amortization and depreciation 69.3 (0.7) (31.5)
Realized losses (gains) on investments, hedging instruments and hedged
items:
Unrelated parties 100.8 107.6 62.7
Related parties - (23.2) (44.4)
Cumulative effect of adoption of accounting principles (0.9) - 10.9
Increase in other assets (640.7) (606.1) (271.8)
Increase in policy and other liabilities 299.1 463.1 335.8
Other, net 1.1 11.0 (47.0)
- - ---------------------------------------------------------------------------------------------------------------------------
Net cash provided by continuing operations 1,275.4 1,375.6 1,318.9
Net cash provided by discontinued operations - 0.7 1.7
- - ---------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 1,275.4 1,376.3 1,320.6
- - ---------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of available-for-sale securities 4,101.6 3,887.7 3,933.9
Proceeds from sale of available-for-sale securities 2,220.5 1,534.9 497.2
Proceeds from repayments of mortgage loans on real estate 1,478.3 1,009.0 1,204.4
Proceeds from sale of limited partnership to related parties - 54.5 158.9
Cost of available-for-sale securities acquired (9,366.7) (9,874.5) (7,123.6)
Cost of mortgage loans on real estate acquired (1,914.4) (1,810.2) (2,123.1)
Short-term investments, net (639.9) (193.1) (568.7)
Disposal of subsidiary, net of cash - (20.0) -
Other, net 254.2 (31.8) 697.0
- - ---------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (3,866.4) (5,443.5) (3,324.0)
Net cash provided by discontinued operations - - 0.6
- - ---------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (3,866.4) (5,443.5) (3,323.4)
- - ---------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in short-term debt 199.8 (100.0) (18.7)
Net proceeds from issuance of long-term debt to NFS 100.0 300.0 300.0
Capital contributed by NFS 200.2 - -
Capital returned to NFS (100.0) (475.0) -
Cash dividends paid to NFS (60.0) (35.0) (35.0)
Increase in investment and universal life insurance product account values 5,116.1 6,278.9 5,976.7
Decrease in investment and universal life insurance product account values (2,865.9) (1,923.4) (4,216.0)
- - ---------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 2,590.2 4,045.5 2,007.0
- - ---------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash (0.8) (21.7) 4.2
Cash, beginning of period 0.9 22.6 18.4
- - ---------------------------------------------------------------------------------------------------------------------------
Cash, end of period $ 0.1 $ 0.9 $ 22.6
===========================================================================================================================
See accompanying notes to consolidated financial statements, including note 15
which describes related party transactions.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
December 31, 2003, 2002 and 2001
(1) ORGANIZATION AND DESCRIPTION OF BUSINESS
Nationwide Life Insurance Company (NLIC, or collectively with its
subsidiaries, the Company) is a leading provider of life insurance and
retirement savings products in the United States of America (U.S.) and is a
wholly owned subsidiary of Nationwide Financial Services, Inc. (NFS). The
Company develops and sells a diverse range of products including individual
annuities, private and public sector pension plans, other investment
products sold to institutions, life insurance and an advisory services
program. The Company markets its products through a diverse distribution
network, including independent broker/dealers, wirehouse and regional
firms, financial institutions, pension plan administrators, life insurance
specialists, certified public accounting firms and the following affiliated
producers: Nationwide Retirement Solutions, TBG Financial, Nationwide
Provident agents and Nationwide agents.
Wholly owned subsidiaries of NLIC include Nationwide Life and Annuity
Insurance Company (NLAIC) and Nationwide Investment Services Corporation.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The significant accounting policies followed by the Company that materially
affect financial reporting are summarized below. The accompanying
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the U.S. (GAAP), which differ
from statutory accounting practices. The statutory financial statements of
NLIC and NLAIC are presented on the basis of accounting practices
prescribed or permitted by the Ohio Department of Insurance (the
Department). The Ohio Department of Insurance has adopted the National
Association of Insurance Commissioners (NAIC) statutory accounting
practices (NAIC SAP) as the basis of its statutory accounting practices.
NLIC and NLAIC have no statutory accounting practices that differ from NAIC
SAP. See also note 14 for discussion of statutory capital requirements and
dividend limitations.
In preparing the consolidated financial statements, management is required
to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosures of contingent assets and
liabilities as of the date of the consolidated financial statements and the
reported amounts of revenues and expenses for the reporting period. Actual
results could differ significantly from those estimates.
The most significant estimates include those used in determining the
balance and amortization of deferred policy acquisition costs (DAC) for
investment products, universal life insurance products, valuation
allowances for mortgage loans on real estate, impairment losses on other
investments and accruals related to federal income taxes and pension and
other postretirement benefits. Although some variability is inherent in
these estimates, the recorded amounts reflect management's best estimates
and management believes the amounts provided are appropriate.
(a) Consolidation Policy
The consolidated financial statements include the accounts of NLIC and
companies in which NLIC directly or indirectly has a controlling
financial interest and, as discussed in note 2(n), effective December
31, 2003, the Company applied the provisions of FIN 46R to those
special purpose entities (SPIEs) with which it is associated. All
significant intercompany balances and transactions have been
eliminated.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Notes to Consolidated Financial Statements, Continued
(b) Valuation of Investments, Investment Income and Related Gains and
Losses
The Company is required to classify its fixed maturity securities and
marketable equity securities as held-to-maturity, available-for-sale
or trading. All fixed maturity and marketable equity securities are
classified as available-for-sale. Available-for-sale securities are
stated at fair value, with the unrealized gains and losses, net of
adjustments to deferred policy acquisition costs (DAC), future policy
benefits and claims, and deferred federal income tax, reported as a
separate component of accumulated other comprehensive income (AOCI) in
shareholders' equity. The adjustment to DAC represents the changes in
amortization of DAC that would have been required as a charge or
credit to operations had such unrealized amounts been realized and
allocated to the product lines. The adjustment to future policy
benefits and claims represents the increase in policy reserves from
using a discount rate that would have been required if such unrealized
gains been realized and the proceeds reinvested at then current market
interest rates, which were lower than the then current effective
portfolio rate.
The fair value of fixed maturity and marketable equity securities is
generally obtained from independent pricing services based on market
quotations. For fixed maturity securities not priced by independent
services (generally private placement securities and securities that
do not trade regularly), an internally developed pricing model or
"corporate pricing matrix" is most often used. The corporate pricing
matrix is developed by obtaining spreads versus the US Treasury yield
for corporate securities with varying weighted average lives and bond
ratings. The weighted average life and bond rating of a particular
fixed maturity security to be priced using the corporate matrix are
important inputs into the model and are used to determine a
corresponding spread that is added to the US Treasury yield to create
an estimated market yield for the that bond. The estimated market
yield and other relevant factors are then used to estimate the fair
value of the particular fixed maturity security. Additionally, the
Company's internal corporate pricing matrix is not suitable for
valuing certain fixed maturity securities, particularly those with
complex cash flows such as certain mortgage-backed and asset-backed
securities. In these cases, a separate "structured product pricing
matrix" has been developed to value, as appropriate, using the same
methodology described above. For securities for which quoted market
prices are not available and for which the Company's structured
product pricing matrix is not suitable for estimating fair values,
qualified company representatives determine the fair value using other
modeling techniques, primarily using a commercial software application
utilized in valuing complex securitized investments with variable cash
flows. As of December 31, 2003, 68% of the fair values of fixed
maturity securities were obtained from independent pricing services,
21% from the Company's pricing matricies and 11% from other sources.
Management regularly reviews its fixed maturity and equity securities
portfolio to evaluate the necessity of recording impairment losses for
other-than-temporary declines in the fair value of investments. A
number of criteria are considered during this process including, but
not limited to, the current fair value as compared to amortized cost
or cost, as appropriate, of the security, the length of time the
security's fair value has been below amortized cost/cost, and by how
much, specific credit issues related to the issuer, and current
economic conditions. Other-than-temporary impairment losses result in
a permanent reduction of the cost basis of the underlying investment.
Also, the Company estimates the cash flows over the life of certain
purchased beneficial interests in securitized financial assets. Based
on current information and events, if the Company estimates that the
fair value of its beneficial interests is not greater than or equal to
its carrying value and if there has been an adverse change in the
estimated cash flows since the last revised estimate, considering both
timing and amount, then an other-than-temporary impairment is
recognized and the purchased beneficial interest is written down to
fair value.
Impairment losses are recorded on investments in long-lived assets
used in operations when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are
less than the assets' carrying amount.
For mortgage-backed securities, the Company recognizes income using a
constant effective yield method based on prepayment assumptions and
the estimated economic life of the securities. When estimated
prepayments differ significantly from anticipated 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. All other investment income is recorded using
the interest-method without anticipating the impact of prepayments.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Mortgage loans on real estate are carried at the unpaid principal
balance less valuation allowances. The Company provides valuation
allowances for impairments of mortgage loans on real estate based on a
review by portfolio managers. Mortgage loans on real estate are
considered impaired 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 the
Company determines that a loan is impaired, a provision for loss is
established equal to the difference between the carrying value and the
estimated value of the mortgage loan. Estimated value is based on the
present value of expected future cash flows discounted at the loan's
effective interest rate, or the fair value of the collateral, if the
loan is collateral dependent. Loans in foreclosure and loans
considered impaired are placed on non-accrual status. Interest
received on non-accrual status mortgage loans on real estate is
included in net investment income in the period received.
The valuation allowance account for mortgage loans on real estate is
maintained at a level believed adequate by the Company to absorb its
best estimate of probable credit losses inherent in the portfolio at
the balance sheet date. The valuation allowance for mortgage loans is
comprised of a specific component, based on known impairments by
specific loan and an unallocated component that is derived based on
the Company's estimate of impairments inherent in the portfolio at the
balance sheet date, but not specifically identified by loan. The
unallocated component is derived for principal amounts related to
loans without a specific reserve. The Company's periodic evaluation of
the adequacy of the allowance for losses is based on past loan loss
experience, known and inherent risks in the portfolio, adverse
situations that may affect the borrower's ability to repay, the
estimated value of the underlying collateral, composition of the loan
portfolio, current economic conditions and other relevant factors.
Real estate is carried at cost less accumulated depreciation. Real
estate designated as held for disposal is carried at the lower of the
carrying value at the time of such designation or fair value less cost
to sell. Other long-term investments are carried on the equity method
of accounting.
Realized gains and losses on the sale of investments are determined on
the basis of specific security identification. Changes in the
Company's mortgage loan valuation allowances and recognition of
impairment losses for other-than-temporary declines in the fair values
of applicable investments are included in realized gains and losses on
investments, hedging instruments and hedged items.
(c) Derivative Instruments
Derivatives are carried at fair value. On the date the derivative
contract is entered into, the Company designates the derivative as
either a hedge of the fair value of a recognized asset or liability or
of an unrecognized firm commitment (fair value hedge), a hedge of a
forecasted transaction or the variability of cash flows to be received
or paid related to a recognized asset or liability (cash flow hedge),
a foreign currency fair value or cash flow hedge (foreign currency
hedge) or a non-hedge transaction. The Company formally documents all
relationships between hedging instruments and hedged items, as well as
its risk-management objective and strategy for entering into various
hedge transactions. This process includes linking all derivatives that
are designated as fair value, cash flow or foreign currency hedges to
specific assets and liabilities on the balance sheet or to specific
firm commitments or forecasted transactions. The Company also formally
assesses, both at the hedge's inception and on an ongoing basis,
whether the derivatives that are used for hedging transactions are
highly effective in offsetting changes in fair values or cash flows of
hedged items. When it is determined that a derivative is not highly
effective as a hedge or that it has ceased to be a highly effective
hedge, the Company discontinues hedge accounting prospectively.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The Company enters into interest rate swaps, cross-currency swaps or
Euro futures to hedge the fair value of existing fixed rate assets and
liabilities. In addition, the Company uses short Treasury future
positions to hedge the fair value of bond and mortgage loan
commitments. Typically, the Company is hedging the risk of changes in
fair value attributable to changes in benchmark interest rates.
Derivative instruments classified as fair value hedges are carried at
fair value, with changes in fair value recorded in realized gains and
losses on investments, hedging instruments and hedged items. Changes
in the fair value of the hedged item, attributable to the risk being
hedged, are also recorded in realized gains and losses on investments,
hedging instruments and hedged items.
The Company may enter into "receive fixed/pay variable" interest rate
swaps to hedge existing floating rate assets or to hedge cash flows
from the anticipated purchase of investments. These derivative
instruments are identified as cash flow hedges and are carried at fair
value with the offset recorded in AOCI to the extent the hedging
relationship is effective. The ineffective portion of the hedging
relationship is recorded in realized gains and losses on investments,
hedging instruments and hedged items. Gains and losses on derivative
instruments that are initially recognized into AOCI are reclassified
out of AOCI and recognized in earnings over the same period(s) that
the hedged item affects earnings.
Accrued interest receivable or payable under interest rate and foreign
currency swaps are recognized as an adjustment to net investment
income or interest credited to policyholder account values consistent
with the nature of the hedged item, except for interest rate swaps
hedging the anticipated sale of investments where amounts receivable
or payable under the swaps are recorded as realized gains and losses
on investments, hedging instruments and hedged items, and except for
interest rate swaps hedging the anticipated purchase of investments
where amounts receivable or payable under the swaps are initially
recorded in AOCI to the extent the hedging relationship is effective.
From time to time, the Company may enter into a derivative transaction
that will not qualify for hedge accounting. The Company does not enter
into speculative positions. Although these transactions do not qualify
for hedge accounting, or have not been designated in hedging
relationships by the Company, they provide the Company with an
economic hedge, which is used as part of its overall risk management
strategies. For example, the Company may sell credit default
protection through a credit default swap. Although the credit default
swap may not be effective in hedging specific investments, the income
stream allows the Company to manage overall investment yields. The
Company may enter into a cross-currency basis swap (pay a variable US
rate and receive a variable foreign-denominated rate) to eliminate the
foreign currency exposure of a variable rate foreign-denominated
liability. Although basis swaps may qualify for hedge accounting, the
Company has chosen not to designate these derivatives as hedging
instruments due to the difficulty in assessing and monitoring
effectiveness for both sides of the basis swap. Derivative instruments
that do not qualify for hedge accounting, or are not designated as
hedging instruments are carried at fair value, with changes in fair
value recorded in realized gains and losses on investments, hedging
instruments and hedged items.
(d) Revenues and Benefits
Investment Products and Universal Life Insurance Products: Investment
products consist primarily of individual and group variable and fixed
deferred annuities. Universal life insurance products include
universal life insurance, variable universal life insurance,
corporate-owned life insurance and other interest-sensitive life
insurance policies. Revenues for investment products and universal
life insurance products consist of net investment income, asset fees,
cost of insurance, policy administration and surrender charges that
have been earned and assessed against policy account balances during
the period. The timing of revenue recognition as it relates to fees
assessed on investment contracts and universal life contracts is
determined based on the nature of such fees. Asset fees, cost of
insurance and policy administration charges are assessed on a daily or
monthly basis and recognized as revenue when assessed and earned.
Certain amounts assessed that represent compensation for services to
be provided in future periods are reported as unearned revenue and
recognized in income over the periods benefited. Surrender charges are
recognized upon surrender of a contract in accordance with contractual
terms. Policy benefits and claims that are charged to expense include
interest credited to policy account values and benefits and claims
incurred in the period in excess of related policy account values.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Traditional Life Insurance Products: Traditional life insurance
products include those products with fixed and guaranteed premiums and
benefits and consist primarily of whole life insurance,
limited-payment life insurance, term life insurance and certain
annuities with life contingencies. Premiums for traditional life
insurance products are recognized as revenue when due. Benefits and
expenses are associated with earned premiums so as to result in
recognition of profits over the life of the contract. This association
is accomplished by the provision for future policy benefits and the
deferral and amortization of policy acquisition costs.
(e) Deferred Policy Acquisition Costs
The costs of acquiring business, principally commissions, certain
expenses of the policy issue and underwriting department and certain
variable sales expenses that relate to and vary with the production of
new or renewal business have been deferred. DAC is subject to
recoverability testing at the time of policy issuance and loss
recognition testing at the end of each reporting period.
For investment products (principally individual and group annuities)
and universal life insurance products, DAC is being amortized with
interest over the lives of the policies in relation to the present
value of estimated future gross profits from projected interest
margins, asset fees, cost of insurance, policy administration and
surrender charges, less policy benefits and policy maintenance
expenses. The DAC asset related to investment products and universal
life insurance products is adjusted to reflect the impact of
unrealized gains and losses on fixed maturity securities
available-for-sale as described in note 2(b).
The most significant assumptions that are involved in the estimation
of future gross profits include future net separate account
performance, surrender/lapse rates, interest margins and mortality.
The Company's long-term assumption for net separate account
performance is 8 percent growth per year. If actual net separate
account performance varies from the 8 percent assumption, the Company
assumes different performance levels over the next three years, such
that the mean return equals the long-term assumption. This process is
referred to as a reversion to the mean. The assumed net separate
account return assumptions used in the DAC models are intended to
reflect what is anticipated. However, based on historical returns of
the S&P 500 Index, the Company's policy regarding the reversion to the
mean process does not permit such returns to be negative or in excess
of 15 percent during the three-year reversion period.
Changes in assumptions can have a significant impact on the amount of
DAC reported for investment products and universal life insurance
products and their related amortization patterns. In the event actual
experience differs from assumptions or assumptions are revised, the
Company is required to record an increase or decrease in DAC
amortization expense (DAC unlocking), which could be significant. In
general, increases in the estimated general and separate account
returns result in increased expected future profitability and may
lower the rate of DAC amortization, while increases in lapse/surrender
and mortality assumptions reduce the expected future profitability of
the underlying business and may increase the rate of DAC amortization.
Due to the magnitude of the DAC balance related to the individual
variable annuity business, the sensitivity of the calculation to minor
changes in the underlying assumptions, the complexity and judgments
involved in related estimate, and the related volatility that could
result in the reported DAC balance without meaningful improvement in
its reasonableness, the Company evaluates the appropriateness of the
individual variable annuity DAC balance within pre-set parameters.
Should the recorded balance of individual variable annuity DAC fall
outside of these parameters for a prescribed period of time, or should
the recorded balance fall outside of these parameters and the Company
determines it is not reasonably possible to get back within this
period of time, assumptions are required to be unlocked and the DAC is
recalculated using revised best estimate assumptions. Otherwise, DAC
is not unlocked to reflect updated assumptions. In the event DAC
assumptions are unlocked and revised, the Company will continue to use
the reversion to the mean process.
For other investment products and universal life insurance products,
DAC is set each quarter to reflect revised best estimate assumptions,
including the use of a reversion to the mean methodology over the next
three years as it relates to net separate account performance. Any
resulting DAC unlocking adjustments are reflected currently as a
charge or credit to DAC amortization expense.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
For traditional life insurance products, DAC is predominantly being
amortized with interest over the premium-paying period of the related
policies in proportion to the ratio of actual annual premium revenue
to the anticipated total premium revenue. Such anticipated premium
revenue is estimated using the same assumptions as those used for
computing liabilities for future policy benefits at issuance. Under
existing accounting guidance, the concept of DAC unlocking does not
apply to traditional life insurance products, although evaluations of
DAC for recoverability at the time of policy issuance and loss
recognition testing at each reporting period are performed as
required.
(f) Separate Accounts
Separate account assets and liabilities represent contractholders'
funds which have been segregated into accounts with specific
investment objectives. Separate account assets are recorded at fair
value based primarily on market quotations of the underlying
securities. The investment income and gains or losses of these
accounts accrue directly to the contractholders. The activity of the
separate accounts is not reflected in the consolidated statements of
income and cash flows except for the fees the Company receives. Such
fees are assessed on a daily or monthly basis and recognized as
revenue when assessed and earned.
(g) Future Policy Benefits
The liability for future policy benefits for investment products in
the accumulation phase, universal life insurance and variable
universal life insurance policies is the policy account balance, which
represents participants' net premiums and deposits plus investment
performance and interest credited less applicable contract charges.
The liability for future policy benefits for traditional life
insurance policies has been calculated by the net level premium method
using interest rates varying from 3.0% to 10.5% and estimates of
mortality, morbidity, investment yields and withdrawals which were
used or which were being experienced at the time the policies were
issued.
The liability for future policy benefits for payout annuities has been
calculated using the present value of future benefits and maintenance
costs discounted using interest rates varying from 3.0% to 13.0%.
Also, as of December 31, 2003 and 2002, the calculated reserve was
adjusted to reflect the incremental reserve that would be required if
unrealized gains and losses had been realized and therefore resulted
in the use of a lower discount rate, as discussed in note 2(b).
(h) Participating Business
Participating business represented approximately 13% in 2003 (15% in
2002 and 17% in 2001) of the Company's life insurance in-force, 56% of
the number of life insurance policies in-force in 2003 (59% in 2002
and 63% in 2001), and 11% of life insurance statutory premiums in 2003
(9% in 2002 and 9% in 2001). The provision for policyholder dividends
was based on then current dividend scales and has been included in
Future policy benefits and claims in the accompanying consolidated
balance sheets.
(i) Federal Income Tax
The Company provides for federal income taxes based on amounts the
Company believes it will ultimately 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 expenses or the realization of
certain tax credits differ from estimates, the Company may be required
to significantly change the provision for federal income taxes
recorded in the consolidated financial statements. Management has used
best estimates to establish reserves based on current facts and
circumstances regarding tax exposure items where the ultimate
deductibility is open to interpretation. Quarterly, management
evaluates the appropriateness of such reserves based on any new
developments specific to their fact patterns. Information considered
includes results of completed tax examinations, Technical Advice
Memorandums and other rulings issued by the Internal Revenue Service
or the tax courts.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The Company utilizes the asset and liability method of accounting for
income tax. Under this method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases and operating loss and
tax credit carryforwards. Deferred tax assets and liabilities are
measured using enacted tax rates expected to apply to taxable income
in the years in which those temporary differences are expected to be
recovered or settled. Under this method, the effect on deferred tax
assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. Valuation
allowances are established when necessary to reduce the deferred tax
assets to the amounts expected to be realized.
(j) Reinsurance Ceded
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 balances of the Company.
(k) Recently Issued Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standards (SFAS) No. 132
(revised 2003) Employers' Disclosures about Pensions and Other
Postretirement Benefits an amendment of FASB Statements No. 87, 88 and
106 (SFAS 132R). SFAS 132R provides revised disclosure guidance for
pension and other postretirement benefit plans but does not change the
measurement or recognition of those plans under existing guidance.
Disclosures previously required under SFAS No. 132 Employers'
Disclosures about Pensions and Other Postretirement Benefits, which
was replaced by SFAS 132R, were retained. In addition, SFAS 132R
requires additional disclosures about the assets, obligations, cash
flows, and net periodic benefit cost of defined benefit pension plans
and other defined benefit pension plans. The Company adopted SFAS 132R
effective December 31, 2003, except for disclosures about estimated
benefit payments, which is expected to be adopted in the second
quarter of 2004, as permitted by SFAS 132R.
In January 2003, the FASB issued Interpretation No. 46, Consolidation
of Variable Interest Entities - an interpretation of ARB No. 51 (FIN
46). Accounting Research Bulletin No. 51, Consolidated Financial
Statements (ARB 51) states that consolidation is usually necessary
when a company has a "controlling financial interest" in another
company, a condition most commonly achieved via ownership of a
majority voting interest. FIN 46 clarifies the application of ARB 51,
to certain "variable interest entities" (VIEs) where (i) the equity
investors are not empowered to make sufficient decisions about the
entity's operations, or do not receive expected returns or absorb
expected losses commensurate with their equity ownership; or (ii) the
entity does not have sufficient equity to finance its activities
without additional subordinated financial support from other parties.
VIEs are consolidated by their primary beneficiary, which is a party
having a majority of the entity's expected losses, expected residual
returns, or both. A company holding a significant variable interest in
a VIE, but not deemed the primary beneficiary is subject to certain
disclosure requirements specified by FIN 46. FIN 46 applies to
entities formed after January 31, 2003, and to VIEs in which an
enterprise obtains an interest after that date. In October 2003, the
FASB delayed the implementation date of FIN 46 for VIEs acquired prior
to January 31, 2003 to interim periods ending after December 15, 2003,
with early adoption permitted.
In December 2003, the FASB issued Interpretation No. 46 (revised
December 2003) Consolidation of Variable Interest Entities - an
interpretation of ARB No. 51 (FIN 46R) that required all public
companies to apply the provisions of FIN 46 or FIN 46R to special
purpose entities created prior to February 1, 2003. Once adopted by an
entity, FIN 46R replaces FIN 46. Public companies, including the
Company, at a minimum, must apply the unmodified provisions of FIN 46
to entities that were considered "special purpose entities" in
practice and under applicable FASB pronouncements or guidance by the
end of the first reporting period ending after December 15, 2003. The
Company had no special purpose entity VIE's as of December 31, 2003.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The Company is required to apply the provisions of FIN 46R to all
entities created after December 31, 2003 and to all other entities no
later than the beginning of the first reporting period beginning after
March 15, 2004. FIN 46 may be applied on a prospective basis with a
cumulative effect adjustment made as of the date of initial
application or by restating previously issued financial statements for
one or more years with a cumulative effect adjustment as of the
beginning of the first year restated. The Company plans to adopt the
remaining provisions of FIN 46R during the first quarter of 2004. The
adoption of the remaining provisions of FIN 46R is not expected to
have a material impact on the results of operations or financial
position of the Company.
In July 2003, the American Institute of Certified Public Accountants
issued Statement of Position 03-1, Accounting and Reporting by
Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts (SOP 03-1). SOP 03-1 addresses a
number of topics; the most significant of which to the Company is the
accounting for contracts with guaranteed minimum death benefits
(GMDB). SOP 03-1 requires companies to evaluate the significance of
the GMDB benefit to determine whether the contract should be accounted
for as an investment or insurance contract. For contracts determined
to be insurance contracts, companies are required to establish a
reserve to recognize a portion of the assessment (revenue) that
compensates the insurance company for benefits to be provided in
future periods. SOP 03-1 also provides guidance on separate account
presentation, interest in separate accounts, gains and losses on the
transfer of assets from the general account to a separate account,
liability valuation, return based on a contractually referenced pool
of assets or index, annuitization options and sales inducements to
contract holders. The Company adopted SOP 03-1 on January 1, 2004. As
a result, the Company expects to record a cumulative effect adjustment
resulting from the adoption of accounting principles of approximately
$3.3 million, net of tax, during the first quarter of 2004. See note
21 for further discussion.
In May 2003, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 150, Accounting
for Certain Financial Instruments with Characteristics of both
Liabilities and Equity (SFAS 150). SFAS 150 establishes standards for
the classification and measurement of certain freestanding financial
instruments that embody obligations of the issuer and have
characteristics of both liabilities and equity. Further, SFAS 150
requires disclosure regarding the terms of those instruments and
settlement alternatives. As originally issued the guidance in SFAS 150
was generally effective for financial instruments entered into or
modified after May 31, 2003, and otherwise effective at the beginning
of the first interim period beginning after June 15, 2003. Adjustments
required as a result of the application of SFAS 150 to existing
instruments should be reported as a cumulative effect of a change in
accounting principle. The adoption of SFAS 150 on July 1, 2003 did not
have any impact on the results of operations or financial position of
the Company.
In April 2003, the FASB released SFAS No. 149, Amendment of Statement
133 on Derivative Instruments and Hedging Activities (SFAS 149). SFAS
149 amends and clarifies financial accounting and reporting for
derivative instruments, including certain derivative instruments
embedded in other contracts, and for hedging activities under SFAS No.
133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133). SFAS 149 is generally effective for contracts entered into
or modified after June 30, 2003. The adoption of SFAS 149 on July 1,
2003 did not have a material impact on the results of operations or
financial position of the Company.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
In April 2003, the FASB released Statement 133 Implementation Issue
B36, Embedded Derivatives: Modified Coinsurance Arrangements and Debt
Instruments That Incorporate Credit Risk Exposures That Are Unrelated
or Only Partially Related to the Creditworthiness of the Obligor under
Those Instruments (DIG B36). DIG B36 addresses the need to separately
account for an embedded derivative within a reinsurer's receivable and
ceding company's payable arising from modified coinsurance or similar
arrangements. Paragraph 12.a. of SFAS 133 indicates that an embedded
derivative must be separated from the host contract (bifurcated) if
the economic characteristics and risks of the embedded derivative
instrument are not clearly and closely related to the economic
characteristics and risks of the host contract. DIG B36 concludes that
bifurcation is necessary in a modified coinsurance and similar
arrangement because the yield on the receivable and payable is based
on or referenced to a specified proportion of the ceding company's
return on either its general account assets or a specified block of
those assets, rather than the overall creditworthiness of the ceding
company. The effective date of implementation was the first day of the
first fiscal quarter beginning after September 15, 2003, October 1,
2003 for the Company. Upon adoption of DIG B36 on October 1, 2003, the
Company recorded a derivative liability of $0.9 million, deferred
taxes of $0.3 million and a charge of $0.6 million as a cumulative
effect of adoption of this accounting principal.
In November 2002, the FASB issued Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees - an
Iinterpretation of FASB Statements No. 5, 57, and 107 and Rescission
of FASB Interpretation No. 34 (FIN 45). FIN 45 requires a guarantor to
provide more detailed interim and annual financial statement
disclosures about obligations under certain guarantees it has issued.
It also requires a guarantor to recognize, at the inception of new
guarantees issued or modified after December 31, 2002, a liability for
the fair value of the obligation undertaken in issuing the guarantee.
Although superceded by FIN 45, the guidance provided in FASB
Interpretation No. 34, Disclosure of Indirect Guarantees of
Indebtedness of Others has been incorporated into FIN 45 without
change. The adoption of FIN 45 on January 1, 2003 did not have a
material impact on the financial position or results of operations of
the Company.
In June 2002, the FASB issued Statement of Financial Accounting
Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or
Disposal Activities (SFAS 146), which the Company adopted January 1,
2003. Adoption of SFAS 146 did not have any impact on the financial
position or results of operations of the Company.
In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13 and
Technical Corrections (SFAS 145), which the Company adopted on October
1, 2002. The adoption of SFAS 145 did not have any impact on the
financial position or results of operations of the Company.
In October 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets (SFAS 144). SFAS 144
supersedes SFAS 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of, and APB Opinion
No. 30, Reporting the Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions (APB 30). SFAS 144 was
adopted by the Company on January 1, 2002 and carries forward many of
the provisions of SFAS 121 for recognition and measurement of the
impairment of long-lived assets to be held and used, and measurement
of long-lived assets to be disposed of by sale, while providing
additional criteria to determine when a long-lived asset is actually
held-for-sale. SFAS 144 also broadens the definition of "discontinued
operations," but does not allow for the accrual of future operating
losses before they occur as previously required by APB 30. Under SFAS
144, if a long-lived asset is part of a group that includes other
assets and liabilities, then the provisions of SFAS 144 apply to the
entire group. In addition, SFAS 144 does not apply to goodwill and
other intangible assets that are not amortized. The adoption of SFAS
144 did not have a material impact on the results of operations or
financial position of the Company.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
In July 2001, the FASB issued SFAS No. 142, Goodwill and Other
Intangible Assets (SFAS 142). SFAS 142 applies to all acquired
intangible assets whether acquired singularly, as part of a group, or
in a business combination. SFAS 142 supersedes APB Opinion No. 17,
Intangible Assets (APB 17) and carries forward provisions in APB 17
related to internally developed intangible assets. SFAS 142 changes
the accounting for goodwill and intangible assets with indefinite
lives from an amortization method to an impairment-only approach. The
Company adopted SFAS 142 on January 1, 2002, at which time, the
Company had no unamortized goodwill and therefore, the adoption of
SFAS 142 did not have any impact on the results of operations or
financial position of the Company.
In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities (SFAS 133). SFAS 133, as amended by
SFAS No. 137, Accounting for Derivative Instruments and Hedging
Activities - Deferral of the Effective Date of FASB Statement No. 133
(SFAS 137), and SFAS 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities (SFAS 138), was adopted by
the Company effective January 1, 2001. All references hereafter to
SFAS 133 include the amendments outlined in SFAS 137 and SFAS 138.
Upon adoption, the provisions of SFAS 133 were applied prospectively.
SFAS 133, establishes accounting and reporting standards for
derivative instruments and hedging activities. It requires an entity
to recognize all derivatives as either assets or liabilities on the
balance sheet and measure those instruments at fair value.
The adoption of SFAS 133 resulted in the Company recording a net
transition adjustment loss of $4.8 million (net of related income tax
of $2.6 million) in net income in 2001. In addition, a net transition
adjustment loss of $3.6 million (net of related income tax of $2.0
million) was recorded in AOCI as of January 1, 2001. The adoption of
SFAS 133 resulted in the Company derecognizing $17.0 million of
deferred assets related to hedges, recognizing $10.9 million of
additional derivative instrument liabilities and $1.3 million of
additional firm commitment assets, while also decreasing hedged future
policy benefits by $3.0 million and increasing the carrying amount of
hedged investments by $10.6 million.
The adoption of SFAS 133 increases the Company's exposure to the
volatility of reported earnings and other comprehensive income. The
amount of volatility will, in part, vary with the level of derivative
and hedging activities, fluctuations in market interest rates, foreign
currency exchange rates and other hedged risks, during any period; and
the effectiveness of hedging derivatives in offsetting changes in fiar
value and cash flows attributable to those hedged risks.
In November 1999, the Emerging Issues Task Force (EITF) issued EITF
Issue No. 99-20, Recognition of Interest Income and Impairment on
Purchased and Retained Beneficial Interests in Securitized Financial
Assets (EITF 99-20). The Company adopted EITF 99-20 on April 1, 2001.
EITF 99-20 establishes the method of recognizing interest income and
impairment on certain asset-backed investment securities that are not
of high credit quality. EITF 99-20 requires the Company to update the
estimate of cash flows over the life of certain retained beneficial
interests in securitization transactions and purchased beneficial
interests in securitized financial assets. Pursuant to EITF 99-20,
based on current information and events, if the Company estimates that
the fair value of its beneficial interests is less than its carrying
value and that there has been an adverse change in the estimated cash
flows since the last revised estimate, considering both timing and
amount, then an other-than-temporary impairment should be recognized.
The cumulative effect, net of tax, upon adoption of EITF 99-20 on
April 1, 2001 decreased net income by $2.3 million with a
corresponding increase to AOCI.
(l) Discontinued Operations
As described more fully in note 15, NLIC paid a dividend to NFS in the
form of all of the shares of common stock of Nationwide Securities,
Inc. (NSI), a wholly owned broker/dealer subsidiary engaged in the
asset management business. The accompanying consolidated financial
statements and related notes reflect this business as discontinued
operations.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
(m) Reclassification
Certain items in the 2002 and 2001 consolidated financial statements
and related footnotes have been reclassified to conform to the 2003
presentation.
(3) INVESTMENTS
The amortized cost, gross unrealized gains and losses and estimated fair
value of securities available-for-sale as of December 31, 2003 and 2002
were:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED ESTIMATED
(in millions) COST GAINS LOSSES FAIR VALUE
=======================================================================================================================
December 31, 2003:
Fixed maturity securities:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies $1,042.5 $ 61.0 $ 1.9 $1,101.6
Obligations of states and political subdivisions 167.6 1.0 5.2 163.4
Debt securities issued by foreign governments 51.8 2.0 0.8 53.0
Public securities 10,000.0 503.7 26.2 10,477.5
Private securities 6,454.2 469.1 25.3 6,898.0
Mortgage-backed securities - U.S. Government backed 3,990.1 73.9 21.8 4,042.2
Asset-backed securities 4,144.0 129.0 61.9 4,211.1
- - -----------------------------------------------------------------------------------------------------------------------
Total fixed maturity securities 25,850.2 1,239.7 143.1 26,946.8
Equity securities 74.0 11.8 0.2 85.6
- - -----------------------------------------------------------------------------------------------------------------------
Total $25,924.2 $1,251.5 $ 143.3 $27,032.4
=======================================================================================================================
DECEMBER 31, 2002:
Fixed maturity securities:
U.S. Treasury securities and obligations of U.S.
Government corporations and agencies $ 774.3 $ 64.4 $ 0.3 $ 838.4
Obligations of states and political subdivisions 20.8 1.1 - 21.9
Debt securities issued by foreign governments 39.3 2.7 - 42.0
Public securities 8,744.3 445.4 75.2 9,114.5
Private securities 5,399.2 489.1 41.4 5,846.9
Mortgage-backed securities - U.S. Government backed 4,347.5 146.5 0.1 4,493.9
Asset-backed securities 3,808.9 157.3 154.8 3,811.4
- - -----------------------------------------------------------------------------------------------------------------------
Total fixed maturity securities 23,134.3 1,306.5 271.8 24,169.0
Equity securities 85.1 7.1 7.9 84.3
- - -----------------------------------------------------------------------------------------------------------------------
Total $23,219.4 $1,313.6 $ 279.7 $24,253.3
=======================================================================================================================
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The amortized cost and estimated fair value of fixed maturity securities
available-for-sale as of December 31, 2003, by expected maturity, are shown
below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties.
AMORTIZED ESTIMATED
(in millions) COST FAIR VALUE
=========================================================================================================================
Fixed maturity securities available-for-sale:
Due in one year or less $1,056.7 $1,079.1
Due after one year through five years 7,442.2 7,784.5
Due after five years through ten years 6,704.7 7,123.5
Due after ten years 2,512.5 2,706.4
- - -------------------------------------------------------------------------------------------------------------------------
Subtotal 17,716.1 18,693.5
Mortgage-backed securities - U.S. Government backed 3,990.1 4,042.2
Asset-backed securities 4,144.0 4,211.1
- - -------------------------------------------------------------------------------------------------------------------------
Total $25,850.2 $26,946.8
=========================================================================================================================
The components of unrealized gains on securities available-for-sale, net, were
as follows as of December 31:
(in millions) 2003 2002
=========================================================================================================================
Unrealized gains, before adjustments and taxes $ 1,108.2 $ 1,033.9
Adjustment to deferred policy acquisition costs (243.7) (300.6)
Adjustment to future policy benefits and claims (110.6) (133.2)
Deferred federal income tax (264.2) (210.0)
- - -------------------------------------------------------------------------------------------------------------------------
Net unrealized gains $ 489.7 $ 390.1
=========================================================================================================================
An analysis of the change in gross unrealized gains on securities
available-for-sale for the years ended December 31:
(in millions) 2003 2002 2001
=========================================================================================================================
Fixed maturity securities $ 61.9 $ 625.5 $ 212.0
Equity securities 12.4 (11.8) 5.5
- - -------------------------------------------------------------------------------------------------------------------------
Net change $ 74.3 $ 613.7 $ 217.5
=========================================================================================================================
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
An analysis of selected data about gross unrealized losses on
available-for-sale securities by time on an unrealized loss position as of
December 31, 2003 and 2002 follows:
LESS THAN OR EQUAL TO MORE TOTAL
ONE YEAR THAN ONE YEAR
-------------------------------------------------------------------------------------
GROSS GROSS GROSS
ESTIMATED UNREALIZED ESTIMATED UNREALIZED ESTIMATED UNREALIZED
(in millions) FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES
==========================================================================================================================
December 31, 2003:
Fixed maturity securities:
U.S. Treasury securities and $ 154.4 $ 1.9 $ - $ - $ 154.4 $ 1.9
obligations of U.S.
Government corporations
and agencies
Obligations of states and 123.4 5.2 - - 123.4 5.2
political subdivisions
Debt securities issued by 19.9 0.8 - - 19.9 0.8
foreign governments
Public securities 1,236.7 24.5 31.7 1.7 1,268.4 26.2
Private securities 832.3 21.4 49.1 3.9 881.4 25.3
Mortgage-backed securities - 984.9 21.7 5.3 0.1 990.2 21.8
U.S. Government backed
Asset-backed securities 787.0 36.2 260.4 25.7 1,047.4 61.9
- - --------------------------------------------------------------------------------------------------------------------------
Total fixed maturity securities 4,138.6 111.7 346.5 31.4 4,485.1 143.1
Equity securities 6.2 0.1 2.0 0.1 8.2 0.2
- - --------------------------------------------------------------------------------------------------------------------------
Total $ 4,144.8 $ 111.8 $ 348.5 $ 31.5 $ 4,493.3 $ 143.3
==========================================================================================================================
% of gross unrealized loss 78.0% 22.0%
DECEMBER 31, 2002:
Fixed maturity securities:
U.S. Treasury securities and $ 55.3 $ 0.3 $ - $ - $ 55.3 $ 0.3
obligations of U.S.
Government corporations
and agencies
Obligations of states and - - - - - -
political subdivisions
Debt securities issued by - - - - - -
foreign governments
Public securities 590.5 46.5 266.7 28.7 857.2 75.2
Private securities 245.6 32.8 70.4 8.6 316.0 41.4
Mortgage-backed securities - 51.4 0.1 19.6 - 71.0 0.1
U.S. Government backed
Asset-backed securities 576.3 62.6 260.8 92.2 837.1 154.8
- - --------------------------------------------------------------------------------------------------------------------------
Total fixed maturity securities 1,519.1 142.3 617.5 129.5 2,136.6 271.8
Equity securities 24.6 3.9 16.1 4.0 40.7 7.9
- - --------------------------------------------------------------------------------------------------------------------------
Total $ 1,543.7 $ 146.2 $ 633.6 $ 133.5 $ 2,177.3 $ 279.7
==========================================================================================================================
% of gross unrealized loss 52.3% 47.7%
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Proceeds from the sale of securities available-for-sale during 2003, 2002
and 2001 were $2.22 billion, $1.53 billion and $497.2 million,
respectively. During 2003, gross gains of $104.0 million ($42.0 million and
$31.3 million in 2002 and 2001, respectively) and gross losses of $27.6
million ($16.6 million and $10.1 million in 2002 and 2001, respectively)
were realized on those sales.
The Company had $27.2 million and $28.0 million of real estate investments
as of December 31, 2003 and 2002, respectively, that were non-income
producing during the preceding twelve months.
Real estate is presented at cost less accumulated depreciation of $22.4
million as of December 31, 2003 ($18.6 million as of December 31, 2002).
The carrying value of real estate held for disposal totaled $10.5 million
and $46.0 million as of December 31, 2003 and 2002, respectively.
The recorded investment of mortgage loans on real estate considered to be
impaired was $46.3 million as of December 31, 2003 ($27.4 million as of
December 31, 2002), which includes $46.3 million ($10.9 million as of
December 31, 2002) of impaired mortgage loans on real estate for which the
related valuation allowance was $3.9 million ($2.5 million as of December
31, 2002). Impaired mortgage loans with no valuation allowance are a result
of collateral dependent loans where the fair value of the collateral is
estimated to be greater than the recorded investment of the loan. During
2003, the average recorded investment in impaired mortgage loans on real
estate was $15.4 million ($5.5 million in 2002) and interest income
recognized on those loans using the cash-basis method of income
recognition, totaled $3.3 million in 2003 ($0.1 million in 2002).
Activity in the valuation allowance account for mortgage loans on real
estate for the years ended December 31 was:
(in millions) 2003 2002 2001
=================================================================================================================
Allowance, beginning of period $ 43.4 $ 42.9 $ 45.3
Net (reductions) additions (credited) charged to allowance (14.3) 0.5 (2.4)
- - --------------------------------------------------------------------------------------------------------------
Allowance, end of period $ 29.1 $ 43.4 $ 42.9
=================================================================================================================
During the third quarter of 2003, the Company refined its analysis of the
overall performance of the mortgage loan portfolio and related allowance
for mortgage loan losses. This analysis included an evaluation of the
current composition of the portfolio, historical losses by property type,
current economic conditions and expected losses incurred as of the balance
sheet date, but not yet identified by specific loan. As a result of the
analysis, the total valuation allowance was reduced by $12.1 million.
An analysis of investment income (loss) from continuing operations by
investment type follows for the years ended December 31:
(in millions) 2003 2002 2001
=====================================================================================================================
Securities available-for-sale:
Fixed maturity securities $1,453.1 1,332.5 1,181.1
Equity securities 1.4 1.9 1.8
Mortgage loans on real estate 579.7 563.8 527.9
Real estate 21.7 26.8 33.1
Short-term investments 9.3 12.6 28.0
Derivatives (100.3) (79.6) (19.7)
Other 64.8 31.0 20.9
- - ---------------------------------------------------------------------------------------------------------------------
Gross investment income 2,029.7 1,889.0 1,773.1
Less investment expenses 49.7 50.5 48.4
- - ---------------------------------------------------------------------------------------------------------------------
Net investment income $1,980.0 1,838.5 1,724.7
=====================================================================================================================
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
An analysis of net realized losses on investments, hedging instruments and
hedged items, by source follows for the years ended December 31:
(in millions) 2003 2002 2001
=============================================================================================================
UNRELATED PARTIES:
Realized gains on sales, net of hedging losses:
Fixed maturity securities, available-for-sale $ 98.5 $ 42.0 $ 30.1
Hedging losses on fixed maturity sales (42.4) (36.2) (1.5)
Equity securities, available-for-sale 5.5 - 1.2
Real estate 4.2 14.0 3.3
Mortgage loans on real estate 3.0 3.2 11.2
Mortgage loan hedging losses (2.4) (1.2) (8.1)
Other - 0.1 1.2
- - -------------------------------------------------------------------------------------------------------------
Total realized gains on sales - unrelated parties 66.4 21.9 37.4
- - -------------------------------------------------------------------------------------------------------------
Realized losses on sales, net of hedging gains:
Fixed maturity securities, available-for-sale (27.2) (15.7) (9.3)
Hedging gains on fixed maturity sales 9.2 10.7 0.1
Equity securities, available-for-sale (0.4) (0.9) (0.8)
Real estate (0.3) (3.0) (1.4)
Mortgage loans on real estate (5.0) (3.3) (0.6)
Mortgage loan hedging gains 0.5 0.9 -
Other (2.0) (1.0) (7.7)
- - -------------------------------------------------------------------------------------------------------------
Total realized losses on sales - unrelated parties (25.2) (12.3) (19.7)
- - -------------------------------------------------------------------------------------------------------------
Other-than-temporary impairments:
Fixed maturity securities, available-for-sale (159.4) (111.6) (66.1)
Equity securities, available-for-sale (8.0) - (13.8)
Real estate (0.8) (2.4) -
Mortgage loans on real estate 11.7 (6.3) (0.7)
- - -------------------------------------------------------------------------------------------------------------
Total other-than-temporary impairments (156.5) (120.3) (80.6)
- - -------------------------------------------------------------------------------------------------------------
Credit default swaps 13.3 (6.4) (0.5)
Derivatives, excluding hedging gains and losses on 1.2 9.5 0.7
sales, and credit default swaps
- - -------------------------------------------------------------------------------------------------------------
Total unrelated parties (100.8) (107.6) (62.7)
Gain on sale of limited partnership - related party - 23.2 44.4
- - -------------------------------------------------------------------------------------------------------------
Net realized losses on investments, $ (100.8) $ (84.4) $ (18.3)
hedging instruments and hedged items
=============================================================================================================
Fixed maturity securities with an amortized cost of $7.8 million as of
December 31, 2003 and $7.3 million as of December 31, 2002 were on deposit
with various regulatory agencies as required by law.
As of December 31, 2003 and 2002 the Company had pledged fixed maturity
securities with a fair value of $101.2 million and $152.4 million,
respectively, as collateral to various derivative counterparties.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
As of December 31, 2003 and 2002 the Company held collateral of $544.5
million and $413.1 million, respectively, on derivative transactions. This
amount is invested in short-term investments with a corresponding liability
recorded in other liabilities. The Company also held $163.0 million and
$25.9 million of securities as off-balance sheet collateral on derivative
transactions as of December 31, 2003 and 2002, respectively.
As of December 31, 2003 and 2002, the Company had loaned securities with a
fair value of $958.1 million and $950.5 million, respectively. As of
December 31, 2003 and 2002 the Company held collateral of $976.6 million
and $974.5 million, respectively. This amount is invested in short-term
investments with a corresponding liability recorded in other liabilities.
(4) DEFERRED POLICY ACQUISITION COSTS
As part of the regular quarterly analysis of DAC, at the end of the third
quarter of 2002, the Company determined that using actual experience to
date and assumptions consistent with those used in the second quarter of
2002, its individual variable annuity DAC balance would be outside a
pre-set parameter of acceptable results. The Company also determined that
it was not reasonably possible that the DAC would return to an amount
within the acceptable parameter within a prescribed period of time.
Accordingly, the Company unlocked its DAC assumptions for individual
variable annuities and reduced the DAC asset to the amount calculated using
the revised assumptions. Because the Company unlocked the net separate
account growth rate assumption for individual variable annuities for the
three-year reversion period, the Company unlocked that assumption for all
investment products and variable universal life insurance products to be
consistent across product lines.
Therefore, the Company recorded an acceleration of DAC amortization
totaling $347.1 million, before tax, or $225.6 million, net of $121.5
million of federal income tax benefit, which has been reported in the
following segments in the amounts indicated, net of tax: Individual Annuity
- $213.4 million, Institutional Products - $7.8 million and Life Insurance
- $4.4 million. The acceleration of DAC amortization was the result of
unlocking certain assumptions underlying the calculation of DAC for
investment products and variable universal life insurance products. The
most significant assumption changes were the resetting of the Company's
anchor date for reversion to the mean calculations to September 30, 2002,
and resetting the assumption for net separate account growth to 8 percent
during the three-year reversion period for all investment products and
variable life insurance products, as well as increasing the future lapses
and costs related to guaranteed minimum death benefits (GMDB) on individual
variable annuity contracts. These adjustments were primarily driven by the
sustained downturn in the equity markets.
(5) VARIABLE ANNUITY CONTRACTS
The Company issues traditional variable annuity contracts through its
separate accounts, for which investment income and gains and losses on
investments accrue directly to, and investment risk is borne by, the
contract holder. The Company also issues non-traditional variable annuity
contracts in which the Company provides various forms of guarantees to
benefit the related contract holders. There are three primary guarantee
types that are provided under non-traditional variable annuity contracts:
(1) Guaranteed Minimum Death Benefits (GMDB); (2) Guaranteed Minimum
Accumulation Benefits (GMAB); and (3) Guaranteed Minimum Income Benefits
(GMIB).
The GMDB provides a specified minimum return upon death. Many, but not all
of these death benefits are spousal, whereby a death benefit will be paid
upon death of the first spouse and the survivor has the option to terminate
the contract or continue it and have the death benefit paid into the
contract and a second death benefit paid upon the survivor's death. There
are six primary GMDB types that the company offers.
o RETURN OF PREMIUM - provides the greater of account value or
total deposits made to the contract less any partial withdrawals
and assessments, which is referred to as "net premiums". There
are two variations of this benefit. In general, there is no lock
in age for this benefit, however for some contracts, the GMDB
reverts to the account value at a specified age, typically age
75.
o RESET - provides the greater of a return of premium death benefit
or the most recent five-year anniversary (prior to lock in age)
account value adjusted for withdrawals. For most contracts, this
GMDB locks in at age 86 or 90 and for others the GMDB reverts to
the account value at age 75, 85, 86 or 90.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
o RATCHET - provides the greater of a return of premium death
benefit or the highest specified "anniversary" account value
(prior to age 86) adjusted for withdrawals. Currently, there are
three versions of ratchet, with the difference being based on the
definition of anniversary: monthaversary - evaluated monthly,
annual - evaluated annually, and five-year - evaluated every
fifth year.
o ROLLUP - provides the greater of a return of premium death
benefit or premiums adjusted for withdrawals accumulated at
generally 5% simple interest up to the earlier of age 86 or 200%
of adjusted premiums. There are two variations of this benefit.
For certain contracts, this GMDB locks in at age 86 and for
others the GMDB reverts to the account value at age 75.
o COMBO - provides the greater of annual ratchet death benefit or
rollup death benefit. This benefit locks in at either age 81 or
86.
o EARNINGS ENHANCEMENT - provides an enhancement to the death
benefit that is a specified percentage of the adjusted earnings
accumulated on the contract at the date of death. There are two
versions of this benefit, one where the benefit expires at age 86
and a credit of 4% of account value is deposited into the
contract and the second where the benefit doesn't have an end
age, but has a cap on the payout and is paid upon the first death
in a spousal situation. Both benefits have age limitations. This
benefit is paid in addition to any other death benefits paid
under the contract.
The GMAB is a living benefit that provides the contract holder with a
guaranteed return of premium, adjusted proportionately for withdrawals,
after a specified period of time, 5, 7 or 10 years, selected by the
contract holder at the issuance of the variable annuity contract. In some
cases, the contract holder also has the option, after a specified period of
time, to drop the rider and continue the variable annuity contract without
the GMAB. In general, the GMAB requires a minimum allocation to guaranteed
term options (GTOs) or adherence to limitations required by an approved
asset allocation strategy.
The GMIB is a living benefit that provides the contract holder with a
guaranteed annuitization value. The GMIB types are:
o RATCHET - provides an annuitization value equal to the greater of
account value, net premiums or the highest one-year anniversary
account value (prior to age 86) adjusted for withdrawals.
o ROLLUP - provides an annuitization value equal to the greater of
account value and premiums adjusted for withdrawals accumulated
at 5% compound interest up to the earlier of age 86 or 200% of
adjusted premiums.
o COMBO - provides an annuitization value equal to the greater of
account value, ratchet GMIB benefit or rollup GMIB benefit.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Following is a summary of the account values and net amount at risk, net of
reinsurance, for variable annuity contracts with guarantees as of December
31, 2003 and 2002:
2003 2002
----------------------------------------------- ----------------------------------------------
ACCOUNT NET AMOUNT WTD. AVG. Account Net amount Wtd. Avg.
(in millions) VALUE AT RISK 1 ATTAINED AGE value at risk 1 attained age
==============================================================================================================================
GMDB:
Return of premium $ 9,760.0 $ 199.8 56.0 $ 8,737.4 $ 736.7 54.0
Reset 17,534.2 569.4 61.0 14,710.3 1,776.9 60.0
Ratchet 8,147.7 141.0 63.0 6,058.3 411.2 63.0
Roll-up 669.7 22.2 68.0 616.7 32.8 67.0
Combo 2,128.7 39.6 67.0 1,104.0 111.6 65.0
- - ------------------------------------------------------------------------------------------------------------------------------
Subtotal $ 38,240.3 972.0 61.0 $ 31,226.7 3,069.2 59.0
============== =============
Earnings enhancement $ 314.1 10.9 59.0 $ 213.1 1.7 61.0
----------------------------------- --------------------------------
Total - GMDB $ 982.9 61.0 $ 3,070.9 59.0
=================================== ================================
GMAB:
5 Year $ 79.9 $ 0.1 N/A n/a n/a n/a
7 Year 125.5 0.5 N/A n/a n/a n/a
10 Year 43.4 0.1 N/A n/a n/a n/a
- - ------------------------------------------------------------------------------------------------------------------------------
Total - GMAB $ 248.8 $ 0.7 N/A n/a n/a n/a
==============================================================================================================================
GMIB: 2
Ratchet $ 416.6 $ - N/A $ 307.8 $ - n/a
Roll-up 1,131.9 - N/A 664.4 - n/a
Combo 1.1 - N/A 0.1 - n/a
- - ------------------------------------------------------------------------------------------------------------------------------
Total - GMIB $ 1,549.6 $ - N/A $ 972.3 $ - n/a
==============================================================================================================================
1 Net amount at risk is calculated on a seriatum basis and represents the
greater of the respective guaranteed benefit less the account value and
zero. As it relates to GMIB, net amount at risk is calculated as if all
policies were eligible to annuitize immediately, although all GMIB options
have a waiting period of at least 7 years from issuance, with the earliest
annuitizations beginning in 2005.
2 The weighted average period remaining until expected annuitization is not
meaningful and has not been presented because there is currently no net
GMIB exposure.
Please refer to note 8 for discussion about the use of derivatives in
managing the guarantee risks discussed above. Also, refer to the equity
market risk section of note 12 for discussion about the risks associated
with these guarantees.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Following is a rollforward of the liabilities for guarantees on variable
annuity contracts reflected in the general account for the years ended
December 31, 2003 and 2002:
(in millions) GMDB GMAB GMIB TOTAL
==========================================================================================================================
Balance as of December 31, 2001 $ 10.8 $ - $ - $ 10.8
Change in fair value 23.6 - - 23.6
Paid guarantee benefits (20.7) - - (20.7)
- - --------------------------------------------------------------------------------------------------------------------------
Balance as of December 31, 2002 13.7 - - 13.7
NEW BUSINESS ACQUIRED - 4.7 - 4.7
Change in fair value 30.0 (0.4) - 29.6
Paid guarantee benefits, net of reinsurance (21.9) - - (21.9)
- - --------------------------------------------------------------------------------------------------------------------------
Balance as of December 31, 2003 $ 21.8 $ 4.3 $ - $ 26.1
==========================================================================================================================
Account balances of contracts with guarantees were invested in separate
accounts as follows as of each December 31:
(in millions) 2003 2002
===============================================================================================================
Bond mutual funds $ 4,620.3 $ 4,476.3
Domestic equity mutual funds 26,399.4 20,040.6
International equity mutual funds 1,622.0 1,158.7
Money market funds 1,792.9 2,550.2
- - ---------------------------------------------------------------------------------------------------------------
Total $ 34,434.6 $ 28,225.8
===============================================================================================================
(6) SHORT-TERM DEBT
NLIC has established a $500.0 million commercial paper program under which
borrowings are unsecured and are issued for terms of 364 days or less. NLIC
had $199.8 million of commercial paper outstanding as of December 31, 2003
at a weighted average effective rate of 1.07%, none as of December 31,
2002. See also note 16.
The Company paid interest on short-term debt totaling $1.3 million, $0.7
million and $5.3 million in 2003, 2002 and 2001, respectively, including
$0.1 million and $0.5 million to NFS in 2003 and 2002, respectively.
(7) LONG-TERM DEBT, PAYABLE TO NATIONWIDE FINANCIAL SERVICES, INC.
Following is a summary of surplus notes payable to NFS as of each December
31:
(in millions) 2003 2002
====================================================================================================================
7.50% surplus note, due December 17, 2031 $ 300.0 $ 300.0
8.15% surplus note, due June 27, 2032 300.0 300.0
6.75% surplus note, due December 23, 2033 100.0 -
- - --------------------------------------------------------------------------------------------------------------------
- - --------------------------------------------------------------------------------------------------------------------
Total long-term debt $ 700.0 $ 600.0
====================================================================================================================
The Company made interest payments to NFS on surplus notes totaling $47.1
million in 2003, $30.1 million in 2002 and none in 2001. Payments of
interest and principal under the notes require the prior approval of the
Ohio Department of Insurance.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
(8) DERIVATIVE FINANCIAL INSTRUMENTS
QUALITATIVE DISCLOSURE
Interest Rate Risk Management
From time to time the Company purchases fixed rate investments to back
variable rate liabilities. As a result, the Company can be exposed to
interest rate risk due to the mismatch between variable rate liabilities
and fixed rate assets. To mitigate this risk, the Company enters into
various types of derivative instruments to minimize fluctuations in fair
values resulting from changes in interest rates. The Company principally
uses pay fixed/receive variable interest rate swaps and short Euro futures
to manage this risk.
Under interest rate swaps, the Company receives variable interest rate
payments and makes fixed rate payments. The fixed interest paid on the swap
offsets the fixed interest received on the investment, resulting in the
Company receiving the variable interest payments on the swap, generally
3-month libor. The net receipt of a variable rate will then match the
variable rate paid on the liability.
Short Euro futures, when considered in combination with the fixed-rate
instruments, effectively change the fixed rate cash flow exposure to
variable rate cash flows. With short Euro futures, if interest rates rise
(fall), the gains (losses) on the futures are recognized in investment
income. When combined with the fixed income received on the investment, the
gains and losses on the Euro futures contracts results in a variable stream
of cash inflows, which matches the variable interest paid on the liability.
As a result of entering into commercial mortgage loan and private placement
commitments, the Company is exposed to changes in the fair value of such
commitments due to changes in interest rates during the commitment period
prior to the loans being funded. To manage this risk, the Company enters
into short Treasury futures during the commitment period.
With short Treasury futures, if interest rates rise (fall), the gains
(losses) on the futures will offset the change in fair value of the
commitment.
Floating rate investments (commercial mortgage loans and corporate bonds)
expose the Company to variability in cash flows and investment income due
to changes in interest rates. Such variability poses risks to the Company
when the assets are funded with fixed rate liabilities. To manage this
risk, the Company enters into receive fixed, pay variable interest rate
swaps.
In using interest rate swaps, the Company receives fixed interest rate
payments and makes variable rate payments. The variable interest paid on
the swap offsets the variable interest received on the investment,
resulting in the Company receiving the fixed interest payments on the swap.
The net receipt of a fixed rate will then match the fixed rate paid on the
liability.
Foreign Currency Risk Management
In conjunction with the Company's medium-term note program, from time to
time, the Company issues both fixed and variable rate liabilities
denominated in foreign currencies. As a result, the Company is exposed to
changes in fair value of the liabilities due to changes in foreign currency
exchange rates and interest rates. To manage these risks, the Company
enters into cross-currency interest rate swaps resulting, when combined
with the hedged obligations, in net U.S. dollar cash outflows.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
For a fixed rate liability, the cross-currency interest rate swap is
structured to receive a fixed rate, in the foreign currency and pay a
variable U.S. dollar rate, generally 3-month libor. For a variable rate
foreign liability, the cross-currency interest rate swap is structured to
receive a variable rate in the foreign currency and pay a variable U.S.
dollar rate, generally 3-month libor. In both cases, the terms of the
foreign currency received on the swap will exactly match the terms of the
foreign currency paid on the liability, thus eliminating currency risk.
Because the resulting cash flows in both cases remain variable, the Company
has designated such cross-currency interest rate swaps as fair value
hedging relationships.
The Company is exposed to changes in fair value of fixed rate investments
denominated in a foreign currency due to changes in foreign currency
exchange rates. To manage this risk, the Company uses cross-currency
interest rate swaps , resulting, when combined with hedged investments, in
net U.S. dollar cash inflows.
Cross-currency interest rate swaps on investments are structured to pay a
fixed rate, in the foreign currency and receive a variable U.S. dollar
rate, generally 3-month libor. The terms of the foreign currency paid on
the swap will exactly match the terms of the foreign currency received on
the asset, thus eliminating currency risk. Because the resulting cash
inflows remain variable, the Company has designated such cross-currency
interest rate swaps in fair value hedging relationships.
Equity Market Risk Management
Many of the Company's individual variable annuity contracts offer GMDB
features. The GMDB generally provides a benefit if the annuitant dies and
the contract value is less than a specified amount, which may be based on
the premiums paid less amounts withdrawn or contract value on a specified
anniversary date. A decline in the stock market causing the contract value
to fall below this specified amount, which varies from contract to contract
based on the date the contract was entered into as well as the GMDB feature
elected, will increase the net amount at risk, which is the GMDB in excess
of the contract value, which could result in additional GMDB claims. To
manage this risk, the Company has implemented a GMDB economic hedging
program for primarily for certain new business generated after December
2002. The program does not qualify for hedge accounting under FAS 133, but
is designed to offset changes in the value of the GMDB obligation up to a
return of the contractholder's premiums paid less amounts withdrawn.
Currently the program shorts S&P 500 index futures, which provides an
offset to changes in the value of the designated obligation. Prior to
implementation of the GMDB hedging program in 2003, the Company managed the
risk of these benefits primarily by entering into reinsurance arrangements.
See note 12 for additional discussion.
The Company also offers certain variable annuity products with a guaranteed
minimum accumulation benefit (GMAB) rider. The GMAB provides the contract
holder with a guaranteed return of premium, adjusted proportionately for
withdrawals, after a specified period of time, 5, 7 or 10 years, selected
by the contract holder at the issuance of the variable annuity contract. In
some cases, the contract holder also has the option, after a specified
period of time, to drop the rider and continue the variable annuity
contract without the GMAB. The GMAB is an embedded derivative, as such, the
equity exposure in this product is recognized at fair value, separately
from the annuity contract, with changes in fair value recognized in the
income statement. The Company is exposed to equity market risk to the
extent that the underlying investment options, which can include fixed and
variable components, selected by the contract holder do not generate enough
earnings over the life of the contract to at least equal the adjusted
premiums. The Company is economically hedging the GMAB exposure for those
risks that exceed a level considered acceptable by purchasing interest rate
futures and shorting S&P 500 futures. The GMAB economic hedge does not
qualify for hedge accounting under FAS 133.
Other Non-Hedging Derivatives
From time-to-time, the Company enters into basis swaps (receive one
variable rate, pay another variable rate) to change the rate
characteristics of a specific investment to better match the variable rate
paid on a liability. While the pay-side terms of the basis swap will line
up with the terms of the asset, the Company is not able to match the
receive-side terms of the derivative to a specific liability; therefore,
basis swaps do not receive hedge accounting treatment.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The Company sells credit default protection on selected debt instruments
and combines the credit default swap with selected assets the Company owns
to replicate a higher yielding bond. These assets may have sufficient
duration for the related liability, but do not earn a sufficient credit
spread. The combined credit default swap and cash instrument provides the
duration and credit spread targeted by the Company. The credit default
swaps do not qualify for hedge accounting treatment.
The Company also has purchased credit default protection on selected debt
instruments exposed to short-term credit concerns, or because the
combination of the corporate bond and purchased default protection provides
sufficient spread and duration targeted by the Company. The purchased
credit default protection does not qualify for hedge accounting treatment.
QUANTITATIVE DISCLOSURE
Fair Value Hedges
During the years ended December 31, 2003, 2002 and 2001 gains of $4.2
million, $7.1 million and $2.1 million, respectively, were recognized in
net realized losses on investments, hedging instruments and hedged items.
This represents the ineffective portion of the fair value hedging
relationships. There were no gains or losses attributable to the portion of
the derivative instruments' change in fair value excluded from the
assessment of hedge effectiveness. There were also no gains or losses
recognized in earnings as a result of hedged firm commitments no longer
qualifying as fair value hedges.
Cash Flow Hedges
For the year ended December 31, 2003 and 2002, the ineffective portion of
cash flow hedges was a loss of $5.4 and a gain of $1.8 million in 2002.
There were no net gains or losses attributable to the portion of the
derivative instruments' change in fair value excluded from the assessment
of hedge effectiveness.
The Company anticipates reclassifying less than $0.2 million in losses out
of AOCI over the next 12-month period.
In general, the maximum length of time over which the Company is hedging
its exposure to the variability in future cash flows associated with
forecasted transactions is twelve months or less. However, in 2003, the
Company did enter into a hedge of a forecasted purchase of shares of a
specified mutual fund, where delivery of the shares will occur 30 years in
the future. During 2003, 2002 and 2001 the Company did not discontinue any
cash flow hedges because the original forecasted transaction was no longer
probable. Additionally, no amounts were reclassified from AOCI into
earnings because it became probable that a forecasted transaction would not
occur.
Other Derivative Instruments, Including Embedded Derivatives
Net realized gains and losses on investments, hedging instruments and
hedged items for the years ended December 31, 2003, 2002 and 2001 include a
net gain of $11.8 million, a net loss of $2.2 million and a net loss of
$1.6 million, respectively, related to other derivative instruments,
including embedded derivatives, not designated in hedging relationships.
For the years ended December 31, 2003, 2002 and 2001, net gains of $4.2
million, $120.4 million and a net loss of $27.7 million, respectively, were
recorded in net realized losses on investments, hedging instruments and
hedged items reflecting the change in fair value of cross-currency interest
rate swaps hedging variable rate medium-term notes denominated in foreign
currencies. An additional net gain of $0.9, loss of $119.6 million and a
net gain of $26.3 million were recorded in net realized losses on
investments, hedging instruments and hedged items to reflect the change in
spot rates of these foreign currency denominated obligations during the
years ended December 31, 2003, 2002 and 2001, respectively.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The notional amount of derivative financial instruments outstanding as
of December 31, 2003 and 2002 were as follows:
(in millions) 2003 2002
===================================================================================================================
INTEREST RATE SWAPS:
Pay fixed/receive variable rate swaps hedging investments $1,954.7 $ 2,206.5
Pay variable/receive fixed rate swaps hedging investments 188.2 229.7
Pay variable/receive variable rate swaps 154.0 221.0
Pay variable/receive fixed rate swaps hedging liabilities 500.0 500.0
Pay variable/receive variable rate swaps 430.0 430.0
Other contracts hedging investments 842.5 690.8
CROSS CURRENCY INTEREST RATE SWAPS:
Hedging foreign currency denominated investments 580.1 111.0
Hedging foreign currency denominated liabilities 2,643.9 3,033.6
Futures contracts 2,615.8 4,250.9
- - -------------------------------------------------------------------------------------------------------------------
Total $9,909.2 $11,673.5
===================================================================================================================
(9) FEDERAL INCOME TAX
Through September 30, 2002, the Company filed a consolidated federal income
tax return with Nationwide Mutual Insurance Company (NMIC), the ultimate
majority shareholder of NFS. Effective October 1, 2002, Nationwide
Corporation's ownership in NFS decreased from 80% to 63%, and as a result,
NFS and its subsidiaries, including the Company, no longer qualify to be
included in the NMIC consolidated federal income tax return. The members of
the NMIC consolidated federal income tax return group participated in a tax
sharing arrangement, which provided, in effect, for each member to bear
essentially the same federal income tax liability as if separate tax
returns were filed.
Under Internal Revenue Code regulations, NFS and its subsidiaries cannot
file a life/non-life consolidated federal income tax return until five full
years following NFS' departure from the NMIC consolidated federal income
tax return group. Therefore, NFS and its direct non-life insurance company
subsidiaries will file a consolidated federal income tax return; NLIC and
NLAIC will file a consolidated federal income tax return; the direct
non-life insurance companies under NLIC will file separate federal income
tax returns until 2008, when NFS expects to be able to file a single
consolidated federal income tax return with all of its subsidiaries,
including NLIC.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The tax effects of temporary differences that give rise to significant
components of the net deferred tax liability as of December 31, 2003
and 2002 were as follows:
(in millions) 2003 2002
========================================================================================================================
DEFERRED TAX ASSETS:
Future policy benefits $ 594.8 $ 549.6
Derivatives 11.7 40.2
Other 104.4 40.1
- - ------------------------------------------------------------------------------------------------------------------------
Gross deferred tax assets 710.9 629.9
Less valuation allowance (7.0) (7.0)
- - ------------------------------------------------------------------------------------------------------------------------
Net deferred tax assets 703.9 622.9
- - ------------------------------------------------------------------------------------------------------------------------
DEFERRED TAX LIABILITIES:
Fixed maturity securities 390.0 402.2
Equity securities and other investments 42.7 37.4
Deferred policy acquisition costs 840.8 762.0
Other 88.1 50.5
- - ------------------------------------------------------------------------------------------------------------------------
Gross deferred tax liabilities 1,361.6 1,252.1
- - ------------------------------------------------------------------------------------------------------------------------
Net deferred tax liability $ 657.7 $ 629.2
========================================================================================================================
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion of the total gross
deferred tax assets will not be realized. Future taxable amounts or
recovery of federal income tax paid within the statutory carryback period
can offset nearly all future deductible amounts. The valuation allowance
was unchanged for each of the years in the three-year period ended December
31, 2003.
The Company's current federal income tax liability was $106.3 million and
$176.4 million as of December 31, 2003 and 2002, respectively.
Federal income tax expense attributable to income from continuing
operations before cumulative effect of adoption of accounting principles
for the years ended December 31 was as follows:
(in millions) 2003 2002 2001
======================================================================================================================
Current $ 106.7 $ 63.7 $ 32.2
Deferred (10.5) (55.0) 129.0
- - ----------------------------------------------------------------------------------------------------------------------
Federal income tax expense $ 96.2 $ 8.7 $161.2
======================================================================================================================
The customary relationship between federal income tax expense and pre-tax
income from continuing operations before cumulative effect of adoption of
accounting principles did not exist in 2002. This is a result of the impact
of the $121.5 million tax benefit associated with the $347.1 million of
accelerated DAC amortization reported in 2002 (see note 4) being calculated
at the U.S. federal corporate income tax rate of 35%.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Total federal income tax expense for the years ended December 31, 2003,
2002 and 2001 differs from the amount computed by applying the U.S. federal
income tax rate to income from continuing operations before federal income
tax expense and cumulative effect of adoption of accounting principles as
follows:
2003 2002 2001
---------------------- ----------------------- -----------------------
(in millions) AMOUNT % Amount % Amount %
=====================================================================================================================
Computed (expected) tax expense $ 152.0 35.0 $ 59.3 35.0 $ 220.1 35.0
Tax exempt interest and dividends
received deduction (45.7) (10.5) (38.9) (22.9) (48.8) (7.7)
Income tax credits (10.8) (2.5) (12.7) (7.5) (11.5) (1.8)
Other, net 0.7 0.1 1.0 0.5 1.4 0.1
- - ---------------------------------------------------------------------------------------------------------------------
Total (effective rate for each year) $ 96.2 22.1 $ 8.7 5.1 $ 161.2 25.6
=====================================================================================================================
Total federal income tax paid (refunded) was $176.0 million, $71.0 million
and $(45.4) million during the years ended December 31, 2003, 2002 and
2001, respectively. The 2002 amount includes $56.0 million for previously
deferred intercompany gains for tax purposes that became due when NFS no
longer qualified to be included in the NMIC consolidated federal income tax
return.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
(10) COMPREHENSIVE INCOME
Comprehensive income includes net income as well as certain items that are
reported directly within a separate component of shareholder's equity that
bypass net income. Other comprehensive income is comprised of net
unrealized gains on securities available-for-sale and accumulated net gains
(losses) on cash flow hedges. The related before and after federal income
tax amounts for the years ended December 31, 2003, 2002 and 2001 were as
follows:
YEARS ENDED DECEMBER 31,
-------------------------------------------
(in millions) 2003 2002 2001
=====================================================================================================================
Unrealized (losses) gains on securities available-for-sale arising during the
period:
Gross $ (16.7) $ 527.5 $ 164.0
Adjustment to deferred policy acquisition costs 56.9 (205.7) (71.7)
Adjustment to future policy benefits and claims 22.6 (133.2) -
Related federal income tax expense (22.4) (66.0) (32.3)
- - ---------------------------------------------------------------------------------------------------------------------
Net unrealized gains 40.4 122.6 60.0
- - ---------------------------------------------------------------------------------------------------------------------
Reclassification adjustment for net losses on securities available-for-sale
realized during the period:
Gross 91.0 86.2 58.7
Related federal income tax benefit (31.8) (30.2) (20.5)
- - ---------------------------------------------------------------------------------------------------------------------
Net reclassification adjustment 59.2 56.0 38.2
- - ---------------------------------------------------------------------------------------------------------------------
Other comprehensive income on securities 99.6 178.6 98.2
available-for-sale
- - ---------------------------------------------------------------------------------------------------------------------
Accumulated net (losses) gains on cash flow hedges:
Gross (40.9) 16.9 (13.5)
Related federal income tax benefit (expense) 14.3 (5.9) 4.7
- - ---------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income on cash flow hedges (26.6) 11.0 (8.8)
- - ---------------------------------------------------------------------------------------------------------------------
Accumulated net loss on transition adjustments:
Transition adjustment - SFAS 133 - - (5.6)
Transition adjustment - EITF 99-20 - - 3.5
Related federal income tax benefit - - 0.7
- - ---------------------------------------------------------------------------------------------------------------------
Other comprehensive loss on transition adjustments - - (1.4)
- - ---------------------------------------------------------------------------------------------------------------------
Total other comprehensive income $ 73.0 $ 189.6 $ 88.0
=====================================================================================================================
Reclassification adjustments for net realized gains and losses on the
ineffective portion of cash flow hedges were immaterial during 2003, 2002
and 2001 and, therefore, are not reflected in the table above.
(11) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following disclosures summarize the carrying amount and estimated fair
value of the Company's financial instruments. Certain assets and
liabilities are specifically excluded from the disclosure requirements of
financial instruments. Accordingly, the aggregate fair value amounts
presented do not represent the underlying value of the Company.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The fair value of a financial instrument is defined as the amount at which
the financial instrument could be bought, or in case of liabilities
incurred, or sold, or in the case of liabilities settled, in a current
transaction between willing parties. In cases where quoted market prices
are not available, fair value is to be based on the best information
available in the circumstances. Such estimates of fair value should
consider prices for similar assets or similar liabilities and the results
of valuation techniques to the extent available in the circumstances.
Examples of valuation techniques include the present value of estimated
expected future cash flows using discount rates commensurate with the risks
involved, option-pricing models, matrix pricing, option-adjusted spread
models, and fundamental analysis. Valuation techniques for measuring assets
and liabilities must be consistent with the objective of measuring fair
value and should incorporate assumptions that market participants would use
in their estimates of values, future revenues, and future expenses,
including assumptions about interest rates, default, prepayment, and
volatility. Many of the Company's assets and liabilities subject to the
disclosure requirements are not actively traded, requiring fair values to
be estimated by management using matrix pricing, present value or other
suitable valuation techniques. These techniques are significantly affected
by the assumptions used, including the discount rate and estimates of
future cash flows. Although fair value estimates are calculated using
assumptions that management believes are appropriate, changes in
assumptions could cause these estimates to vary materially. In that regard,
the derived fair value estimates cannot be substantiated by comparison to
independent markets and, in many cases, could not be realized in the
immediate settlement of the instruments.
Although insurance contracts, other than policies such as annuities that
are classified as investment contracts, are specifically exempted from the
disclosure requirements, the Company's estimate of the fair values of
policy reserves on life insurance contracts is provided to make the fair
value disclosures more meaningful.
The tax ramifications of the related unrealized gains and losses can have a
significant effect on the estimates of fair value and have not been
considered in arriving at such estimates.
In estimating its fair value disclosures, the Company used the following
methods and assumptions:
Fixed maturity and equity securities: The fair value of fixed maturity
and marketable equity securities is generally obtained from
independent pricing services based on market quotations. For fixed
maturity securities not priced by independent services (generally
private placement securities and securities that do not trade
regularly), an internally developed pricing model or "corporate
pricing matrix" is most often used. The corporate pricing matrix is
developed by obtaining spreads versus the US Treasury yield for
corporate securities with varying weighted average lives and bond
ratings. The weighted average life and bond rating of a particular
fixed maturity security to be priced using the corporate matrix are
important inputs into the model and are used to determine a
corresponding spread that is added to the US Treasury yield to create
an estimated market yield for the that bond. The estimated market
yield and other relevant factors are then used to estimate the fair
value of the particular fixed maturity security. Additionally, the
Company's internal corporate pricing matrix is not suitable for
valuing certain fixed maturity securities, particularly those with
complex cash flows such as certain mortgage-backed and asset-backed
securities. In these cases, a separate "structured product pricing
matrix" has been developed to value, as appropriate, using the same
methodology described above. For securities for which quoted market
prices are not available and for which the Company's structured
product pricing matrix is not suitable for estimating fair values,
qualified company representatives determine the fair value using other
modeling techniques, primarily using a commercial software application
utilized in valuing complex securitized investments with variable cash
flows. As of December 31, 2003, 68% of the fair values of fixed
maturity securities were obtained from independent pricing services,
21% from the Company's pricing matricies and 11% from other sources.
Mortgage loans on real estate, net: The fair value for mortgage loans
on real estate is estimated using discounted cash flow analyses using
interest rates currently being offered for similar loans to borrowers
with similar credit ratings. Loans with similar characteristics are
aggregated for purposes of the calculations. Estimated fair value is
based on the present value of expected future cash flows discounted at
the loan's effective interest rate.
Policy loans, short-term investments and cash: The carrying amounts
reported in the consolidated balance sheets for these instruments
approximate their fair value.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Separate account assets and liabilities: The fair value of assets held
in separate accounts is based on quoted market prices. The fair value
of liabilities related to separate accounts is the amount payable on
demand, which is net of certain surrender charges.
Investment contracts: The fair value for the Company's liabilities
under investment type contracts is based on one of two methods. For
investment contracts without defined maturities, fair value is the
amount payable on demand. For investment contracts with known or
determined maturities, fair value is estimated using discounted cash
flow analysis. Interest rates used in this analysis are similar to
currently offered contracts with maturities consistent with those
remaining for the contracts being valued.
Policy reserves on life insurance contracts: Included are disclosures
for individual and corporate-owned life insurance, universal life
insurance and supplementary contracts with life contingencies for
which the estimated fair value is the amount payable on demand. Also
included are disclosures for the Company's limited payment policies,
for which the Company has used discounted cash flow analyses similar
to those used for investment contracts with known maturities to
estimate fair value.
Short-term debt and collateral received - securities lending and
derivatives: The carrying amounts reported in the consolidated balance
sheets for these instruments approximates their fair value.
Long-term debt, payable to NFS: The fair value for long-term debt is
based on estimated market prices.
Commitments to extend credit: Commitments to extend credit have
nominal fair value because of the short-term nature of such
commitments. See note 12.
Interest rate and cross currency interest rate swaps: The fair value
for interest rate and cross currency interest rate swaps are
calculated with pricing models using current rate assumptions.
Futures contracts: The fair value for futures contracts is based on
quoted market prices.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Carrying amount and estimated fair value of financial instruments
subject to disclosure requirements and policy reserves on life
insurance contracts were as follows as of December 31:
2003 2002
--------------------------- --------------------------
CARRYING ESTIMATED Carrying Estimated
(in millions) AMOUNT FAIR VALUE amount fair value
====================================================================================================================
ASSETS
Investments:
Securities available-for-sale:
Fixed maturity securities $26,946.8 $26,946.8 $ 24,169.0 $ 24,169.0
Equity securities 85.6 85.6 84.3 84.3
Mortgage loans on real estate, net 8,345.8 8,830.0 7,923.2 8,536.4
Policy loans 618.3 618.3 629.2 629.2
Short-term investments 1,860.8 1,860.8 1,210.3 1,210.3
Cash 0.1 0.1 0.9 0.9
Assets held in separate accounts 57,084.5 57,084.5 47,208.2 47,208.2
LIABILITIES
Investment contracts (28,663.4) (27,239.8) (25,276.3) (23,634.1)
Policy reserves on life insurance contracts (6,658.9) (6,706.7) (6,403.5) (6,479.6)
Short-term debt (199.8) (199.8) - -
Long-term debt, payable to NFS (700.0) (803.7) (600.0) (728.5)
Collateral received - securities lending and derivatives (1,521.1) (1,521.1) (1,363.6) (1,363.6)
Liabilities related to separate accounts (57,084.5) (56,118.6) (47,208.2) (45,524.6)
DERIVATIVE FINANCIAL INSTRUMENTS
Interest rate swaps hedging assets (99.4) (99.4) (141.2) (141.2)
Cross currency interest rate swaps 599.1 599.1 325.1 325.1
Futures contracts (25.2) (25.2) (45.7) (45.7)
Other derivatives 4.6 4.6 - -
- - --------------------------------------------------------------------------------------------------------------------
(12) RISK DISCLOSURES
The following is a description of the most significant risks facing the
Company and how it mitigates those risks:
Credit Risk: The risk that issuers of securities, mortgagees on real estate
mortgage loans or other parties, including reinsurers and derivatives
counterparties, default on their contractual obligations. The Company
mitigates this risk by adhering to investment policies that provide
portfolio diversification on an asset class, creditor, and industry basis,
and by complying with investment limitations governed by State insurance
laws and regulations, as applicable. The Company actively monitors and
manages exposures, including restructuring, reducing, or liquidating
investments, and determines whether any securities are impaired or loans
are deemed uncollectible and takes charges in the period such assessments
are made. The ratings of reinsurers who owe the Company money are regularly
monitored along with outstanding balances as part of the Company's
reinsurance collection process, with timely follow-up on delayed payments.
The aggregate credit risk taken in the investment portfolio is influenced
by management's risk/return preferences, the economic and credit
environment, the relationship of credit risk in the asset portfolio to
other business risks that the Company is exposed to and the Company's
current and expected future capital position.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Interest Rate Risk: The risk that interest rates will change and cause a
decrease in the value of an insurer's investments relative to the value of
its liabilities, and/or an unfavorable change in prepayment activity,
resulting in compressed interest margins. For example, if liabilities come
due more quickly than assets mature, an insurer could potentially have to
borrow funds or sell assets prior to maturity and potentially recognize a
gain or loss. In some investments that contain borrower options, this risk
may be realized through unfavorable cash flow patterns, e.g. increased
principal repayment when interest rates have declined. When unfavorable
interest rate movements occur, interest margins may compress, reducing
profitability. The Company mitigates this risk by offering products that
transfer this risk to the purchaser and/or by attempting to approximately
match the maturity schedule of its assets with the expected payouts of its
liabilities, both at inception and on an ongoing basis. In some investments
that permit prepayment at the borrower option, make-whole provisions are
required such that if the borrower prepays in a lower-rate environment, the
Company be compensated for the loss of future income. In other situations,
the Company accepts some interest rate risk in exchange for a higher yield
on the investment.
Legal/Regulatory Risk: The risk that changes in the legal or regulatory
environment in which an insurer operates will result in increased
competition, reduced demand for a company's products, or create additional
expenses not anticipated by the insurer in pricing its products. The
Company mitigates this risk by offering a wide range of products and by
operating throughout the U.S., thus reducing its exposure to any single
product or jurisdiction, and also by employing practices that identify and
minimize the adverse impact of this risk.
Ratings Risk: The risk that rating agencies change their outlook or rating
of the Company or a subsidiary of the company. The rating agencies
generally utilize proprietary capital adequacy models in the process of
establishing ratings for the Company and certain subsidiaries. The Company
is at risk to changes in these models and the impact that changes in the
underlying business that it is engaged in can have on such models. To
mitigate this risk, the Company maintains regular communications with the
rating agencies and evaluates the impact of significant transactions on
such capital adequacy models and considers the same in the design of
transactions to minimize the adverse impact of this risk.
Financial Instruments with Off-Balance-Sheet Risk: The Company is a party
to financial instruments with off-balance-sheet risk in the normal course
of business through management of its investment portfolio. These financial
instruments include commitments to extend credit in the form of loans.
These instruments involve, to varying degrees, elements of credit risk in
excess of amounts recognized on the consolidated balance sheets.
Commitments to fund fixed rate mortgage loans on real estate are agreements
to lend to a borrower and are subject to conditions established in the
uinderlying contract. Commitments generally have fixed expiration dates or
other termination clauses and may require payment of a deposit. Commitments
extended by the Company are based on management's case-by-case credit
evaluation of the borrower and the borrower's loan collateral. The
underlying mortgaged property represents the collateral if the commitment
is funded. The Company's policy for new mortgage loans on real estate is to
generally lend no more than 80% of collateral value. Should the commitment
be funded, the Company's exposure to credit loss in the event of
nonperformance by the borrower is represented by the contractual amounts of
these commitments less the net realizable value of the collateral. The
contractual amounts also represent the cash requirements for all unfunded
commitments. Commitments on mortgage loans on real estate of $391.8 million
extending into 2004 were outstanding as of December 31, 2003. The Company
also had $110.3 million of commitments to purchase fixed maturity
securities outstanding as of December 31, 2003.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Notional amounts of derivative financial instruments, primarily interest
rate swaps, interest rate futures contracts and foreign currency swaps,
significantly exceed the credit risk associated with these instruments and
represent contractual balances on which calculations of amounts to be
exchanged are based. Credit exposure is limited to the sum of the aggregate
fair value of positions that have become favorable to the Company,
including accrued interest receivable due from counterparties. Potential
credit losses are minimized through careful evaluation of counterparty
credit standing, selection of counterparties from a limited group of high
quality institutions, collateral agreements and other contract provisions.
Any exposures related to derivative activity are aggregated with other
credit exposures between the Company and the derivative counterparty to
assess adherence to established credit limits. As of December 31, 2003, the
Company's credit risk from these derivative financial instruments was $75.8
million, net of $544.5 million of cash collateral and $163.0 million in
securities pledged as collateral.
Equity Market Risk: Asset fees calculated as a percentage of the separate
account assets are a significant source of revenue to the Company. As of
December 31, 2003, approximately 80% of separate account assets were
invested in equity mutual funds. Gains and losses in the equity markets
will result in corresponding increases and decreases in the Company's
separate account assets and the reported asset fee revenue. In addition, a
decrease in separate account assets may decrease the Company's expectations
of future profit margins due to a decrease in asset fee revenue and/or an
increase in GMDB or GMAB claims, which may require the Company to
accelerate the amortization of DAC.
Many of the Company's individual variable annuity contracts offer GMDB
features. The GMDB generally provides a benefit if the annuitant dies and
the contract value is less than a specified amount, which may be based on
the premiums paid less amounts withdrawn or contract value on a specified
anniversary date. A decline in the stock market causing the contract value
to fall below this specified amount, which varies from contract to contract
based on the date the contract was entered into as well as the GMDB feature
elected, will increase the net amount at risk, which is the GMDB in excess
of the contract value, which could result in additional GMDB claims. The
Company utilizes a combination of risk management techniques to mitigate
this risk. In general, for most contracts issued prior to July 2002, the
Company obtained reinsurance from independent third parties, whereas for
certain contracts issued after December 2002, the Company has been
executing an economic hedging program. The GMDB economic hedging program is
designed to offset changes in the economic value of the GMDB obligation up
to a return of the contract holder's premium payments, however the first
10% of GMDB claims are not hedged. Currently the program shorts S&P 500
index futures, which provides an offset to changes in the value of the
designated obligation. The Company's economic evaluation of the GMDB
obligation is not consistent with current accounting treatment of the GMDB
obligation. Therefore the hedging activity will lead to volatility of
earnings. This volatility was negligible in 2003. As of December 31, 2003,
the net amount at risk, defined as the excess of the death benefit over the
account value, was $2.8 billion before reinsurance and $982.9 million net
of reinsurance. As of December 31, 2003 and 2002, the Company's reserve for
GMDB claims was $21.8 million and $13.7 million, respectively. See note 21
for discussion of the impact of adopting a new accounting principle
regarding GMDB reserves in 2004.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The Company also offers certain variable annuity products with a GMAB
rider. The GMAB provides the contract holder with a guaranteed return of
premium, adjusted proportionately for withdrawals, after a specified period
of time, 5, 7 or 10 years, selected by the contract holder at the time of
issuance of the variable annuity contract. In some cases, the contract
holder also has the option, after a specified period of time, to drop the
rider and continue the variable annuity contract without the GMAB. The
design of the GMAB rider limits the risk to the Company in a variety of
ways including the requirement that a significant portion of the premium be
allocated to a guaranteed term option (GTO) that is a fixed rate
investment, thereby reducing the equity exposure. The GMAB represents an
embedded derivative in the variable annuity contract that is required to be
separated from and valued apart from the host variable annuity contract.
The embedded derivative is carried at fair value and reported in other
future policy benefits and claims. The Company initially records an offset
to the fair value of the embedded derivative on the balance sheet, which is
amortized through the income statement over the term of the GMAB period of
the contract. The fair value of the GMAB embedded derivative is calculated
based on actuarial assumptions related to the projected benefit cash flows
incorporating numerous assumptions including, but not limited to,
expectations of contract holder persistency, market returns, correlation's
of market returns and market return volatility. The Company began selling
contracts with the GMAB feature on May 1, 2003. Beginning October 1, 2003,
the Company launched an enhanced version of the rider that offered
increased equity exposure to the contract holder in return for a higher
charge. The Company simultaneously began economically hedging the GMAB
exposure for those risks that exceed a level it considered acceptable. The
GMAB economic hedge consists of shorting interest rate futures and S&P 500
futures contracts and does not qualify for hedge accounting under FAS 133.
See note 2(c) for discussion of economic hedges. The objective of the GMAB
economic hedge strategy is to manage the exposures with risk beyond a level
considered acceptable to the Company. The Company is exposed to equity
market risk related to the GMAB feature should the growth in the underlying
investments, including any GTO investment, fail to reach the guaranteed
return level. The GMAB embedded derivative will create volatility in
earnings, however the hedging program provides substantial mitigation of
this exposure. This volatility was negligible in 2003. The fair value of
the GMAB embedded derivative as of December 31, 2003 was $4.3 million.
Changes in the fair value of the GMAB embedded derivative and the hedging
instruments totaled $(0.4) million and $(0.1) million, respectively, during
the year ended December 31, 2003.
Significant Concentrations of Credit Risk: The Company grants mainly
commercial mortgage loans on real estate to customers throughout the U. S.
As of December 31, 2003, the Company has a diversified portfolio with no
more than 23% in any geographic area and no more than 2% with any one
borrower. As of December 31, 2003, 31% of the carrying value of the
Company's commercial mortgage loan portfolio financed retail properties.
Significant Business Concentrations: As of December 31, 2003, the Company
did not have a material concentration of financial instruments in a single
investee, industry or geographic location. Also, the Company did not have a
concentration of business transactions with a particular customer, lender
or distribution source, a market or geographic area in which business is
conducted that makes it overly vulnerable to a single event which could
cause a severe impact to the Company's financial position.
Guarantee Risk: In connection with the selling of securitized interests in
Low Income Housing Tax Credit Funds (Tax Credit Funds), see note 18, the
Company guarantees a specified minimum return to the investor. The
guaranteed return varies by transaction and follows general market trends.
The Company's risk related to securitized interests in Tax Credit Funds is
that the tax benefits provided to the investor are not sufficient to
provide the guaranteed cumulative after-tax yields. The Company mitigates
these risks by having qualified individuals with extensive industry
experience perform due diligence on each of the underlying properties to
ensure they will be capable of delivering the amount of credits anticipated
and by requiring cash reserves to be held at various levels within these
structures to provide for possible shortfalls in the amount of credits
generated.
Reinsurance: The Company has entered into reinsurance contracts to cede a
portion of its general account individual annuity business. Total
recoveries due from these contracts were $635.9 million as of December 31,
2003. The contracts are immaterial to the Company's results of operations.
The ceding of risk does not discharge the original insurer from its primary
obligation to the contractholder. Under the terms of the contracts, trusts
have been established 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% or 102% of the reinsured
reserves, as outlined in each of the underlying contract.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Collateral - Derivatives: The Company enters into agreements with various
counterparties to execute over-the-counter derivative transactions. The
Company's policy is to include a Credit Support Annex with each agreement
to protect the Company for any exposure above the approved credit
threshold. This also protects the counterparty against exposure to the
Company. The Company generally posts securities as collateral and receives
cash as collateral from counterparties. The Company maintains ownership of
the pledged securities at all times and is entitled to receive from the
borrower any payments for interest or dividends received on such securities
during the period it is pledged as collateral.
Collateral - Securities Lending: The Company, through its agent, lends
certain portfolio holdings and in turn receives cash collateral. The cash
collateral is invested in high-quality short-term investments. The
Company's policy requires a minimum of 102% of the fair value of the
securities loaned be maintained as collateral. Net returns on the
investments, after payment of a rebate to the borrower, are shared between
the Company and its agent. Both the borrower and the Company can request or
return the loaned securities at any time. The Company maintains ownership
of the securities at all times and is entitled to receive from the borrower
any payments for interest or dividends received on such securities during
the loan term.
(13) PENSION PLAN, POSTRETIREMENT BENEFITS OTHER THAN PENSIONS AND RETIREMENT
SAVINGS PLAN
The Company, together with certain affiliated companies, sponsors pension
plans covering all employees of participating companies who have completed
at least one year of service and who have met certain age requirements.
Plan contributions are invested in a group annuity contract of NLIC.
Benefits are based upon the highest average annual salary of a specified
number of consecutive years of the last ten years of service. The Company
funds pension costs accrued for direct employees plus an allocation of
pension costs accrued for employees of affiliates whose work efforts
benefit the Company.
Pension costs charged to operations by the Company during the years ended
December 31, 2003, 2002 and 2001 were $13.2 million, $10.0 million and $5.0
million, respectively. The Company has recorded a prepaid pension asset of
$7.7 million as of December 31, 2003 compared to pension liability of $0.5
million as of December 31, 2002.
In addition to the defined benefit pension plan, the Company, together with
certain other affiliated companies, participates in life and health care
defined benefit plans for qualifying retirees. Postretirement life and
health care benefits are contributory and generally available to full time
employees, hired prior to June 1, 2000, who have attained age 55 and have
accumulated 15 years of service with the Company after reaching age 40.
Postretirement health care benefit contributions are adjusted annually and
contain cost-sharing features such as deductibles and coinsurance. In
addition, there are caps on the Company's portion of the per-participant
cost of the postretirement health care benefits. These caps can increase
annually, by no more than three percent through 2006, at which time the cap
will be frozen. The Company's policy is to fund the cost of health care
benefits in amounts determined at the discretion of management. Plan assets
are invested primarily in group annuity contracts of NLIC.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
(the Act) was signed into law on December 8, 2003. FASB Staff Position FAS
106-1, Accounting and Disclosure Requirements Related to the Medicare
Prescription Drug, Improvement and Modernization Act of 2003 permits
employers that sponsor postretirement benefit plans to defer accounting for
the effects of the Act until the FASB issues guidance on how to account for
the provisions of the Act. Specific authoritative guidance on accounting
for the Act is pending. The issued guidance could require the plan sponsor
to change previously reported information. The Company will defer
recognition of the Act until the guidance is issued. Any measures of the
accumulated postretirement benefit obligation (APBO) and net periodic
postretirement benefit cost (NPPBC) do not reflect the effects of the Act.
The Company's accrued postretirement benefit expense as of December 31,
2003 and 2002 was $50.5 million and $51.9 million, respectively, and the
NPPBC for 2003, 2002 and 2001 was $1.1 million, $3.5 million and $2.9
million, respectively.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
Information regarding the funded status of the pension plans as a whole and
the postretirement life and health care benefit plan as a whole, both of
which are U.S. plans, as of December 31, 2003 and 2002 follows:
PENSION BENEFITS POSTRETIREMENT BENEFITS
--------------------------- ------------------------------
(in millions) 2003 2002 2003 2002
========================================================================================================================
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation at beginning of year $ 2,236.2 $ 2,132.2 $ 269.7 $ 314.0
Service cost 104.0 103.3 9.9 13.2
Interest cost 131.7 135.6 19.5 22.5
Participant contributions - - 4.2 4.0
Plan amendment 1.6 (11.5) - (117.7)
Actuarial loss (gain) 85.1 (13.1) (2.8) 54.0
Benefits paid (101.6) (97.6) (20.4) (20.3)
Impact of settlement/curtailment - (12.7) - -
Impact of plan merger - - 26.7 -
- - ------------------------------------------------------------------------------------------------------------------------
Benefit obligation at end of year 2,457.0 2,236.2 306.8 269.7
- - ------------------------------------------------------------------------------------------------------------------------
CHANGE IN PLAN ASSETS:
Fair value of plan assets at beginning of year 1,965.0 2,200.7 106.9 119.7
Actual return on plan assets 265.4 (142.4) 16.5 (12.7)
Employer contributions1 113.6 4.3 20.3 16.2
Participant contributions - - 4.2 4.0
Benefits paid1 (101.6) (97.6) (20.4) (20.3)
- - ------------------------------------------------------------------------------------------------------------------------
Fair value of plan assets at end of year 2,242.4 1,965.0 127.5 106.9
- - ------------------------------------------------------------------------------------------------------------------------
Funded status (214.6) (271.2) (179.3) (162.8)
Unrecognized prior service cost 30.3 33.6 (103.3) (116.9)
Unrecognized net losses 192.1 225.9 56.9 71.9
Unrecognized net (asset) obligation at transition (2.5) (3.8) - 0.1
- - ------------------------------------------------------------------------------------------------------------------------
Prepaid (accrued) benefit cost, net $ 5.3 $ (15.5) $ (225.7) $ (207.7)
========================================================================================================================
- - ------------------------------------------------------------------------------------------------------------------------
Accumulated benefit obligation $ 2,020.2 $ 1,821.0 N/A N/A
========================================================================================================================
________
1 Employer contributions and benefits paid include only those
amounts contributed directly to or paid directly from plan
assets.
Effective January 1, 2003, the pension plan was amended to improve benefits
for certain participants, resulting in an increase in the projected benefit
of $1.6 million. Two significant plan changes were enacted to the
postretirement benefit plans as of December 31, 2002. The postretirement
medical plan was revised to reflect the current expectation that there will
be no further increases in the benefit cap after 2006. Prior to 2007, it is
assumed that benefit caps will increase by 3 percent per year, at which
time the cap will be frozen. The postretirement death benefit plan was
revised to reflect that all employer subsidies will be phased out beginning
in 2007. The 2007 subsidy is assumed to be 2/3 of the current subsidy and
the 2008 subsidy is assumed to be 1/3 of the current amount. There is no
employer subsidized benefit assumed after 2008.
The plan sponsor and participating employers, including the Company, expect
to contribute $130.0 million to the pension plan and $20.0 million to the
postretirement benefit plan in 2004.
Effective January 1, 2002, the Economic Growth and Tax Relief
Reconciliation Act of 2001 (EGTRRA) raised IRS limits for benefits and
salaries considered in qualified pension plans. The projected benefit
obligation decreased by $11.5 million from December 31, 2001 due to the
anticipation of the EGTRRA sunset provisions not recognized in the December
31, 2001 calculations.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
On June 30, 2002, NMIC Medicare operations ceased, and all Medicare
employees were terminated as Nationwide employees. Curtailment charges of
$10.5 million and curtailment credits of $10.0 million were directly
assigned to NMIC for the years ended December 31, 2003 and 2002
respectively.
Weighted average assumptions used in calculating benefit obligations and
the funded status of the pension plan and postretirement life and health
care benefit plan as of the end of each period presented were as follows:
PENSION BENEFITS POSTRETIREMENT BENEFITS
---------------------------- -----------------------------
2003 2002 2003 2002
===================================================================================================================
Discount rate 5.50% 6.00% 6.10% 6.60%
Rate of increase in future compensation levels 4.00% 4.50% - -
Assumed health care cost trend rate:
Initial rate - - 11.00%1 11.30%1
Ultimate rate - - 5.20%1 5.70%1
Declining period - - 11 YEARS 11 Years
- - -------------------------------------------------------------------------------------------------------------------
________
1 The 2003 initial rate is 12.0% for participants over age 65, with
an ultimate rate of 5.6% and the 2002 initial rate is 12.3% for
participants over age 65, with an ultimate rate of 6.3%.
The Company uses a December 31 measurement date for all plans.
The asset allocation for the pension plan as a whole at the end of 2003 and
2002, and the target allocation for 2004, by asset category, are as
follows:
TARGET
ALLOCATION PERCENTAGE PERCENTAGE OF PLAN ASSETS
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Asset Category 2004 2003 2002
===================================================================================================================================
Equity Securities 40 - 65 45% 43%
Debt Securities 25 - 50 55% 57%
Real Estate 0 - 10 0% 0%
Total - 100% 100%
===================================================================================================================================
The plan employs a total return investment approach whereby a mix of
equities and fixed income investments are used to maximize the long-term
return of plan assets for a prudent level of risk. Risk tolerance is
established through careful consideration of plan liabilities, plan funded
status, and corporate financial condition. Plan language requires
investment in a group annuity contract backed by fixed investments with an
interest rate guarantee to match liabilit ies for specific classes of
retirees. On a periodic basis, the portfolio is analyzed to establish the
optimal mix of assets given current market conditions given the risk
tolerance. In the most recent study, asset sub-classes were considered in
debt securities (diversified US investment grade bonds, diversified
high-yield US securities, and international fixed income, emerging markets,
and commercial mortgage loans) and equity investments (domestic equities,
private equities, international equities, emerging market equities and real
estate investments). Each asset sub-class chosen contains a diversified
blend of securities from that sub-class. Investment mix is measured and
monitored on an on-going basis through regular investment reviews, annual
liability measurements, and periodic asset/liability studies.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The asset allocation for the other postretirement life and healthcare
benefit plan as a whole at the end of 2003 and 2002, and the target
allocation for 2004, by asset category, are as follows:
TARGET
ALLOCATION PERCENTAGE PERCENTAGE OF PLAN ASSETS
- - ---------------------------------------------------------------------------------------------------------------------------------
Asset Category 2004 2003 2002
=================================================================================================================================
-
Equity Securities 50 - 80 59% 53%
Debt Securities 20 - 50 35% 39%
Other 0 - 10 6% 8%
Total - 100% 100%
=================================================================================================================================
The other postretirement life and health care benefit plan employs a
total return investment approach whereby a mix of equities and fixed
income investments are used to maximize the long-term return of plan
assets for a prudent level of risk. Risk tolerance is established
through careful consideration of plan liabilities, plan funded status,
and corporate financial condition. Plan investments for retiree life
insurance benefits include a retiree life insurance contract issued by
NLIC and for retiree medical liabilities both a group annuity contract
issued by NLIC backed by fixed investments with an interest rate
guarantee and a separate account invested in diversified US equities.
The investment mix is measured and monitored on an on-going basis
through regular investment reviews, annual liability measurements, and
periodic asset/liability studies.
The components of net periodic pension cost for the pension plan as a
whole for the years ended December 31, 2003, 2002 and 2001 were as
follows:
(in millions) 2003 2002 2001
========================================================================================================================
Service cost (benefits earned during the period) $ 104.0 $ 103.3 $ 89.3
Interest cost on projected benefit obligation 131.7 135.6 129.1
Expected return on plan assets (156.7) (178.6) (183.8)
Recognized gains 0.1 - (7.8)
Amortization of prior service cost 4.5 4.4 3.2
Amortization of unrecognized transition asset (1.3) (1.3) (1.3)
- - ------------------------------------------------------------------------------------------------------------------------
Net periodic pension cost $ 82.3 $ 63.4 $ 28.7
========================================================================================================================
Weighted average assumptions used in calculating the net periodic pension
cost, set at the beginning of each year, for the pension plan were as
follows:
2003 2002 2001
====================================================================================================================
Weighted average discount rate 6.00% 6.50% 6.75%
Rate of increase in future compensation levels 4.50% 4.75% 5.00%
Expected long-term rate of return on plan assets 7.75% 8.25% 8.00%
- - --------------------------------------------------------------------------------------------------------------------
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The Company employs a prospective building block approach in determining
the long-term expected rate of return for plan assets. This process is
integrated with the determination of other economic assumptions such as
discount rate and salary scale. Historical markets are studied and
long-term historical relationships between equities and fixed-income are
preserved consistent with the widely accepted capital market principle that
assets with higher volatility generate a greater return over the long run
called a risk premium. Historic risk premiums are used to develop expected
real rates of return of each asset sub-class. The expected real rates of
return, reduced for investment expenses, are applied to the target
allocation of each asset sub-class to produce an expected real rate of
return for the target portfolio. This expected real rate of return will
vary by plan and will change when the plan's target investment portfolio
changes. Current market factors such as inflation and interest rates are
incorporated in the process as follows. For a given measurement date, the
discount rate is set by reference to the yield on high-quality corporate
bonds to approximate the rate at which plan benefits could effectively be
settled. The historic real rate of return is subtracted from these bonds to
generate an assumed inflation rate. The expected long-term rate of return
for plan assets is the assumed inflation rate plus the expected real rate
of return. This process effectively sets the expected return for the plan's
portfolio at the yield for the reference bond portfolio, adjusted for
expected risk premiums of the target asset portfolio. Given the prospective
nature of this calculation, short-term fluctuations in the market do not
impact the expected risk premiums. However, as the yield for the reference
bond fluctuates, the assumed inflation rate and the expected long-term rate
are adjusted in tandem.
In 2002, the pension plan's target investment portfolio was modified based
on the recommendations of a pension optimization study. This change in
investment strategy is expected to increase long-term real rates of return
0.50% while maintaining the same aggregate risk level. For this reason, the
expected long-term rate of return was increased to 8.25% in 2002 from 8.00%
in 2001.
The components of NPPBC for the postretirement benefit plan as a whole for
the years ended December 31, 2003, 2002 and 2001 were as follows:
(in millions) 2003 2002 2001
=====================================================================================================================
Service cost (benefits attributed to employee service during the year) $ 9.9 $ 13.2 $ 12.6
Interest cost on accumulated postretirement benefit obligation 19.5 22.5 21.4
Expected return on plan assets (8.0) (9.2) (9.6)
Amortization of unrecognized transition obligation of affiliates - 0.6 0.6
Net amortization and deferral (9.9) (0.5) (0.4)
- - ---------------------------------------------------------------------------------------------------------------------
NPPBC $11.5 $ 26.6 $ 24.6
=====================================================================================================================
Weighted average actuarial assumptions used for the measurement of the
NPPBC, set at the beginning of each year, for the postretirement benefit
plan for 2003, 2002 and 2001 were as follows:
2003 2002 2001
==========================================================================================================================
Discount rate 6.60% 7.25% 7.50%
Long-term rate of return on plan assets 7.50% 7.75% 8.00%
Assumed health care cost trend rate:
Initial rate 11.30% 1 11.00% 1 11.00%
Ultimate rate 5.70% 1 5.50% 1 5.50%
Declining period 11 YEARS 4 Years 4 Years
- - --------------------------------------------------------------------------------------------------------------------------
1 The 2003 initial rate is 12.0% for participants over age 65, with an
ultimate rate of 5.6% and the 2002 initial rate is 12.3% for participants
over age 65, with an ultimate rate of 6.3%.
Because current plan costs are very close to the employer dollar caps, the
health care cost trend has an immaterial effect on plan obligations and
expense for the postretirement benefit plan as a whole. For this reason,
the effect of a one percentage point increase or decrease in the assumed
health care cost trend rate on the APBO as of December 31, 2003 and on the
NPPBC for the year ended December 31, 2003 was not calculated.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The Company, together with other affiliated companies, sponsors defined
contribution retirement savings plans covering substantially all employees
of the Company. Employees may make salary deferral contributions of up to
22%. Salary deferrals of up to 6% are subject to a 50% Company match. The
Company's expense for contributions to these plans totaled $5.5 million,
$5.7 million and $5.6 million for 2003, 2002 and 2001, respectively,
including $0.5 million and $0.4 million related to discontinued operations
for 2002 and 2001, respectively.
(14) SHAREHOLDER'S EQUITY, REGULATORY RISK-BASED CAPITAL, RETAINED EARNINGS AND
DIVIDEND RESTRICTIONS
The State of Ohio, where NLIC and NLAIC are domiciled, imposes minimum
risk-based capital requirements that were developed by the NAIC. The
formulas for determining the amount of risk-based capital specify various
weighting factors that are applied to financial balances or various levels
of activity based on the perceived degree of risk. Regulatory compliance is
determined by a ratio of total adjusted capital, as defined by the NAIC, to
authorized control level risk-based capital, as defined by the NAIC.
Companies below specific trigger points or ratios are classified within
certain levels, each of which requires specified corrective action. NLIC
and NLAIC each exceed the minimum risk-based capital requirements for all
periods presented herein.
The statutory capital and surplus of NLIC as of December 31, 2003 and 2002
was $2.23 billion and $1.61 billion, respectively. The statutory net income
of NLIC for the years ended December 31, 2003, 2002 and 2001 was $444.4
million, $92.5 million and $83.1 million, respectively.
The Company is limited in the amount of shareholder dividends it may pay
without prior approval by the Department. As of January 1, 2004, based on
statutory financial results as of and for the year ended December 31, 2003,
NLIC could pay dividends totaling $284.4 million without obtaining prior
approval. In February 2004, NLIC obtained prior approval from the Ohio
Department of Insurance to pay a dividend to NFS in the amount of $75.0
million because the December 31, 2003 statutory financial statements had
not been filed at the time of the dividend.
In addition, the payment of dividends by NLIC may also be subject to
restrictions set forth in the insurance laws of the State of New York that
limit the amount of statutory profits on NLIC's participating policies
(measured before dividends to policyholders) that can inure to the benefit
of the Company and its shareholders.
The Company currently does not expect such regulatory requirements to
impair its ability to pay operating expenses, interest and shareholder
dividends in the future.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
(15) RELATED PARTY TRANSACTIONS
Pursuant to a cost sharing agreement among NMIC and certain of its direct
and indirect subsidiaries, including the Company, NMIC provides certain
operational and administrative services, such as investment management,
advertising, personnel and general management services, to those
subsidiaries. Expenses covered by such agreement are subject to allocation
among NMIC and such subsidiaries. Measures used to allocate expenses among
companies include individual employee estimates of time spent, special cost
studies, salary expense, commission expense and other methods agreed to by
the participating companies and that are within industry guidelines and
practices. In addition, Nationwide Services Company, LLC, a subsidiary of
NMIC, provides computer, telephone, mail, employee benefits administration,
and other services to NMIC and certain of its direct and indirect
subsidiaries, including the Company, based on specified rates for units of
service consumed. For the years ended December 31, 2003, 2002 and 2001, the
Company made payments to NMIC and Nationwide Services Company, LLC,
totaling $170.4 million, $135.6 million and $139.8 million, respectively.
The Company does not believe that expenses recognized under these
agreements are materially different than expenses that would have been
recognized had the Company operated on a stand-alone basis.
NLIC has issued group annuity and life insurance contracts and performs
administrative services for various employee benefit plans sponsored by
NMIC or its affiliates. Total account values of these contracts were $5.22
billion and $4.50 billion as of December 31, 2003 and 2002, respectively.
Total revenues from these contracts were $138.9 million, $143.3 million and
$150.7 million for the years ended December 31, 2003, 2002 and 2001,
respectively, and include policy charges, net investment income from
investments backing the contracts and administrative fees. Total interest
credited to the account balances were $111.8 million, $114.8 million and
$122.5 million for the years ended December 31, 2003, 2002 and 2001,
respectively. The terms of these contracts are consistent in all material
respects with what the Company offers to unaffiliated parties who are
similarly situated.
Funds of Gartmore Global Investments, Inc. (GGI), an affiliate, are offered
as investment options in certain of the Company's products. As of December
31, 2003 and 2002, customer allocations to GGI funds were $12.80 billion
and $12.21 billion, respectively. For the years ended December 31, 2003 and
2002, GGI paid the Company $38.6 million and $35.3 million, respectively,
for the distribution and servicing of these funds.
NLIC has a reinsurance agreement with NMIC whereby all of NLIC's accident
and health business not ceded to unaffiliated reinsurers is ceded to NMIC
on a modified coinsurance basis. Either party may terminate the agreement
on January 1 of any year with prior notice. Under a modified coinsurance
agreement, the ceding company retains invested assets and investment
earnings are paid to the reinsurer. Under the terms of NLIC's agreements,
the investment risk associated with changes in interest rates is borne by
the reinsurer. Risk of asset default is retained by NLIC, although a fee is
paid to NLIC for the retention of such risk. The ceding of risk does not
discharge the original insurer from its primary obligation to the
policyholder. The Company believes that the terms of the modified
coinsurance agreements are consistent in all material respects with what
the Company could have obtained with unaffiliated parties. Revenues ceded
to NMIC for the years ended December 31, 2003, 2002 and 2001 were $286.7
million, $325.0 million and $200.7 million, respectively, while benefits,
claims and expenses ceded were $247.5 million, $328.4 million and $210.1
million, respectively.
Under a marketing agreement with NMIC, NLIC makes payments to cover a
portion of the agent marketing allowance that is paid to Nationwide agents.
These costs cover product development and promotion, sales literature, rent
and similar items. Payments under this agreement totaled $24.8 million,
$24.9 million and $26.4 million for the years ended December 31, 2003, 2002
and 2001, respectively.
The Company leases office space from NMIC and certain of its subsidiaries.
For the years ended December 31, 2003, 2002 and 2001, the Company made
lease payments to NMIC and its subsidiaries of $17.5 million, $20.2 million
and $18.7 million, respectively.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The Company also participates in intercompany repurchase agreements with
affiliates whereby the seller will transfer securities to the buyer at a
stated value. Upon demand or after a stated period, the seller will
repurchase the securities at the original sales price plus interest. As of
December 31, 2003 and 2002, the Company had no borrowings from affiliated
entities under such agreements. During 2003, 2002 and 2001, the most the
Company had outstanding at any given time was $126.0 million, $224.9
million and $368.5 million, respectively, and the Company incurred interest
expense on intercompany repurchase agreements of $0.1 million, $0.3 million
and $0.2 million for 2003, 2002 and 2001, respectively. The Company
believes that the terms of the repurchase agreements are materially
consistent with what the Company could have obtained with unaffiliated
parties.
The Company and various affiliates entered into agreements with Nationwide
Cash Management Company (NCMC), an affiliate, under which NCMC acts as a
common agent in handling the purchase and sale of short-term securities for
the respective accounts of the participants. Amounts on deposit with NCMC
for the benefit of the Company were $205.9 million and $87.0 million as of
December 31, 2003 and 2002, respectively, and are included in short-term
investments on the accompanying consolidated balance sheets. For the years
ending December 31, 2003, 2002 and 2001, the Company paid NCMC fees and
expenses totaling $0.3 million, $0.3 million and $0.4 million,
respectively.
Certain annuity products are sold through affiliated companies, which are
also subsidiaries of NFS. Total commissions and fees paid to these
affiliates for each of the years in the three year period ended December
31, 2003 were $62.0 million, $50.3 million and $52.9 million, respectively.
Through September 30, 2002, the Company filed a consolidated federal income
tax return with NMIC, as discussed in more detail in note 9, beginning
October 1, 2002, NLIC files a consolidated federal income tax return with
NLAIC. Total payments to (from) NMIC were $71.0 million and $(45.4) million
for the years ended December 31, 2002 and 2001, respectively. Total
payments to (from) NLAIC were $(2.7) million and $0 for the years ended
December 31, 2003 and 2002, respectively.
In the third quarter of 2003, NLIC received a capital contribution of 100%
of the common stock of Nationwide Retirement Plan Solutions (NRPS) from
NFS. The capital contribution was valued at $0.2 million. Immediately after
receipt of this capital contribution, NRPS was dissolved into NLIC.
In first quarter 2003 NLIC received a $200.0 million capital contribution
from NFS for general corporate purposes.
In 2003 and 2002, NLIC paid dividends of $60.0 million and $35.0 million,
respectively, to NFS. During 2003 and 2002 NLIC paid dividends in the form
of return of capital of $100.0 million and $475.0 million to NFS,
respectively. Furthermore, in February 2004, NLIC paid a $75.0 million
dividend to NFS.
In addition, in June 2002, NLIC paid a dividend to NFS in the form of all
of the shares of common stock of NSI, a wholly owned broker/dealer
subsidiary. Therefore, the results of the operations of NSI have been
reflected as discontinued operations for all periods presented. This was a
transaction between related parties and therefore was recorded at carrying
value, $10.0 million, of the underlying components of the transaction
rather than fair value. Such amount represents a non-cash transaction that
is not reflected in the Consolidated Statement of Cash Flows.
In December 2001, NLIC issued NFS a 7.50%, $300.0 million surplus note
maturing on December 17, 2031. In June 2002, NLIC issued NFS an 8.15%,
$300.0 million surplus note maturing June 27, 2032. In December 2003, NLIC
issued NFS a 6.75%, $100.0 million surplus note maturing December 23, 2033.
The Company made interest payments on surplus notes to NFS totaling $47.1
million and $30.1 million in 2003 and 2002, respectively. In addition, the
Company made interest payments on unsecured notes to NFS totaling less than
$0.1 million and $0.5 million in 2003 and 2002, respectively. As of
December 31, 2003 there were no outstanding balances on unsecured notes to
NFS.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
During 2001, the Company entered into a transaction with NMIC, whereby it
sold 78% of its interest in a limited partnership (representing 49% of the
limited partnership) to NMIC for $158.9 million. As a result of this sale,
the Company recorded a realized gain of $44.4 million, and related tax
expense of $15.5 million. During 2002, the Company entered into
transactions with NMIC and Nationwide Indemnity Company (NIC), whereby it
sold 100% of its remaining interest in the limited partnership
(representing 15.11% of the limited partnership) to NMIC and NIC for a
total of $54.5 million. As a result of this sale, the Company recorded a
realized gain of $23.2 million and related tax expense of $8.1 million. The
sales prices for each transaction, which were paid in cash, represented the
fair value of the portions of limited partnership interests that were sold
and were based on valuations of the limited partnership and its underlying
investments as of the effective dates of the transactions. The valuations
were completed by qualified management of the limited partnership and
utilized a combination of internal and independent valuations of the
underlying investments of the limited partnership. Additionally, senior
financial officers and the Boards of Directors of the Company and NMIC
separately reviewed, through their respective Finance Committees, and
approved the process and methodology of the valuations prior to the
execution of these transactions. The Company no longer holds an economic or
voting interest in the limited partnership.
(16) BANK LINES OF CREDIT
The Company has available as a source of funds a $1.00 billion revolving
credit facility entered into by NFS, NLIC and NMIC. The facility is
comprised of a five-year $700.0 million agreement maturing in May of 2005
and a 364 day $300.0 million agreement maturing in May of 2004 with a group
of financial institutions. The Company and NMIC intend to renew both parts
of the credit facility in 2004. The facility provides for several and not
joint liability with respect to any amount drawn by any party. The facility
contains covenants, including, but not limited to, requirements that the
Company maintain consolidated tangible net worth, as defined, in excess of
$1.69 billion and NLIC maintain statutory surplus in excess of $935.0
million. The Company had no amounts outstanding under this agreement as of
December 31, 2003. NLIC is currently required to maintain an available
credit facility equal to 50% of any amounts outstanding under its $500.0
million commercial paper program. Therefore, availability under the
aggregate $1.00 billion credit facility is reduced by an amount equal to
50% of any commercial paper outstanding. NLIC had $199.8 million of
commercial paper outstanding as of December 31, 2003.
Also, the Company has entered into an agreement with its custodial bank to
borrow against the cash collateral that is posted in connection with its
securities lending program. This is an uncommitted facility, which is
contingent on the liquidity of the securities lending program. The maximum
amount available under the agreement is $100.0 million. The borrowing rate
on this program rate is equal to fed funds plus 3 basis points. There were
no amounts outstanding under this agreement as of December 31, 2003.
(17) CONTINGENCIES
On October 29, 1998, the Company was named in a lawsuit filed in Ohio state
court by plaintiff Mercedes Castillo that challenged the sale of deferred
annuity products for use as investments in tax-deferred contributory
retirement plans (Mercedes Castillo v. Nationwide Financial Services, Inc.,
Nationwide Life Insurance Company and Nationwide Life and Annuity Insurance
Company). On May 3, 1999, the complaint was amended to, among other things,
add Marcus Shore as a second plaintiff. The amended complaint was brought
as a class action on behalf of all persons who purchased individual
deferred annuity contracts or participated in group annuity contracts sold
by the Company and the other named Company affiliates, which were allegedly
used to fund certain tax-deferred retirement plans. The amended complaint
seeks unspecified compensatory and punitive damages. On May 28, 2002, the
Court granted the motion of Marcus Shore to withdraw as a named plaintiff
and denied plaintiffs' motion to add new persons as named plaintiffs. On
November 4, 2002, the Court issued a decision granting the Company's motion
for summary judgment on all of plaintiff Mercedes Castillo's individual
claims, and ruling that plaintiff's motion for class certification was
moot. Following appeal by the plaintiff, both of those decisions were
affirmed by the Ohio Court of Appeals on September 9, 2003. The plaintiff
filed a notice of appeal of the decision by the Ohio Court of Appeals on
October 24, 2003. The Ohio Supreme Court announced on January 21, 2004 that
the appeal was not accepted and the time for reconsideration has expired.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
On October 31, 2003, a lawsuit seeking class action status containing
allegations similar to those made in the Castillo case was filed against
NLIC in Arizona federal court by plaintiff Robert Helman (Robert Helman et
al v. Nationwide Life Insurance Company et al). This lawsuit is in a very
preliminary stage and the Company is of evaluating its merits. The Company
intends to defend this lawsuit vigorously.
On August 15, 2001, the Company was named in a lawsuit filed in Connecticut
federal court (Lou Haddock, as trustee of the Flyte Tool & Die,
Incorporated Deferred Compensation Plan, et al v. Nationwide Financial
Services, Inc. and Nationwide Life Insurance Company). The plaintiffs first
amended their complaint on September 6, 2001 to include class action
allegations, and have subsequently amended their complaint twice. As
amended, in the current complaint, the plaintiffs seek to represent a class
of ERISA qualified retirement plans that purchased variable annuities from
NLIC. Plaintiffs allege that they invested ERISA plan assets in their
variable annuity contracts, and that the Company acquired and breached
ERISA fiduciary duties by accepting service payments from certain mutual
funds that allegedly consisted of or diminished those ERISA plan assets.
The complaint seeks disgorgement of some or all of the fees allegedly
received by the Company and other unspecified relief for restitution, along
with declaratory and injunctive relief and attorneys' fees. On December 3,
2001, the plaintiffs filed a motion for class certification. Plaintiffs
filed a supplement to that motion on September 19, 2003. The Company
opposed that motion on December 24, 2003. On January 30, 2004, the Company
filed its Revised Memorandum in Support of Summary Judgment, and a Motion
Requesting that the Court Decide Summary Judgment before Class
Certification. Plaintiffs are opposing that motion. The Company intends to
defend this lawsuit vigorously.
On May 1, 2003, a class action was filed against NLIC in the United States
District Court for the Eastern District of Louisiana, (Edward Miller,
Individually, and on behalf of all others similarly situated, v. Nationwide
Life Insurance Company). The complaint alleges that in 2001, plaintiff
Edward Miller purchased three group modified single premium variable
annuities issued by NLIC. Plaintiff alleges that NLIC represented in its
prospectus and promised in its annuity contracts that contract holders
could transfer assets without charge among the various funds available
through the contracts, that the transfer rights of contract holders could
not be modified and that NLIC's expense charges under the contracts were
fixed. Plaintiff claims that NLIC has breached the contracts and violated
federal securities laws by imposing trading fees on transfers that were
supposed to have been without charge. Plaintiff seeks compensatory damages
and rescission on behalf of himself and a class of persons who purchased
this type of annuity or similar contracts issued by NLIC between May 1,
2001 and April 30, 2002 inclusive and were allegedly damaged by paying
transfer fees. The Company's motion to dismiss the complaint was granted by
the Court on October 28, 2003. Plaintiff has appealed that dismissal.
On January 21, 2004, the Company was named in a lawsuit filed in the U.S.
District Court for the Northern District of Mississippi (United Investors
Life Insurance Company v. Nationwide Life Insurance Company and/or
Nationwide Life Insurance Company of America and/or Nationwide Life and
Annuity Insurance Company and/or Nationwide Life and Annuity Company of
America and/or Nationwide Financial Services, Inc. and/or Nationwide
Financial Corporation, and John Does A-Z). In its complaint, the plaintiff
alleges that the Company and/or its affiliated life insurance companies (1)
tortiously interfered with the plaintiff's contractual and fiduciary
relationship with Waddell & Reed, Inc. and/or its affiliates, Waddell &
Reed Financial, Inc., Waddell & Reed Financial Services, Inc. and W & R
Insurance Agency, Inc. (collectively, "Waddell & Reed"), (2) conspired with
and otherwise caused Waddell & Reed to breach its contractual and fiduciary
obligations to the plaintiff, and (3) tortiously interfered with the
plaintiff's contractual relationship with policyholders of insurance
policies issued by the plaintiff. The complaint seeks compensatory damages,
punitive damages, pre- and post-judgment interest, a full accounting, and
costs and disbursements, including attorneys' fees. The plaintiff seeks to
have each defendant judged jointly and severally liable for all damages.
This lawsuit is in a very preliminary stage, and the Company intends to
defend it vigorously.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The financial services industry, including mutual fund, variable annuity
and distribution companies have been the subject of increasing scrutiny by
regulators, legislators, and the media over the past year. Numerous
regulatory agencies, including the United States Securities and Exchange
Commission and the New York Attorney General, have commenced industry-wide
investigations regarding late trading and market timing in connection with
mutual funds and variable insurance contracts, and have commenced
enforcement actions against some mutual fund companies on those issues.
Investigations and enforcement actions have also been commenced, on a
smaller scale, regarding the sales practices of mutual fund and variable
annuity distributors. These legal proceedings are expected to continue in
the future. These investigations and proceedings could result in legal
precedents, as well as new industry-wide legislation, rules, or
regulations, that could significantly affect the financial services
industry, including variable annuity companies. The Company has been
contacted by regulatory agencies for information relating to market timing,
late trading, and sales practices. The Company is cooperating with these
regulatory agencies and is responding to those information requests.
There can be no assurance that any such litigation or regulatory actions
will not have a material adverse effect on the Company in the future.
(18) SECURITIZATION TRANSACTIONS
To date, the Company has sold $290.1 million of credit enhanced equity
interests in Tax Credit Funds to unrelated third parties. The Company has
guaranteed cumulative after-tax yields to third party investors ranging
from 5.10% to 5.25% and as of December 31, 2003 held guarantee reserves
totaling $2.9 million on these transactions. These guarantees are in effect
for periods of approximately 15 years each. The Tax Credit Funds provide a
stream of tax benefits to the investors that will generate a yield and
return of capital. To the extent that the tax benefits are not sufficient
to provide these cumulative after-tax yields, then the Company must fund
any shortfall, which is mitigated by stabilization collateral set aside by
the Company at the inception of the transactions.
The maximum amount of undiscounted future payments that the Company could
be required to pay the investors under the terms of the guarantees is
$824.2 million. The Company does not anticipate making any payments related
to the guarantees.
At the time of the sales, $4.3 million of net sale proceeds were set aside
as collateral for certain properties owned by the Tax Credit Funds that had
not met all of the criteria necessary to generate tax credits. Such
criteria include completion of construction and the leasing of each unit to
a qualified tenant among other criteria. Properties meeting the necessary
criteria are considered to have "stabilized." The properties are evaluated
regularly and upon stabilizing, the collateral is released. During 2003 and
2002, $3.1 million and $0.5 million of stabilization collateral had been
released into income, respectively.
To the extent there are cash deficits in any specific property owned by the
Tax Credit Funds, property reserves, property operating guarantees and
reserves held by the Tax Credit Funds are exhausted before the Company is
required to perform under its guarantees. To the extent the Company is ever
required to perform under its guarantees, it may recover any such funding
out of the cash flow distributed from the sale of any and/or all of the
underlying properties of the Tax Credit Funds. This cash flow distribution
would be paid to the Company prior to any cash flow distributions to
unrelated third party investors.
(19) SEGMENT INFORMATION
The Company uses differences in products as the basis for defining its
reportable segments. The Company reports three product segments: Individual
Annuity, Institutional Products and Life Insurance. In addition, the
Company reports certain other revenues and expenses in a Corporate segment.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The Individual Annuity segment consists of individual The BEST of
AMERICA(R) and private label deferred variable annuity products, deferred
fixed annuity products and income products. Individual deferred annuity
contracts provide the customer with tax-deferred accumulation of savings
and flexible payout options including lump sum, systematic withdrawal or a
stream of payments for life. In addition, variable annuity contracts
provide the customer with access to a wide range of investment options and
asset protection in the event of an untimely death, while fixed annuity
contracts generate a return for the customer at a specified interest rate
fixed for prescribed periods.
The Institutional Products segment is comprised of the Company's private
and public sector group retirement plans, medium-term note program and
structured products initiatives. The private sector includes the 401(k)
business generated through fixed and variable annuities. The public sector
includes the Internal Revenue Code Section 457 business in the form of
fixed and variable annuities.
The Life Insurance segment consists of investment life products, including
individual variable life and COLI products, traditional life insurance
products and universal life insurance. Life insurance products provide a
death benefit and generally also allow the customer to build cash value on
a tax-advantaged basis.
In addition to the product segments, the Company reports a Corporate
segment. The Corporate segment includes net investment income not allocated
to the three product segments, unallocated expenses and interest expense on
debt and expenses of the Company's non-insurance subsidiaries not reported
within the three product segments. In addition to these operating revenues
and expenses, the Company also reports net realized gains and losses on
investments not related to securitizations, hedging instruments and hedged
items in the Corporate segment, but does not consider them as part of
pre-tax operating earnings.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The following tables summarize the financial results of the Company's
business segments for the years ended December 31, 2003, 2002 and 2001.
INDIVIDUAL INSTITUTIONAL LIFE
(in millions) ANNUITY PRODUCTS INSURANCE CORPORATE TOTAL
===========================================================================================================================
2003
Net investment income $ 807.9 $ 787.7 $ 324.3 $ 60.1 $ 1,980.0
Other operating revenue 517.7 162.3 536.2 0.4 1,216.6
Net realized losses on investments, hedging - - - (100.8) (100.8)
instruments and hedged items
- - ---------------------------------------------------------------------------------------------------------------------------
Total operating revenues 1,325.6 950.0 860.5 (40.3) 3,095.8
- - ---------------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder account values 602.5 512.3 185.6 - 1,300.4
Amortization of deferred policy acquisition costs 228.4 45.6 101.9 - 375.9
Interest expense on debt, primarily with NFS - - - 48.4 48.4
Other benefits and expenses 324.0 183.1 423.0 6.6 936.7
- - ---------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 1,154.9 741.0 710.5 55.0 2,661.4
- - ---------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before federal
income tax expense 170.7 209.0 150.0 (95.3) $ 434.4
===============
Net realized losses on investments, hedging
instruments and hedged items - - - 100.8
- - ------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings 1 $ 170.7 $ 209.0 $ 150.0 $ 5.5
============================================================================================================
- - ------------------------------------------------------------------------------------------------------------
Assets as of period end $ 49,392.5 $ 33,837.4 $ 11,243.5 $ 6,097.5 $ 100,570.9
===========================================================================================================================
2002
Net investment income $ 668.5 $ 800.2 $ 328.6 $ 41.2 $ 1,838.5
Other operating revenue 526.2 177.9 537.7 0.7 1,242.5
Net realized losses on investments, hedging
instruments and hedged items - - - (84.4) (84.4)
- - ---------------------------------------------------------------------------------------------------------------------------
Total operating revenues 1,194.7 978.1 866.3 (42.5) 2,996.6
- - ---------------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder account values 505.9 548.9 186.4 - 1,241.2
Amortization of deferred policy acquisition costs 528.2 53.7 88.2 - 670.1
Interest expense on debt, primarily with NFS - - - 36.0 36.0
Other benefits and expenses 283.4 172.1 420.2 4.1 879.8
- - ---------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 1,317.5 774.7 694.8 40.1 2,827.1
- - ---------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
federal income tax expense (122.8) 203.4 171.5 (82.6) 169.5
===============
Net realized losses on investments, hedging
instruments and hedged items - - - 84.4
- - ---------------------------------------------------------------------------------------------------------------------------
Pre-tax operating (loss) earnings 1 $ (122.8) $ 203.4 $ 171.5 $ 1.8
===========================================================================================================================
- - ---------------------------------------------------------------------------------------------------------------------------
Assets as of period end $ 40,830.0 $ 30,440.7 $ 9,676.3 $ 5,075.6 $ 86,022.6
===========================================================================================================================
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
INDIVIDUAL INSTITUTIONAL LIFE
(in millions) ANNUITY PRODUCTS INSURANCE CORPORATE TOTAL
===========================================================================================================================
2001
Net investment income $ 534.7 $ 847.5 $ 323.3 $ 19.2 $ 1,724.7
Other operating revenue 556.0 209.4 511.5 (0.3) 1,276.6
Net realized losses on investments, hedging
instruments and hedged items - - - (18.3) (18.3)
- - ---------------------------------------------------------------------------------------------------------------------------
Total operating revenues 1,090.7 1,056.9 834.8 0.6 2,983.0
- - ---------------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder account values 433.2 627.8 177.7 - 1,238.7
Amortization of deferred policy acquisition costs 220.0 47.6 80.3 - 347.9
Interest expense on debt primarily with NFS - - - 6.2 6.2
Other benefits and expenses 206.1 170.2 387.1 (2.1) 761.3
- - ---------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 859.3 845.6 645.1 4.1 2,354.1
- - ---------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before 231.4 211.3 189.7 (3.5) $ 628.9
federal income tax expense
============
Net realized losses on investments, hedging
instruments and hedged items not related
to securitizations - - - 20.2
- - ---------------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings 1 $ 231.4 $ 211.3 $ 189.7 $ 16.7
===========================================================================================================================
- - ---------------------------------------------------------------------------------------------------------------------------
2
Assets as of period end $ 43,885.4 $ 34,130.1 $ 9,129.0 $ 4,010.1 $ 91,154.6
===========================================================================================================================
____________
1 Excludes net realized gains and losses on investments not related to
securitizations, hedging instruments and hedged items, discontinued
operations and cumulative effect of adoption of accounting principles.
2 Inclues $24.8 million of assets related to discontinued operations.
The Company has no significant revenue from customers located outside of
the U.S. nor does the Company have any significant long-lived assets
located outside the U.S.
(20) VARIABLE INTEREST ENTITIES
As of December 31, 2003, the Company has relationships with eight VIEs
where the Company is the primary beneficiary. Each of these VIEs is a
conduit that assists the Company in structured products transactions. One
of the VIEs is used in the securitization of mortgage loans, while the
others are involved in the sale of Low-Income-Housing Tax Credit Funds (Tax
Credit Funds) to third-party investors where the Company provides
guaranteed returns (See note 18). The Company has not yet adopted FIN 46 or
FIN 46R as it relates to these VIEs. As such, these VIEs and their results
of operations are not included in the consolidated financial statements.
The net assets of these VIEs totaled $176.1 million as of December 31,
2003. The most significant components of net assets are $58.7 million of
mortgage loans on real estate, $241.9 million of other long-term
investments, $37.9 million in other assets, $59.2 million of short-term
debt and $103.3 million of other liabilities. The total exposure to loss on
these VIEs where the Company may be the primary beneficiary is less than
$0.1 million as of December 31, 2003.
For the mortgage loan VIE, which is the VIE to which the short-term debt
relates to, the creditors have no recourse against the Company in the event
of default by the VIE.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
In addition to the VIEs described above, the Company also holds variable
interests, in the form of limited partnership (LP) or similar investments,
in a number of tax credit funds. These investments have been held by the
Company for periods of 1 to 7 years and allow the Company to experience
certain tax credits and other tax benefits from affordable housing
projects. The Company also has certain investments in securitization
transactions that qualify as VIEs, but for which the Company is not the
primary beneficiary. The total exposure to loss on these VIEs where the
Company is not the primary beneficiary is $44.2 million as of December 31,
2003.
(21) SUBSEQUENT EVENT
As discussed in note 2(n), the Company adopted SOP 03-1 effective January
1, 2004. In connection with this adoption, the following cumulative effect
adjustments are expected to be recorded in the 2004 consolidated financial
statements.
(in millions) JANUARY 1, 2004
==================================================================================================================================
Increase in future policy benefits - ratchet interest crediting $ (12.3)
Increase in future policy benefits - secondary guarantees - life insurance (2.4)
Increase in future policy benefits - GMDB claim reserves (1.8)
Increase in future policy benefits - GMIB claim reserves (1.0)
Deferred acquisition costs related to above 12.4
Deferred federal income taxes 1.8
Cumulative effect of adoption of accounting principle, net of tax $ (3.3)
==================================================================================================================================
Under SOP 03-1, the Company's GMDB claim reserves are determined by
estimating the expected value of death benefits on contracts that trigger a
policy benefit and recognizing the excess ratably over the accumulation
period based on total expected assessments. The Company will regularly
evaluate estimates used and will adjust the additional liability balance as
appropriate, with a related charge or credit to other benefits and claims,
if actual experience or other evidence suggests that earlier assumptions
should be revised.
The following assumptions and methodology were used to determine the GMDB
claim reserves upon adoption of SOP 03-1:
o Data used was based on a combination of historical numbers and
future projections involving 250 stochastically generated
investment performance scenarios
o Mean gross equity performance of 8.1%
o Equity volatility of 18.7%
o Mortality - 100% of Annuity 2000 table
o Discount rate of 8.0%
Lapse rate assumptions vary by duration as shown below:
DURATION 1 2 3 4 5 6 7 8 9 10+
- - ---------------------------------------------------------------------------------------------------------------------
Minimum 4.50% 5.50% 6.50% 8.50% 10.50% 10.50% 10.50% 17.50% 17.50% 17.50%
MAXIMUM 4.50% 8.50% 11.50% 17.50% 22.50% 22.50% 22.50% 22.50% 22.50% 19.50%
GMABs are considered derivatives under SFAS 133 resulting in the related
liabilities being recognized at fair value with changes in fair value
reported in earnings, and therefore, excluded from the SOP 03-1 claim
reserve.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Consolidated Financial Statements
The GMIB claim reserves will be determined each period by estimating the
expected value of the annuitization benefits in excess of the projected
account balance at the date of annuitization and recognizing the excess
ratably over the accumulation period based on total assessments. The
Company will regularly evaluate estimates used and will adjust the
additional liability balance as appropriate, with a related charge or
credit to other benefits and claims, if actual experience or other evidence
suggests that earlier assumptions should be revised. The assumptions used
in calculating the GMIB claim reserves are consistent with those used for
calculating the GMDB claim reserves. In addition, the calculation of the
GMIB claim reserves assumes utilization ranges from a low of 3% when the
contract holder's annuitization value is 10% in the money to 100%
utilization when the contract holder is 90% in the money.
SCHEDULE I
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONSOLIDATED SUMMARY OF INVETMENTS -
OTHER THAN INVESTMENTS IN RELATED PARTIES
x (in millions)
As of December 31, 2003
- - --------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D
- - --------------------------------------------------------------------------------------------------------------------
Amount at
which shown
in the
Market consolidated
Type of Investment Cost value balance sheet
- - --------------------------------------------------------------------------------------------------------------------
Fixed maturity securities available-for-sale:
Bonds:
U.S. Government and government agencies and authorities $ 1,042.5 $ 1,101.6 $ 1,101.6
States, municipalities and political subdivisions 167.6 163.4 163.4
Foreign governments 51.8 53.0 53.0
Public utilities 1,907.7 2,009.1 2,009.1
All other corporate 22,680.6 23,619.7 23,619.7
----------------------------------------
Total fixed maturity securities available-for-sale 25,850.2 26,946.8 26,946.8
----------------------------------------
Equity securities available-for-sale:
Common stocks:
Industrial, miscellaneous and all other 74.0 85.6 85.6
Non-redeemable preferred stock - - -
----------------------------------------
Total equity securities available-for-sale 74.0 85.6 85.6
----------------------------------------
Mortgage loans on real estate, net 8,371.2 8,345.8 1
Real estate, net:
Investment properties 85.8 69.3 2
Acquired in satisfaction of debt 27.9 27.2 2
Policy loans 618.3 618.3
Other long-term investments 100.5 98.1 3,4
Short-term investments, including amounts managed by a related party 1,860.8 1,860.8
-------------- -------------
Total investments $ 36,988.7 $ 38,051.9
============== =============
- - ----------
1 Difference from Column B is primarily due to valuation allowances due to
impairments on mortgage loans on real estate (see note 3 to the
consolidated financial statements), hedges and commitment hedges on
mortgage loans on real estate.
2 Difference from Column B primarily results from adjustments for accumulated
depreciation.
3 Difference from Column B is primarily due to operating gains and/or losses
of investments in limited partnerships.
4 Amount shown does not agree to the consolidated balance sheet due to
unconsolidated related party investments in the amount of $32.5 million.
See accompanying independent auditors' report.
SCHEDULE III
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(in millions)
As of December 31, 2003, 2002 AND 2001 and for each of the years then ended
- - ------------------------------- ----------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F
- - ------------------------------- --------------------------------------------------------- ------------------
Deferred policy Future policy benefits, Other policy
acquisition losses, claims and Unearned claims and Premium
Segment costs loss expenses premiums1 benefits payable1 revenue
- - ------------------------------- ----------------------------------------------------------------------------------------------
2003: Individual Annuity $ 1,984.0 $ 15,127.4 $ 89.7
Institutional Products 301.1 14,796.7 -
Life Insurance 1,174.9 5,114.6 190.1
Corporate (240.7) 283.6 -
--------------------------------------- ------------------
Total $ 3,219.3 $ 35,322.3 $ 279.8
======================================= ==================
2002: Individual Annuity $ 1,835.5 $ 12,782.8 $ 69.4
Institutional Products 304.8 13,708.8 -
Life Insurance 1,128.3 4,813.3 190.5
Corporate (297.5) 374.9 -
--------------------------------------- ------------------
Total $ 2,971.1 $ 31,679.8 $ 259.9
======================================= ==================
2001: Individual Annuity $ 1,946.8 $ 8,857.2 $ 60.9
Institutional Products 307.7 11,872.7 -
Life Insurance 1,025.2 4,252.3 190.2
Corporate (90.7) 233.8 -
--------------------------------------- ------------------
Total $ 3,189.0 $ 25,216.0 $ 251.1
======================================= ==================
- - ------------------------------- ----------------------------------------------------------------------------------------------
Column A Column G Column H Column I Column J Column K
- - ------------------------------- ----------------------------------------------------------------------------------------------
Benefits, claims, Amortization Other
Net investment losses and of deferred policy operating Premiums
Segment income2 settlement expenses acquisition costs expenses2 written
- - ------------------------------- ----------------------------------------------------------------------------------------------
2003: Individual Annuity $ 807.9 $ 739.8 $ 228.4 $ 186.7
Institutional Products 787.7 512.3 45.6 183.1
Life Insurance 324.3 451.3 101.9 157.3
Corporate 60.1 - - 55.0
----------------------------------------------------------------------------
Total $ 1,980.0 $ 1,703.4 $ 375.9 $ 582.1
============================================================================
2002: Individual Annuity $ 668.5 $ 605.4 $ 528.2 $ 183.9
Institutional Products 800.2 548.9 53.7 172.1
Life Insurance 328.6 458.2 88.2 148.5
Corporate 41.2 - - 40.1
----------------------------------------------------------------------------
Total $ 1,838.5 $ 1,612.5 $ 670.1 $ 544.6
============================================================================
2001: Individual Annuity $ 534.7 $ 501.8 $ 220.0 $ 137.5
Institutional Products 847.5 627.8 47.6 170.2
Life Insurance 323.3 431.2 80.3 133.7
Corporate 19.2 - - 4.1
----------------------------------------------------------------------------
Total $ 1,724.7 $ 1,560.8 $ 347.9 $ 445.5
============================================================================
- - ----------
1 Unearned premiums and other policy claims and benefits payable are included
in Column C amounts.
2 Allocations of net investment income and certain operating expenses are
based on a number of assumptions and estimates, and reported operating
results would change by segment if different methods were applied.
See accompanying independent auditors' report.
SCHEDULE IV
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
REINSURANCE
(in millions)
As of December 31, 2003, 2002 and 2001
- - -----------------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E Column F
- - -----------------------------------------------------------------------------------------------------------------------------
Percentage
Ceded to Assumed of amount
Gross other from other Net assumed
amount companies companies amount to net
---------------------------------------------------------------------------------
2003
Life insurance in force $ 118,953.1 $ 43,124.3 $ 13.0 $ 75,841.8 N/A
=================================================================================
Premiums:
Life insurance 1 $ 298.3 $ 18.7 $ 0.3 $ 279.8 0.1%
Accident and health insurance 291.8 295.2 3.4 - N/M
---------------------------------------------------------------------------------
Total $ 590.1 $ 313.9 $ 3.7 $ 279.8 1.3%
=================================================================================
2002
Life insurance in force $ 114,644.4 $ 40,883.5 $ 14.2 $ 73,775.1 0.0%
=================================================================================
Premiums:
Life insurance 1 $ 275.9 $ 16.3 $ 0.3 $ 259.9 0.1%
Accident and health insurance 303.4 306.6 3.2 - N/M
---------------------------------------------------------------------------------
Total $ 579.3 $ 322.9 $ 3.5 $ 259.9 1.4%
=================================================================================
2001
Life insurance in force $ 107,765.8 $ 37,331.3 $ 17.1 $ 70,451.6 0.0%
=================================================================================
Premiums:
Life insurance 1 $ 264.9 $ 14.0 $ 0.2 $ 251.1 0.1%
Accident and health insurance 176.4 182.2 5.8 - N/M
---------------------------------------------------------------------------------
Total $ 441.3 $ 196.2 $ 6.0 $ 251.1 2.4%
=================================================================================
- - ----------
1 The life insurance caption represents principally premiums from traditional
life insurance and life-contingent immediate annuities and excludes
deposits on investment products and universal life insurance products.
See accompanying independent auditors' report.
SCHEDULE V
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in millions)
Years ended December 31, 2003, 2002 and 2001
- - ------------------------------------------------------------------------------------------------------------------------------
Column A Column B Column C Column D Column E
- - ------------------------------------------------------------------------------------------------------------------------------
Charged
Balance at (credited) to Charged to Balance at
Description beginning costs and other end of
of period expenses accounts Deductions1 period
- - ----------------------------------------------------------------------------------------------------------------------------
2003
Valuation allowances - mortgage loans on real estate $ 43.4 $ (14.3) $ - $ - $ 29.1
Valuation allowances - real estate - - - - -
------------------------------------------------------------------
Total $ 43.4 $ (14.3) $ - $ - $ 29.1
==================================================================
2002
Valuation allowances - mortgage loans on real estate $ 42.9 $ 1.5 $ - $ 1.0 $ 43.4
Valuation allowances - real estate - - - - -
------------------------------------------------------------------
Total $ 42.9 $ 1.5 $ - $ 1.0 $ 43.4
==================================================================
2001
Valuation allowances - mortgage loans on real estate $ 45.3 $ (1.2) $ - $ 1.2 $ 42.9
Valuation allowances - real estate 5.2 - - 5.2 -
------------------------------------------------------------------
Total $ 50.5 $ (1.2) $ - $ 6.4 $ 42.9
==================================================================
- - ----------
1 Amounts represent direct write-downs charged against the valuation
allowance.
See accompanying independent auditors' report.
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 JUNE 30, 2004
OR
[ ] 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: 2-64559
NATIONWIDE LIFE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
OHIO 31-4156830
(State or other jurisdiction of incorporation or organization) (IRS Employer Identification No.)
ONE NATIONWIDE PLAZA, COLUMBUS, OHIO 43215
(Address of principal executive offices) (Zip Code)
(614) 249-7111
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last
report)
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 __
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
YES NO X_
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
As of July 30, 2004 the registrant had 3,814,779 shares outstanding of its
common stock (par value $1 per share).
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION H(1)(A) AND
(B) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM IN THE REDUCED DISCLOSURE
FORMAT.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION..............................................................................................3
ITEM 1 Unaudited Consolidated Financial Statements...................................................................3
ITEM 2 Management's Narrative Analysis of the Results of Operations.................................................23
ITEM 3 Quantitative and Qualitative Disclosures About Market Risk...................................................45
ITEM 4 Controls and Procedures......................................................................................45
PART II - OTHER INFORMATION................................................................................................45
ITEM 1 Legal Proceedings............................................................................................45
ITEM 2 Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.............................47
ITEM 3 Defaults Upon Senior Securities..............................................................................47
ITEM 4 Submission of Matters to a Vote of Security Holders..........................................................47
ITEM 5 Other Information............................................................................................47
ITEM 6 Exhibits and Reports on Form 8-K.............................................................................48
SIGNATURE..................................................................................................................49
PART I - FINANCIAL INFORMATION
ITEM 1 UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- -------------------------------
-------------------------------- -------------------------------
2004 2003 2004 2003
==================================================================================================================================
==================================================================================================================================
REVENUES:
Policy charges $ 254.2 $ 228.9 $ 508.9 $ 451.8
Life insurance premiums 65.5 70.5 130.5 145.8
Net investment income 482.3 494.5 985.1 980.8
Net realized losses on investments, hedging instruments
and hedged items
and hedged items (27.1) (21.8) (38.6) (64.8)
Other 5.0 3.0 6.5 5.5
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total revenues 779.9 775.1 1,592.4 1,519.1
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
BENEFITS AND EXPENSES:
Interest credited to policyholder account values 312.2 331.1 628.0 656.5
Other benefits and claims 86.5 88.2 169.9 187.1
Policyholder dividends on participating policies 11.2 9.6 19.7 20.5
Amortization of deferred policy acquisition costs 102.2 94.2 205.8 173.5
Interest expense on debt, primarily with Nationwide Financial
Services, Inc. (NFS) 15.1 11.8 29.4 23.6
Other operating expenses 150.2 133.4 297.1 268.1
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 677.4 668.3 1,349.9 1,329.3
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before federal income
tax expense 102.5 106.8 242.5 189.8
Federal income tax expense 16.7 25.2 51.4 42.2
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations 85.8 81.6 191.1 147.6
Cumulative effect of adoption of accounting principle, net of tax - - (3.3) -
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Net income $ 85.8 $ 81.6 $ 187.8 $ 147.6
==================================================================================================================================
==================================================================================================================================
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES (a
wholly-owned subsidiary of Nationwide Financial Services, Inc.)
Consolidated Balance Sheets
(in millions, except per share amounts)
JUNE 30, December 31,
2004 2003
====================================================================================================================================
====================================================================================================================================
(UNAUDITED)
ASSETS
Investments:
Securities available-for-sale, at fair value:
Fixed maturity securities (cost $26,293.7 in 2004; $25,850.2 in 2003) $ 26,901.6 $ 26,946.8
Equity securities (cost $43.2 in 2004; $74.0 in 2003) 50.7 85.6
Mortgage loans on real estate, net 8,648.6 8,345.8
Real estate, net 89.1 96.5
Policy loans 626.9 618.3
Other long-term investments 434.1 130.6
Short-term investments, including amounts managed by a related party 1,450.8 1,860.8
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total investments 38,201.8 38,084.4
Cash 5.3 0.1
Accrued investment income 366.7 367.1
Deferred policy acquisition costs 3,450.1 3,219.3
Other assets 1,878.0 1,815.5
Assets held in separate accounts 58,071.2 57,084.5
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total assets $ 101,973.1 $ 100,570.9
====================================================================================================================================
====================================================================================================================================
LIABILITIES AND SHAREHOLDER'S EQUITY
Liabilities:
Future policy benefits and claims $ 35,868.5 $ 35,322.3
Short-term debt 257.2 199.8
Long-term debt, payable to NFS 700.0 700.0
Other liabilities 3,155.9 3,264.7
Liabilities related to separate accounts 58,071.2 57,084.5
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities 98,052.8 96,571.3
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Shareholder's equity:
Common stock, $1 par value; authorized - 5.0 shares; issued
and outstanding - 3.8 shares 3.8 3.8
Additional paid-in capital 271.3 271.3
Retained earnings 3,370.0 3,257.2
Accumulated other comprehensive income 275.2 467.3
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total shareholder's equity 3,920.3 3,999.6
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total liabilities and shareholder's equity $ 101,973.1 $ 100,570.9
====================================================================================================================================
====================================================================================================================================
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly-owned subsidiary of Nationwide Financial Services, Inc.)
Consolidated Statements of Shareholder's Equity
Six Months Ended June 30, 2004 and 2003
(Unaudited)
(in millions)
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE
SHAREHOLDER'S
STOCK CAPITAL EARNINGS INCOME EQUITY
====================================================================================================================================
====================================================================================================================================
Balance as of December 31, 2002 $ 3.8 $ 171.1 $ 2,979.6 $ 394.3 $ 3,548.8
Comprehensive income:
Net income - - 147.6 - 147.6
Net unrealized gains on securities available-for-sale - - - 207.6 207.6
arising during the period, net of tax
Accumulated net gains on cash flow hedges, net of tax - - - 1.3 1.3
- ----------------
- ----------------
Total comprehensive income 356.5
- ----------------
- ----------------
Capital contributed by NFS - 200.0 - - 200.0
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2003 $ 3.8 $ 371.1 $ 3,127.2 $ 603.2 $ 4,105.3
====================================================================================================================================
====================================================================================================================================
Balance as of December 31, 2003 $ 3.8 $ 271.3 $ 3,257.2 $ 467.3 $ 3,999.6
Comprehensive loss:
Net income - - 187.8 - 187.8
Net unrealized losses on securities available-for-sale - - (190.5)
(190.5)
arising during the period, net of tax
Accumulated net losses on cash flow hedges, net of tax - - (1.6)
(1.6)
- ----------------
- ----------------
Total comprehensive loss
(4.3)
- ----------------
- ----------------
Dividend to NFS - - (75.0) -
(75.0)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2004 $ 3.8 $ 271.3 $ 3,370.0 $ 275.2 $ 3,920.3
====================================================================================================================================
====================================================================================================================================
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly-owned subsidiary of Nationwide Financial Services, Inc.)
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(IN MILLIONS)
SIX MONTHS ENDED
JUNE 30,
---------------------------------------
---------------------------------------
2004 2003
==================================================================================================================================
==================================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 187.8 $ 147.6
Adjustments to reconcile net income to net cash provided by operating activities:
Interest credited to policyholder account values 628.0 656.5
Capitalization of deferred policy acquisition costs (269.0) (311.8)
Amortization of deferred policy acquisition costs 205.8 173.5
Amortization and depreciation 42.9 26.6
Realized losses on investments, hedging instruments and hedged items 43.8 73.4
Decrease (increase) in accrued investment income 0.4 (35.1)
Increase in other assets (64.2) (652.2)
Increase in policy and other liabilities 146.3 533.0
Other, net (1.4) 8.3
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 920.4 619.8
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturity of securities available-for-sale 1,922.9 1,961.7
Proceeds from sale of securities available-for-sale 314.5 1,045.4
Proceeds from repayments of mortgage loans on real estate 816.4 496.1
Cost of securities available-for-sale acquired (2,713.0) (6,135.8)
Cost of mortgage loans on real estate acquired (1,101.3) (689.3)
Net change in short-term investments 399.8 (214.5)
Collateral (paid) received - securities lending, net (157.8) 349.1
Other, net (188.4) (234.3)
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (706.9) (3,421.6)
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in short-term debt 57.4 300.0
Contributed capital from NFS - 200.0
Cash dividend paid to NFS (75.0) -
Investment and universal life insurance product deposits 2,021.6 3,020.8
Investment and universal life insurance product withdrawals (2,212.3) (718.7)
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Net cash (used in) provided by financing activities (208.3) 2,802.1
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Net increase in cash 5.2 0.3
Cash, beginning of period 0.1 0.9
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Cash, end of period $ 5.3 $ 1.2
==================================================================================================================================
==================================================================================================================================
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004 AND 2003
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Nationwide
Life Insurance Company and subsidiaries (NLIC or collectively, the Company)
have been prepared in accordance with accounting principles generally
accepted in the United States of America (GAAP) for interim financial
information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all information and
footnotes required by GAAP for complete financial statements. GAAP differs
from statutory accounting practices prescribed or permitted by regulatory
authorities. The financial information included herein reflects all
adjustments (all of which are normal and recurring in nature), which are,
in the opinion of management, necessary for a fair presentation of
financial position and results of operations. Operating results for all
periods presented are not necessarily indicative of the results that may be
expected for the full year. All significant intercompany balances and
transactions have been eliminated. The accompanying unaudited consolidated
financial statements should be read in conjunction with the audited
consolidated financial statements and related notes for the year ended
December 31, 2003 included in the Company's 2003 Annual Report on Form
10-K.
(2) RECLASSIFICATION
Certain items in the unaudited consolidated financial statements and
related notes have been reclassified to conform to the current
presentation.
(3) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2004, the Financial Accounting Standards Board (FASB) issued FASB
Staff Position (FSP) FAS 97-1, Situations in Which Paragraphs 17(b) and 20
of FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises
for Certain Long-Duration Contracts and for Realized Gains and Losses from
the Sale of Investments, Permit or Require Accrual of an Unearned Revenue
Liability (FSP FAS 97-1), to clarify the guidance related to unearned
revenue reserves (URR). The primary purpose of FSP FAS 97-1 is to address
the practice question of whether Statement of Position (SOP) 03-1,
Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts (SOP
03-1), issued by the American Institute of Certified Public Accountants
(AICPA), restricts the application of the URR guidance in Statement of
Financial Accounting Standards (SFAS) No. 97 to situations in which profits
are expected to be followed by losses. Because the Company was computing
its URR in accordance with FSP FAS 97-1 at the time SOP 03-1 was adopted,
the issuance of FSP FAS 97-1 had no impact on the Company's financial
position or results of operations as of June 30, 2004.
The Medicare Prescription Drug, Improvement and Modernization Act of 2003
(the Act) was signed into law on December 8, 2003. FSP FAS 106-1,
Accounting and Disclosure Requirements Related to The Medicare Prescription
Drug, Improvement and Modernization Act of 2003 (FSP FAS 106-1), issued in
January 2004, permits employers that sponsor postretirement benefit plans
that provide prescription drug benefits to defer accounting for the effects
of the Act until the FASB issues guidance on how to account for the
provisions of the Act. Under FSP FAS 106-1, the Company elected to defer
recognition of the effects of the Act until the issuance of guidance. In
May 2004, the FASB issued FSP FAS 106-2, Accounting and Disclosure
Requirements Related to The Medicare Prescription Drug, Improvement and
Modernization Act of 2003 (FSP FAS 106-2), which superceded FSP FAS 106-1
and provided guidance on accounting and disclosures related to the Act.
Specifically, measures of the accumulated postretirement benefit obligation
and net periodic postretirement benefit cost on or after the date of
enactment must reflect the effects of the Act. Adoption of FSP FAS 106-2,
effective June 30, 2004, had no impact on the Company's financial position
or results of operations due the application of Company maximum
contribution caps and because the Company does not apply to the government
for benefit reimbursements.
In March 2004, the Emerging Issues Task Force (EITF) reached consensus on
further guidance concerning the identification of and accounting for
other-than-temporary impairments and disclosures for cost method
investments, as required by EITF Issue No. 03-1, The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments
(EITF 03-1). The Company will apply the additional guidance concerning
other-than-temporary impairments during its third quarter beginning July 1,
2004, which is not expected to have a material impact on the Company's
financial position or results of operations, as the Company does not
currently hold any material cost method investments.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2004 AND 2003
In addition, effective June 30, 2004, the Company revised its method of
evaluating securities to be sold based on additional interpretation of the
intent to hold criteria in EITF 03-1. The revision had no impact on the
Company's consolidated financial position or results of operations.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
In December 2003, the FASB issued SFAS No. 132 (revised 2003), Employers'
Disclosures about Pensions and Other Postretirement Benefits - an amendment
of FASB Statements No. 87, 88 and 106 (SFAS 132R). SFAS 132R provides
revised disclosure guidance for pension and other postretirement benefit
plans but does not change the measurement or recognition of those plans
under existing guidance. Disclosures previously required under SFAS No.
132, Employers' Disclosures about Pensions and Other Postretirement
Benefits, which was replaced by SFAS 132R, were retained. In addition, SFAS
132R requires additional disclosures about the assets, obligations, cash
flows and net periodic benefit cost of defined benefit pension plans and
other postretirement benefit plans on both an interim period and annual
basis. See note 6 for required disclosures. The Company adopted SFAS 132R
effective December 31, 2003, except for the provisions relating to annual
disclosures about estimated benefit payments, which will be adopted in the
fourth quarter of 2004, as permitted by SFAS 132R.
In July 2003, the AICPA issued SOP 03-1 to address many topics. The most
significant topic to the Company is the accounting for contracts with
guaranteed minimum death benefits (GMDB). SOP 03-1 requires companies to
evaluate the significance of a GMDB to determine whether a contract should
be accounted for as an investment or insurance contract. For contracts
determined to be insurance contracts, companies are required to establish a
reserve to recognize a portion of the assessment (revenue) that compensates
the insurance company for benefits to be provided in future periods. SOP
03-1 also provides guidance on separate account presentation, interest in
separate accounts, gains and losses on the transfer of assets from the
general account to a separate account, liability valuation, return based on
a contractually referenced pool of assets or index, annuitization options,
and sales inducements to contract holders. The Company adopted SOP 03-1
effective January 1, 2004, which resulted in a $3.3 million charge, net of
tax, as the cumulative effect of adoption of this accounting principle.
The following table summarizes the components of cumulative effect
adjustments recorded in the Company's 2004 consolidated statements of
income:
(in millions) JANUARY 1, 2004
===================================================================================================================================
===================================================================================================================================
Increase in future policy benefits:
Ratchet interest crediting $ (12.3)
Secondary guarantees - life insurance (2.4)
GMDB claim reserves (1.8)
Guaranteed Minimum Income Benefits (GMIB) claim reserves (1.0)
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Subtotal (17.5)
Adjustment to amortization of deferred policy acquisition costs related to above 12.4
Deferred federal income taxes 1.8
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Cumulative effect of adoption of accounting principle, net of tax $ (3.3)
===================================================================================================================================
===================================================================================================================================
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities - an interpretation of ARB No. 51 (FIN 46).
Accounting Research Bulletin No. 51, Consolidated Financial Statements (ARB
51), states that consolidation is usually necessary when a company has a
"controlling financial interest" in another company, a condition most
commonly achieved via ownership of a majority voting interest. FIN 46
clarifies the application of ARB 51 to certain "variable interest entities"
(VIEs) where: (i) the equity investors are not empowered to make sufficient
decisions about the entity's operations, or do not receive expected returns
or absorb expected losses commensurate with their equity ownership; or (ii)
the entity does not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support
from other parties. VIEs are consolidated by their primary beneficiary,
which is a party having a majority of the entity's expected losses,
expected residual returns, or both. A company holding a significant
variable interest in a VIE but not deemed the primary beneficiary is
subject to certain disclosure requirements specified by FIN 46. FIN 46
applies to entities formed after January 31, 2003. In October 2003, the
FASB delayed the implementation date of FIN 46 for VIEs formed prior to
January 31, 2003 to interim periods ending after December 15, 2003, with
earlier adoption permitted.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
In December 2003, the FASB issued Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities - an interpretation of
ARB No. 51 (FIN 46R), which required all public companies to apply the
provisions of FIN 46 or FIN 46R to special purpose entities created prior
to February 1, 2003. Once adopted by an entity, FIN 46R replaces FIN 46. At
a minimum, public companies were required to apply the provisions of FIN
46R or the unmodified provisions of FIN 46 to entities that were considered
"special purpose entities" in practice and under applicable GAAP by the end
of the first reporting period ending after December 15, 2003. Companies
were permitted to apply either FIN 46 or FIN 46R to special purpose
entities at the initial effective date on an entity-by-entity basis. The
Company has no variable interests in special purpose entities. The primary
difference between FIN 46R and FIN 46 was the criteria to be followed in
determining the primary beneficiary. The primary beneficiary could be
different based on the two Interpretations. The Company adopted the
remaining provisions of FIN 46R effective January 1, 2004. See note 11 for
further discussion.
(4) VARIABLE ANNUITY CONTRACTS
The Company issues traditional variable annuity contracts through its
separate accounts, for which investment income and gains and losses on
investments accrue directly to, and investment risk is borne by, the
contract holder. The Company also issues non-traditional variable annuity
contracts in which the Company provides various forms of guarantees to
benefit the related contract holders. There are three primary guarantee
types that are provided under non-traditional variable annuity contracts:
(1) GMDB; (2) Guaranteed Minimum Accumulation Benefits (GMAB); and (3)
GMIB.
The GMDB provides a specified minimum return upon death. Many, but not all,
of these death benefits are spousal, whereby a death benefit will be paid
upon death of the first spouse. The survivor has the option to terminate
the contract or continue it and have the death benefit paid into the
contract and a second death benefit paid upon the survivor's death. The
Company offers six primary GMDB types:
o RETURN OF PREMIUM - provides the greater of account value or total
deposits made to the contract less any partial withdrawals and
assessments, which is referred to as "net premiums." There are two
variations of this benefit. In general, there is no lock in age for
this benefit. However, for some contracts the GMDB reverts to the
account value at a specified age, typically age 75.
o RESET - provides the greater of a return of premium death benefit or
the most recent five-year anniversary (prior to lock-in age) account
value adjusted for withdrawals. For most contracts, this GMDB locks in
at age 86 or 90, and for others the GMDB reverts to the account value
at age 75, 85, 86 or 90.
o RATCHET - provides the greater of a return of premium death benefit or
the highest specified "anniversary" account value (prior to age 86)
adjusted for withdrawals. Currently, there are three versions of
ratchet, with the difference based on the definition of anniversary:
monthaversary - evaluated monthly; annual - evaluated annually; and
five-year - evaluated every fifth year.
o ROLLUP - provides the greater of a return of premium death benefit or
premiums adjusted for withdrawals accumulated at generally 5% simple
interest up to the earlier of age 86 or 200% of adjusted premiums.
There are two variations of this benefit. For certain contracts, this
GMDB locks in at age 86, and for others the GMDB reverts to the
account value at age 75.
o COMBO - provides the greater of annual ratchet death benefit or rollup
death benefit. This benefit locks in at either age 81 or 86.
o EARNINGS ENHANCEMENT - provides an enhancement to the death benefit
that is a specified percentage of the adjusted earnings accumulated on
the contract at the date of death. There are two versions of this
benefit: (1) the benefit expires at age 86, and a credit of 4% of
account value is deposited into the contract; and (2) the benefit does
not have an end age, but has a cap on the payout and is paid upon the
first death in a spousal situation. Both benefits have age
limitations. This benefit is paid in addition to any other death
benefits paid under the contract.
The GMAB is a living benefit that provides the contract holder with a
guaranteed return of premium, adjusted proportionately for withdrawals,
after a specified period of time (5, 7 or 10 years) selected by the
contract holder at the issuance of the variable annuity contract. In some
cases, the contract holder also has the option, after a specified period of
time, to drop the rider and continue the variable annuity contract without
the GMAB. In general, the GMAB requires a minimum allocation to guaranteed
term options or adherence to limitations required by an approved asset
allocation strategy.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The GMIB is a living benefit that provides the contract holder with a
guaranteed annuitization value. The GMIB types are:
o RATCHET - provides an annuitization value equal to the greater of
account value, net premiums or the highest one-year anniversary
account value (prior to age 86) adjusted for withdrawals.
o ROLLUP - provides an annuitization value equal to the greater of
account value and premiums adjusted for withdrawals accumulated at 5%
compound interest up to the earlier of age 86 or 200% of adjusted
premiums.
o COMBO - provides an annuitization value equal to the greater of
account value, ratchet GMIB benefit or rollup GMIB benefit
The following table summarizes the account values and net amount at risk,
net of reinsurance, for variable annuity contracts with guarantees invested
in both general and separate accounts as of the dates indicated:
JUNE 30, 2004 December 31, 2003
-------------------------------------------- -------------------------------------------
-------------------------------------------- -------------------------------------------
ACCOUNT NET AMOUNT WTD. AVG. Account Net amount Wtd. avg.
(in millions) VALUE AT RISK1 ATTAINED AGE value at risk1 attained age
==================================================================================================================================
==================================================================================================================================
GMDB:
Return of premium $ 9,540.3 $ 82.8 56 $ 9,692.8 $ 199.8 56
Reset 16,958.5 234.6 61 17,021.2 569.4 61
Ratchet 8,604.6 71.9 64 7,793.4 140.9 63
Roll-up 632.2 11.0 68 647.7 22.2 68
Combo 2,375.8 33.4 67 2,128.7 39.6 67
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Subtotal 38,111.4 433.7 61 37,283.8 971.9 61
Earnings enhancement 272.8 11.0 60 314.1 10.9 59
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total - GMDB $ 38,384.2 $ 444.7 61 $ 37,597.9 $ 982.8 61
==================================================================================================================================
==================================================================================================================================
GMAB:
5 Year $ 247.9 $ 0.1 N/A $ 79.9 $ 0.1 N/A
7 Year 336.9 0.2 N/A 125.5 0.4 N/A
10 Year 174.9 0.3 N/A 43.4 0.1 N/A
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total - GMAB $ 759.7 $ 0.6 N/A $ 248.8 $ 0.6 N/A
==================================================================================================================================
==================================================================================================================================
GMIB2:
Ratchet $ 416.6 $ - N/A $ 416.6 $ - N/A
Roll-up 1,134.5 - N/A 1,131.9 - N/A
Combo 1.0 - N/A 1.1 - N/A
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total - GMIB $ 1,552.1 $ - N/A $ 1,549.6 $ - N/A
==================================================================================================================================
==================================================================================================================================
- - --------
1 Net amount at risk is calculated on a seriatum basis and represents the
greater of the respective guaranteed benefit less the account value and
zero. As it relates to GMIB, net amount at risk is calculated as if all
policies were eligible to annuitize immediately, although all GMIB
options have a waiting period of at least 7 years from issuance, with the
earliest annuitizations beginning in 2005.
2 The weighted average period remaining until expected annuitization is not
meaningful and has not been presented because there is currently no net
GMIB exposure.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Following is a rollforward of the liabilities for guarantees on variable
annuity contracts reflected in the Company's general account for the
periods indicated:
(in millions) GMDB GMAB GMIB TOTAL
====================================================================================================================================
Balance as of December 31, 2002 $ 13.7 $ - $ - $ 13.7
Expense provision 30.0 - 0.4 30.4
Net claims paid (21.9) - -
(21.9)
Value of new business sold - 4.7 - 4.7
Change in fair value - (0.4) -
(0.4)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance as of December 31, 2003 $ 21.8 4.3 0.4 $ 26.5
Expense provision 18.0 - 0.1 18.1
Net claims paid (14.0) - -
(14.0)
Value of new business sold - 12.5 - 12.5
Change in fair value - (3.0) -
(3.0)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2004 $ 25.8 $ 13.8 $ 0.5 $ 40.1
====================================================================================================================================
The following table summarizes account balances of contracts with
guarantees that were invested in separate accounts as of the dates
indicated:
JUNE 30, December 31,
(in millions) 2004 2003
====================================================================================================================================
Mutual funds:
Bond $ 4,009.1 $ 4,370.7
Domestic equity 25,809.7 24,612.9
International equity 1,598.5 1,508.4
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total mutual funds 31,417.3 30,492.0
Money market funds 1,606.9 1,620.3
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 33,024.2 $ 32,112.3
====================================================================================================================================
The Company's GMDB claim reserves are determined by estimating the expected
value of death benefits on contracts that trigger a policy benefit and
recognizing the excess ratably over the accumulation period based on total
expected assessments. The Company regularly evaluates estimates used and
adjusts the additional liability balance as appropriate, with a related
charge or credit to other benefits and claims in the period of evaluation
if actual experience or other evidence suggests that earlier assumptions
should be revised.
The following assumptions and methodology were used to determine the GMDB
claim reserves as of June 30, 2004 and December 31, 2003:
o Data used was based on a combination of historical numbers and future
projections involving 250 stochastically generated economic scenarios
o Mean gross equity performance - 8.1%
o Equity volatility - 18.7%
o Mortality - 100% of Annuity 2000 table
o Asset fees - equivalent to mutual fund and product loads
o Discount rate - 8.0%
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Lapse rate assumptions vary by duration as shown below:
DURATION (YEARS) 1 2 3 4 5 6 7 8 9 10+
- - --------------------------------------------------------------------------------------------------------------------
Minimum 4.50% 5.50% 6.50% 8.50% 10.50% 10.50% 10.50% 17.50% 17.50% 17.50%
MAXIMUM 4.50% 8.50% 11.50% 17.50% 22.50% 22.50% 22.50% 22.50% 22.50% 19.50%
GMABs are considered derivatives under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities, as amended, resulting in the
related liabilities being recognized at fair value, with changes in fair
value reported in earnings, and therefore, excluded from the SOP 03-1
policy benefits.
GMIB claim reserves are determined each period by estimating the expected
value of annuitization benefits in excess of the projected account balance
at the date of annuitization and recognizing the excess ratably over the
accumulation period based on total assessments. The Company regularly
evaluates estimates used and adjusts the additional liability balance as
appropriate, with a related charge or credit to other benefits and claims
in the period of evaluation if actual experience or other evidence suggests
that earlier assumptions should be revised. The assumptions used in
calculating GMIB claim reserves are consistent with those used for
calculating GMDB claim reserves. In addition, the calculation of GMIB claim
reserves assumes utilization ranges from a low of 3% when the contract
holder's annuitization value is 10% in the money to 100% utilization when
the contract holder is 90% in the money.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(5) COMPREHENSIVE (LOSS) INCOME
Comprehensive (loss) income includes net income and certain items that are
reported directly within separate components of shareholders' equity that
bypass net income (other comprehensive income or loss). Other comprehensive
(loss) income is comprised of: (1) net unrealized (losses) gains on
securities available-for-sale, net of tax, adjusted for the related impacts
on deferred policy acquisition costs (DAC) and future policy benefits and
claims; and (2) accumulated net (losses) gains on cash flow hedges, net of
tax.
The following table summarizes the Company's other comprehensive (loss)
income, before and after federal income tax benefit (expense), for the
periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------
- -----------------------------
(in millions) 2004 2003 2004 2003
====================================================================================================================================
Net unrealized (losses) gains on securities available-for-sale
arising during the period:
Gross $ (871.7) $ 370.6 $ (523.4) $ 387.4
Adjustment to deferred policy acquisition costs 285.8 (102.6) 155.8 (128.0)
Adjustment to future policy benefits and claims 62.1 2.9 43.3 (1.1)
Related federal income tax benefit (expense) 183.3 (94.8) 113.5 (90.4)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Net unrealized (losses) gains (340.5) 176.1 (210.8) 167.9
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Reclassification adjustment for net losses on securities
available-for-sale realized during the period:
Gross 24.3 12.7 31.2 61.1
Related federal income tax benefit (8.4) (4.5) (10.9) (21.4)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Net reclassification adjustment 15.9 8.2 20.3 39.7
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income on securities
available-for-sale (324.6) 184.3 (190.5) 207.6
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Accumulated net (losses) gains on cash flow hedges:
Gross (10.0) 1.4 (2.5) 2.0
Related federal income tax benefit (expense) 3.5 (0.5) 0.9 (0.7)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive (loss) income on cash flow hedges (6.5) 0.9 (1.6) 1.3
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total other comprehensive (loss) income $ (331.1) $ 185.2 $ (192.1) $ 208.9
====================================================================================================================================
Reclassification adjustments for net realized gains and losses on the
ineffective portion of cash flow hedges were immaterial during the first
three and six months of 2004 and 2003.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(6) PENSION PLAN AND POSTRETIREMENT BENEFITS OTHER THAN PENSIONS
The following table summarizes the components of net periodic benefit cost
for the Company's pension plan as a whole for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
===================================================================================================================================
===================================================================================================================================
Service cost $ 29.8 $ 26.0 $ 59.6 $ 52.0
Interest cost 33.2 32.9 66.3 65.9
Expected return on plan assets (40.5) (39.2) (81.0) (78.4)
Recognized net actuarial loss 1.2 0.1 2.3 0.1
Amortization of prior service cost 0.8 1.2 1.6 2.3
Amortization of unrecognized transition asset (0.4) (0.4) (0.7) (0.7)
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 24.1 $ 20.6 $ 48.1 $ 41.2
===================================================================================================================================
===================================================================================================================================
The Company previously disclosed in its financial statements for the year
ended December 31, 2003 that the plan sponsor and all participating
employers, including the Company, expected to contribute $130.0 million to
the pension plan in 2004. Through June 30, 2004, $120 million had been
contributed, including $21.6 million by the Company. The estimated
contribution for the entire plan for the remainder of the year is $10.0
million. Tax planning strategies influence the timing of plan
contributions.
The following table summarizes the components of net periodic benefit cost
for the Company's postretirement benefit plan as a whole for the periods
indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
===================================================================================================================================
===================================================================================================================================
Service cost $ 2.7 $ 2.5 $ 5.4 $ 5.0
Interest cost 5.1 4.9 10.2 9.8
Expected return on plan assets (2.1) (2.0) (4.2) (4.0)
Recognized net actuarial loss 1.2 1.0 2.5 1.9
Amortization of prior service cost (3.4) (3.4) (6.8) (6.8)
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 3.5 $ 3.0 $ 7.1 $ 5.9
===================================================================================================================================
===================================================================================================================================
The Company previously disclosed in its financial statements for the year
ended December 31, 2003 that the plan sponsor and all participating
employers, including the Company, expected to contribute $20.7 million to
the postretirement benefit plan in 2004. Through June 30, 2004, $8.0
million had been contributed, including $0.7 million by the Company. The
estimated contribution for the entire plan for the remainder of the year is
$12.7 million. Postretirement plan contributions are generally funded on a
monthly basis.
(7) RELATED PARTY TRANSACTIONS
The Company has entered into significant, recurring transactions and
agreements with Nationwide Mutual Insurance Company (NMIC) and other
affiliates as a part of its ongoing operations. The nature of the
transactions and agreements include annuity and life insurance contracts,
reinsurance agreements, cost sharing agreements, administration services,
marketing agreements, office space leases, intercompany repurchase
agreements and cash management services. The transactions and agreements
are described more fully in note 15 to the audited consolidated financial
statements included in the Company's 2003 Annual Report on Form 10-K.
During 2004, there have been no material changes to the nature and terms of
these transactions and agreements.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
Amounts on deposit with a related party in cash management for the benefit
of the Company were $538.8 million and $688.7 million as of June 30, 2004
and December 31, 2003, respectively.
The Company also participates in intercompany repurchase agreements with
affiliates whereby the seller transfers securities to the buyer at a stated
value. Upon demand or after a stated period, the seller repurchases the
securities at the original sales price plus interest. As of June 30, 2004
and December 31, 2003, the Company had no borrowings outstanding from
affiliated entities under such agreements. During the first six months of
2004 and 2003, the maximum outstanding borrowings under such agreements
were $126.6 million and $67.3 million, respectively, and the amounts the
Company incurred for interest expense on intercompany repurchase agreements
during these periods were immaterial. The Company believes that the terms
of the repurchase agreements are materially consistent with what the
Company could have obtained from unaffiliated parties.
Funds of Gartmore Global Investments, Inc. (GGI), an affiliate, are offered
to the Company's customers as investment options in certain of the
Company's products. As of June 30, 2004 and 2003, customer allocations to
GGI funds totaled $13.49 billion and $12.24 billion, respectively. For the
quarter ended June 30, 2004 and 2003, GGI paid the Company $11.0 million
and $9.4 million, respectively, for the distribution and servicing of these
funds, compared to $21.7 million and $18.2 million for the first six months
of 2004 and 2003, respectively.
During the first six months of 2004, NLIC paid $75.0 million in dividends
to NFS. During the first six months of 2003, NLIC received a $200.0 million
capital contribution from NFS.
(8) CONTINGENCIES
The Company is a party to litigation and arbitration proceedings in the
ordinary course of its business. It is not possible to determine the
ultimate outcome of the pending investigations and legal proceedings or to
provide reasonable ranges of potential losses. Some of the matters referred
to below are in very preliminary stages, and the Company does not have
sufficient information to make an assessment of plaintiffs' claims for
liability or damages. In some of the cases seeking to be certified as class
actions, the court has not yet decided whether a class will be certified or
(in the event of certification) the size of the class and class period. In
many of the cases, plaintiffs are seeking undefined amounts of damages or
other relief, including punitive damages and equitable remedies, that are
difficult to quantify and cannot be defined based on the information
currently available. The Company does not believe, based on information
currently known by the Company's management, that the outcomes of such
pending investigations and legal proceedings are likely to have a material
adverse effect on the Company's consolidated financial position. However,
given the large and/or indeterminate amounts sought in certain of these
matters and inherent unpredictability of litigation, it is possible that an
adverse outcome in certain matters could have a material adverse effect on
the Company's consolidated financial results in a particular quarterly or
annual period.
In recent years, life insurance companies have been named as defendants in
lawsuits, including class action lawsuits relating to life insurance and
annuity pricing and sales practices. A number of these lawsuits have
resulted in substantial jury awards or settlements.
The financial services industry, including mutual fund, variable annuity
and distribution companies, has been the subject of increasing scrutiny by
regulators, legislators and the media over the past year. Numerous
regulatory agencies, including the Securities and Exchange Commission
(SEC), the National Association of Securities Dealers and the New York
State Attorney General, have commenced industry-wide investigations
regarding late trading and market timing in connection with mutual funds
and variable insurance contracts, and have commenced enforcement actions
against some mutual fund companies on those issues. Investigations and
enforcement actions have also been commenced, on a smaller scale, regarding
the sales practices of mutual fund and variable annuity distributors. These
legal proceedings are expected to continue in the future. These
investigations and proceedings could result in legal precedents and new
industry-wide legislation, rules or regulations that could significantly
affect the financial services industry, including variable annuity
companies. The Company has been contacted by regulatory agencies for
information relating to market timing, late trading, distribution and
service provider compensation arrangements, and sales practices. The SEC,
in conjunction with the New York State Attorney General, is conducting an
investigation of market timing in certain international and global mutual
funds offered in insurance products sponsored by the Company. The Company
is cooperating with these regulatory agencies and is responding to those
information requests.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
On April 13, 2004, NLIC was named in a class action lawsuit filed in
Circuit Court, Third Judicial Circuit, Madison County, Illinois entitled
Woodbury v. Nationwide Life Insurance Company. The plaintiff purports to
represent a class of persons in the United States who, through their
ownership of a Nationwide annuity or insurance product, held units of any
Nationwide sub-account invested in mutual funds which included foreign
securities in their portfolios and which allegedly experienced market
timing trading activity. The complaint contains allegations of negligence,
reckless indifference and breach of fiduciary duty. The plaintiff seeks to
recover compensatory and punitive damages in an amount not to exceed
$75,000 per plaintiff or class member. NLIC removed this case to the United
States District Court for the Southern District of Illinois on June 1,
2004. The plaintiffs moved to remand on June 28, 2004. This lawsuit is in a
preliminary stage, and NLIC intends to defend it vigorously.
On January 21, 2004, the Company was named in a lawsuit filed in the United
States District Court for the Northern District of Mississippi entitled
United Investors Life Insurance Company v. Nationwide Life Insurance
Company and/or Nationwide Life Insurance Company of America and/or
Nationwide Life and Annuity Insurance Company and/or Nationwide Life and
Annuity Company of America and/or Nationwide Financial Services, Inc.
and/or Nationwide Financial Corporation, and John Does A-Z. In its
complaint, plaintiff United Investors alleges that the Company and/or its
affiliated life insurance companies caused the replacement of variable
insurance policies and other financial products issued by United Investors
with policies issued by the Nationwide defendants. The plaintiff raises
claims for (1) violations of the Federal Lanham Act, and common law unfair
competition and defamation, (2) tortious interference with the plaintiff's
contractual relationship with Waddell & Reed, Inc. and/or its affiliates,
Waddell & Reed Financial, Inc., Waddell & Reed Financial Services, Inc. and
W&R Insurance Agency, Inc., or with the plaintiff's contractual
relationships with its variable policyholders, (3) civil conspiracy, and
(4) breach of fiduciary duty. The complaint seeks compensatory damages,
punitive damages, pre- and post-judgment interest, a full accounting, and
costs and disbursements, including attorneys' fees. The Company filed a
motion to dismiss the complaint on June 1, 2004. The Company intends to
defend this lawsuit vigorously.
On October 31, 2003, the Company was named in a lawsuit seeking class
action status filed in the United States District Court for the District of
Arizona entitled Robert Helman et al v. Nationwide Life Insurance Company
et al. The suit challenges the sale of deferred annuity products for use as
investments in tax-deferred contributory retirement plans. On April 8,
2004, the plaintiff filed an amended class action complaint on behalf of
all persons who purchased an individual variable deferred annuity contract
or a certificate to a group variable annuity contract issued by NLIC or
Nationwide Life and Annuity Insurance Company which were allegedly used to
fund certain tax-deferred retirement plans. The amended class action
complaint seeks unspecified compensatory damages. NLIC filed a motion to
dismiss the complaint on May 24, 2004. On July 27, 2004, the court granted
NLIC's motion to dismiss. The plaintiff has appealed that dismissal to the
United States Court of Appeals for the Ninth Circuit. NLIC intends to
defend this lawsuit vigorously.
On May 1, 2003, NLIC was named in a class action lawsuit filed in the
United States District Court for the Eastern District of Louisiana entitled
Edward Miller, Individually, and on behalf of all others similarly
situated, v. Nationwide Life Insurance Company. The complaint alleges that
in 2001, plaintiff Edward Miller purchased three group modified single
premium variable annuities issued by NLIC. The plaintiff alleges that NLIC
represented in its prospectus and promised in its annuity contracts that
contract holders could transfer assets without charge among the various
funds available through the contracts, that the transfer rights of contract
holders could not be modified and that NLIC's expense charges under the
contracts were fixed. The plaintiff claims that NLIC has breached the
contracts and violated federal securities laws by imposing trading fees on
transfers that were supposed to have been without charge. The plaintiff
seeks compensatory damages and rescission on behalf of himself and a class
of persons who purchased this type of annuity or similar contracts issued
by NLIC between May 1, 2001 and April 30, 2002 inclusive and were allegedly
damaged by paying transfer fees. NLIC's motion to dismiss the complaint was
granted by the Court on October 28, 2003. The plaintiff has appealed that
dismissal to the United States Court of Appeals for the Fifth Circuit. The
Company intends to defend this lawsuit vigorously.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
On August 15, 2001, the Company was named in a lawsuit filed in the United
States Court for the District of Connecticut entitled Lou Haddock, as
trustee of the Flyte Tool & Die, Incorporated Deferred Compensation Plan,
et al v. Nationwide Financial Services, Inc. and Nationwide Life Insurance
Company. The plaintiffs first amended their complaint on September 5, 2001
to include class action allegations and have subsequently amended their
complaint three times. As amended, in the current complaint the plaintiffs
seek to represent a class of ERISA qualified retirement plans that
purchased variable annuities from NLIC. The plaintiffs allege that they
invested ERISA plan assets in their variable annuity contracts and that the
Company breached ERISA fiduciary duties by allegedly accepting service
payments from certain mutual funds. The complaint seeks disgorgement of
some or all of the payments allegedly received by the Company, other
unspecified relief for restitution, declaratory and injunctive relief, and
attorneys' fees. On December 13, 2001, the plaintiffs filed a motion for
class certification. The plaintiffs filed a supplement to that motion on
September 19, 2003. The Company opposed that motion on December 24, 2003.
On January 30, 2004, the Company filed a Revised Memorandum in Support of
Summary Judgment. The plaintiffs have opposed that motion. The Company
intends to defend this lawsuit vigorously.
(9) SECURITIZATION TRANSACTIONS
As of June 30, 2004, the Company had sold $394.9 million of credit enhanced
equity interests in Low-Income-Housing Tax Credit Funds (Tax Credit Funds)
to unrelated third parties. The Company has guaranteed cumulative after-tax
yields to third party investors ranging from 4.85% to 5.25% and as of June
30, 2004 held guarantee reserves totaling $3.9 million on these
transactions. These guarantees are in effect for periods of approximately
15 years each. The Tax Credit Funds provide a stream of tax benefits to the
investors that will generate a yield and return of capital. If the tax
benefits are not sufficient to provide these cumulative after-tax yields,
then the Company must fund any shortfall, which is mitigated by
stabilization collateral set aside by the Company at the inception of the
transactions. The maximum amount of undiscounted future payments that the
Company could be required to pay the investors under the terms of the
guarantees is $1.08 billion. The Company does not anticipate making any
payments related to the guarantees.
At the time of the sales, $5.1 million of net sale proceeds were set aside
as collateral for certain properties owned by the Tax Credit Funds that had
not met all of the criteria necessary to generate tax credits. Such
criteria include completion of construction and the leasing of each unit to
a qualified tenant, among others. Properties meeting the necessary criteria
are considered to have "stabilized." The properties are evaluated
regularly, and the collateral is released when stabilized. None of the
stabilization collateral had been released into income during the second
quarter of 2004 compared to $0.2 million during the second quarter of 2003
and compared to $0.1 million and $2.0 million during the first six months
of 2004 and 2003, respectively.
To the extent there are cash deficits in any specific property owned by the
Tax Credit Funds, property reserves, property operating guarantees and
reserves held by the Tax Credit Funds are exhausted before the Company is
required to perform under its guarantees. To the extent the Company is ever
required to perform under its guarantees, it may recover any such funding
out of the cash flow distributed from the sale of any and/or all of the
underlying properties of the Tax Credit Funds. This cash flow distribution
would be paid to the Company prior to any cash flow distributions to
unrelated third party investors.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(10) SEGMENT INFORMATION
Management of the Company views its business primarily based on the
underlying products, and this is the basis used for defining its reportable
segments. During the second quarter of 2004, the Company reorganized its
segment reporting structure and now reports four segments: Individual
Investments, Retirement Plans, Individual Protection, and Corporate and
Other. The Company has reclassified segment results for all prior periods
presented to be consistent with the new reporting structure. The primary
segment profitability measure that management uses is pre-tax operating
earnings, which is calculated by adjusting income from continuing
operations before federal income taxes and cumulative effect of adoption of
accounting principles, if any, to exclude net realized gains and losses on
investments, hedging instruments and hedged items, except for periodic net
coupon settlements on non-qualifying derivatives and realized gains and
losses related to securitizations, if any.
The Individual Investments segment consists of individual The BEST of
AMERICA(R) and private label deferred variable annuity products, deferred
fixed annuity products, income products, and advisory services program
revenues and expenses. This segment differs from the former Individual
Annuity segment due to the addition of the advisory services program
results. Individual deferred annuity contracts provide the customer with
tax-deferred accumulation of savings and flexible payout options including
lump sum, systematic withdrawal or a stream of payments for life. In
addition, individual variable annuity contracts provide the customer with
access to a wide range of investment options and asset protection in the
event of an untimely death, while individual fixed annuity contracts
generate a return for the customer at a specified interest rate fixed for
prescribed periods.
The Retirement Plans segment is comprised of the Company's private and
public sector retirement plans business. This segment differs from the
former Institutional Products segment because it no longer includes the
results of the structured products and medium-term note businesses. The
private sector includes Internal Revenue Code (IRC) Section 401(k) business
generated through fixed and variable annuities. The public sector includes
IRC Section 457 business in the form of fixed and variable annuities and
administration-only business.
The Individual Protection segment consists of investment life products,
including individual variable life and corporate-owned life insurance
(COLI) products, traditional life insurance products and universal life
insurance. This segment is unchanged from the former Life Insurance
segment. Life insurance products provide a death benefit and generally
allow the customer to build cash value on a tax-advantaged basis.
The Corporate and Other segment includes certain structured products
business, the medium-term note program, net investment income not allocated
to the three product segments, periodic net coupon settlements on
non-qualifying derivatives, unallocated expenses, interest expense on debt,
revenues and expenses of the Company's non-insurance subsidiaries not
reported in other segments, and realized gains and losses related to
securitizations. This segment differs from the former Corporate segment as
it now includes results from the structured products and medium-term note
businesses, but no longer includes results from the advisory services
program.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The following table summarizes the Company's business segment operating
results for the three months ended June 30, 2004 and 2003 (including
reclassifications related to the segment reorganization):
INDIVIDUAL RETIREMENT INDIVIDUAL CORPORATE
(in millions) INVESTMENTS PLANS PROTECTION AND OTHER TOTAL
====================================================================================================================================
====================================================================================================================================
2004
REVENUES:
Net investment income $ 202.7 $ 154.5 $ 80.4 $ 44.7 $ 482.3
Other operating revenue 146.0 40.1 133.6 7.3 327.0
Net realized losses on investments, hedging
instruments and hedged items1 - - - (29.4) (29.4)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues 348.7 194.6 214.0 22.6 779.9
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account values 143.2 105.9 45.9 17.2 312.2
Amortization of deferred policy acquisition costs 69.0 10.4 22.8 - 102.2
Interest expense on debt - - - 15.1 15.1
Other benefits and expenses 81.0 44.3 108.0 14.4 247.7
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 293.2 160.6 176.7 46.3 677.2
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
federal income tax expense 55.5 34.0 37.3 (24.3) $ 102.5
==============
==============
Net realized losses on investments, hedging
instruments and hedged items1 - - - 29.4
- - ----------------------------------------------------------------------------------------------------------------------
- - ----------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings $ 55.5 $ 34.0 $ 37.3 $ 5.1
=====================================================================================================================
=====================================================================================================================
2003
REVENUES:
Net investment income $ 201.6 $ 161.4 $ 80.8 $ 50.7 $ 494.5
Other operating revenue 128.1 36.8 134.5 7.3 306.7
Net realized losses on investments, hedging
instruments and hedged items1 - - - (26.1) (26.1)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues 329.7 198.2 215.3 31.9 775.1
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
BENEFITS AND EXPENSES:
Interest credited to policyholder account values 153.7 111.7 44.6 21.1 331.1
Amortization of deferred policy acquisition costs 57.0 10.2 27.0 - 94.2
Interest expense on debt - - - 11.8 11.8
Other benefits and expenses 79.0 46.1 104.0 2.1 231.2
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 289.7 168.0 175.6 35.0 668.3
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
federal income tax expense 40.0 30.2 39.7 (3.1) $ 106.8
==============
==============
Net realized losses on investments, hedging
instruments and hedged items1 - - - 26.1
- - ----------------------------------------------------------------------------------------------------------------------
- - ----------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings $ 40.0 $ 30.2 $ 39.7 $ 23.0
======================================================================================================================
======================================================================================================================
- - ---------
1 Excluding periodic net coupon settlements on non-qualifying derivatives.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
The following table summarizes the Company's business segment operating
results for the six months ended June 30, 2004 and 2003 (including
reclassifications related to the segment reorganization):
INDIVIDUAL RETIREMENT INDIVIDUAL CORPORATE
(in millions) INVESTMENTS PLANS PROTECTION AND OTHER TOTAL
====================================================================================================================================
====================================================================================================================================
2004
REVENUES:
Net investment income $ 414.3 $ 311.1 $ 163.5 $ 96.2 $ 985.1
Other operating revenue 287.4 80.1 272.1 11.5 651.1
Net realized losses on investments, hedging
instruments and hedged items1 - - - (43.8)
(43.8)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues 701.7 391.2 435.6 63.9 1,592.4
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account values 288.4 213.6 91.1 34.9 628.0
Amortization of deferred policy acquisition costs 141.2 20.0 44.6 - 205.8
Interest expense on debt - - - 29.4 29.4
Other benefits and expenses 159.9 90.9 218.9 17.0 486.7
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 589.5 324.5 354.6 81.3 1,349.9
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
federal income tax expense 112.2 66.7 81.0 (17.4) $ 242.5
==============
==============
Net realized losses on investments, hedging
instruments and hedged items1 - - - 43.8
- - ----------------------------------------------------------------------------------------------------------------------
- - ----------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings $ 1 12.2 $ 66.7 $ 81.0 $ 26.4
======================================================================================================================
======================================================================================================================
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Assets as of period end $ 50,611.4 $ 29,131.6 $ 11,795.2 $ 10,434.9 $ 101,973.1
====================================================================================================================================
====================================================================================================================================
2003
REVENUES:
Net investment income $ 396.5 $ 322.2 $ 161.3 $ 100.8 $ 980.8
Other operating revenue 254.0 72.1 271.5 14.1 611.7
Net realized losses on investments, hedging
instruments and hedged items1 - - - (73.4) (73.4)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues 650.5 394.3 432.8 41.5 1,519.1
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
BENEFITS AND EXPENSES:
Interest credited to policyholder account values 299.9 223.4 90.8 42.4 656.5
Amortization of deferred policy acquisition costs 102.6 21.9 49.0 - 173.5
Interest expense on debt - - - 23.6 23.6
Other benefits and expenses 173.1 90.0 210.7 1.9 475.7
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 575.6 335.3 350.5 67.9 1,329.3
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
federal income tax expense 74.9 59.0 82.3 (26.4) $ 189.8
==============
==============
Net realized losses on investments, hedging
instruments and hedged items1 - - - 73.4
- - ----------------------------------------------------------------------------------------------------------------------
- - ----------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings $ 74.9 $ 59.0 $ 82.3 $ 47.0
======================================================================================================================
======================================================================================================================
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Assets as of period end $ 46,445.7 $ 32,267.5 $ 10,731.7 $ 5,382.8 $ 94,827.7
====================================================================================================================================
====================================================================================================================================
- - ---------
1 Excluding periodic net coupon settlements on non-qualifying derivatives.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(A WHOLLY-OWNED SUBSIDIARY OF NATIONWIDE FINANCIAL SERVICES, INC.)
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
(11) VARIABLE INTEREST ENTITIES
As of June 30, 2004, the Company had relationships with ten VIEs where the
Company was the primary beneficiary. Each of these VIEs is a conduit that
assists the Company in structured products transactions. One of the VIEs is
used in the securitization of mortgage loans, while the others are involved
in the sale of Tax Credit Funds to third party investors where the Company
provides guaranteed returns (see note 9). Effective January 1, 2004, the
Company began applying the provisions of FIN 46R to these entities. FIN 46R
did not require the restatement of any prior periods. As such, for periods
subsequent to December 31, 2003, the results of operations and financial
position of these VIEs are included along with corresponding minority
interest liabilities and related income in the accompanying consolidated
financial statements.
The net assets of these VIEs totaled $299.2 million as of June 30, 2004.
The most significant components of net assets were $37.9 million of
mortgage loans on real estate, $334.5 million of other long-term
investments, $31.8 million of other assets, $38.3 million of short-term
debt, and $119.0 million of other liabilities. The total exposure to loss
on these VIEs where the Company is the primary beneficiary was less than
$0.1 million as of June 30, 2004. For the mortgage loan VIE, to which the
short-term debt relates, the creditors have no recourse against the Company
in the event of default by the VIE.
In addition to the VIEs described above, the Company holds variable
interests, in the form of limited partnerships or similar investments, in a
number of Tax Credit Funds where the Company is not the primary
beneficiary. These investments have been held by the Company for periods of
1 to 8 years and allow the Company to experience certain tax credits and
other tax benefits from affordable housing projects. The Company also has
certain investments in securitization transactions that qualify as VIEs,
but for which the Company is not the primary beneficiary. The total
exposure to loss on these VIEs was $31.7 million as of June 30, 2004.
ITEM 2 MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS
FORWARD-LOOKING INFORMATION
The information included herein contains certain forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995
with respect to the results of operations and businesses of Nationwide Life
Insurance Company and subsidiaries (NLIC or collectively, the Company).
These forward-looking statements involve certain risks and uncertainties.
Factors that may cause actual results to differ materially from those
contemplated or projected, forecast, estimated or budgeted in such
forward-looking statements include, among others, the following
possibilities:
(i) The potential impact on the Company's reported consolidated net income
that could result from the adoption of certain accounting standards
issued by the Financial Accounting Standards Board or other
standard-setting bodies;
(ii) Tax law changes impacting the tax treatment of life insurance and
investment products;
(iii) Repeal of the federal estate tax;
(iv) Heightened competition, including specifically the intensification of
price competition, the entry of new competitors and the development of
new products by new and existing competitors;
(v) Adverse state and federal legislation and regulation, including
limitations on premium levels, increases in minimum capital and
reserves, and other financial viability requirements; restrictions on
mutual fund distribution payment arrangements such as revenue sharing
and 12b-1 payments; and regulation changes resulting from industry
practice investigations;
(vi) Failure to expand distribution channels in order to obtain new
customers or failure to retain existing customers;
(vii) Inability to carry out marketing and sales plans, including, among
others, development of new products and/or changes to certain existing
products and acceptance of the new and/or revised products in the
market;
(viii) Changes in interest rates and the equity markets causing a reduction
of investment income and/or asset fees; an acceleration of the
amortization of deferred policy acquisition costs (DAC); reduction in
the value of the Company's investment portfolio or separate account
assets; or a reduction in the demand for the Company's products;
(ix) General economic and business conditions which are less favorable than
expected;
(x) Competitive, regulatory or tax changes that affect the cost of, or
demand for, the Company's products;
(xi) Unanticipated changes in industry trends and ratings assigned by
nationally recognized rating organizations;
(xii) Deviations from assumptions regarding future persistency, mortality,
morbidity and interest rates used in calculating reserve amounts and
in pricing the Company's products; and
(xiii) Adverse litigation results and/or resolution of litigation and/or
arbitration or investigation results.
INTRODUCTION
The following analysis of unaudited consolidated results of operations and
financial condition of the Company should be read in conjunction with the
unaudited consolidated financial statements and related notes included
elsewhere herein.
The Company is a leading provider of long-term savings and retirement
products in the United States of America. The Company develops and sells a
diverse range of products including individual annuities, private and
public group retirement plans, other investment products sold to
institutions, life insurance and advisory services.
CRITICAL ACCOUNTING POLICIES AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In preparing the unaudited consolidated financial statements, management is
required to make estimates and assumptions that affect the reported amounts
of assets and liabilities and the disclosures of contingent assets and
liabilities as of the date of the unaudited consolidated financial
statements and the reported amounts of revenues and expenses for the
reporting period. Actual results could differ significantly from those
estimates.
The most critical estimates include those used in determining DAC for
investment products and universal life insurance products, impairment
losses on investments, valuation allowances for mortgage loans on real
estate, federal income taxes, and pension and other postretirement employee
benefits.
Note 2 to the audited consolidated financial statements included in the
Company's 2003 Annual Report on Form 10-K provides a summary of significant
accounting policies. Note 3 to the unaudited consolidated financial
statements included in Part I, Item 1 - Unaudited Consolidated Financial
Statements of this report provides a discussion of recently issued
accounting pronouncements.
Deferred Policy Acquisition Costs for Investment Products and Universal
Life Insurance Products
The Company has deferred the costs of acquiring business, principally
commissions, certain expenses of the policy issue and underwriting
department, and certain variable sales expenses that relate to and vary
with the production of new or renewal business. DAC is subject to
recoverability testing at the time of policy issuance and loss recognition
testing at the end of each reporting period.
For investment products (principally individual and group annuities) and
universal life insurance products, DAC is being amortized with interest
over the lives of the policies in relation to the present value of
estimated future gross profits from projected interest margins, asset fees,
cost of insurance, policy administration and surrender charges, less policy
benefits and policy maintenance expenses. The DAC asset related to
investment products and universal life insurance products is adjusted to
reflect the impact of unrealized gains and losses on fixed maturity
securities available-for-sale, as described in note 2(b) to the audited
consolidated financial statements included in the Company's 2003 Annual
Report on Form 10-K.
The most significant assumptions that are involved in the estimation of
future gross profits include future net separate account performance,
surrender/lapse rates, interest margins and mortality. The Company's
long-term assumption for net separate account performance is currently 8%
growth per year. If actual net separate account performance varies from the
8% assumption, the Company assumes different performance levels over the
next three years such that the mean return equals the long-term assumption.
This process is referred to as a reversion to the mean. The assumed net
separate account return assumptions used in the DAC, models are intended to
reflect what is anticipated. However, based on historical returns of the
Standard and Poor's (S&P) 500 Index, the Company's policy regarding the
reversion to the mean process does not permit such returns to be negative
or in excess of 15% during the three-year reversion period.
Changes in assumptions can have a significant impact on the amount of DAC
reported for investment products and universal life insurance products and
their related amortization patterns. In the event actual experience differs
from assumptions or assumptions are revised, the Company is required to
record an increase or decrease in DAC amortization expense (DAC unlocking),
which could be significant. In general, increases in the estimated general
and separate account returns result in increased expected future
profitability and may lower the rate of DAC amortization, while increases
in lapse/surrender and mortality assumptions reduce the expected future
profitability of the underlying business and may increase the rate of DAC
amortization.
The Company evaluates the appropriateness of the individual variable
annuity DAC balance within pre-set parameters due to the magnitude of DAC
balance related to the individual variable annuity business, the
sensitivity of the calculation to minor changes in the underlying
assumptions, and the related volatility that could result in the reported
DAC balance without meaningful improvement to its reasonableness. If the
recorded balance of individual variable annuity DAC falls outside of these
parameters for a prescribed period of time, or if the recorded balance
falls outside of these parameters and the Company determines it is not
reasonably possible to get back within this period of time, assumptions are
required to be unlocked, and the DAC is recalculated using revised best
estimate assumptions. Otherwise, DAC is not unlocked to reflect updated
assumptions. If DAC assumptions were unlocked and revised, the Company
would continue to use the reversion to the mean process.
For other investment products and universal life insurance products, DAC is
adjusted each quarter to reflect revised best estimate assumptions,
including the use of a reversion to the mean methodology over the next
three years as it relates to net separate account performance. Any
resulting DAC unlocking adjustments are reflected currently in the
consolidated statements of income.
Impairment Losses on Investments
Management regularly reviews each investment in its fixed maturity and
equity securities portfolios to evaluate the necessity of recording
impairment losses for other-than-temporary declines in the fair value of
investments.
Under the Company's accounting policy, for debt and equity securities that
can be contractually prepaid or otherwise settled in a way that may limit
the Company's ability to fully recover cost, an impairment is deemed to be
other-than-temporary unless the Company has both the ability and intent to
hold the investment for a reasonable period until the security's forecasted
recovery and evidence exists indicating that recovery will occur in a
reasonable period of time. Also, the Company estimates cash flows over the
life of purchased beneficial interests in securitized financial assets. If
the Company estimates that the fair value of its beneficial interests is
not greater than or equal to its carrying value based on current
information and events, and if there has been an adverse change in
estimated cash flows since the last revised estimate, considering both
timing and amount, then the Company recognizes an other-than-temporary
impairment and writes down the purchased beneficial interest to fair value.
For other debt securities, an other-than-temporary impairment charge is
taken when the Company does not have the ability and intent to hold the
security until the forecasted recovery or if it is no longer probable that
the Company will recover all amounts due under the contractual terms of the
security. Many criteria are considered during this process including, but
not limited to, the current fair value as compared to amortized cost or
cost, as appropriate, of the security; the amount and length of time a
security's fair value has been below amortized cost/cost; specific credit
issues and financial prospects related to the issuer; the Company's intent
to hold or dispose of the securities; and current economic conditions.
Other-than-temporary impairment losses result in a permanent reduction to
the cost basis of the underlying investment.
Impairment losses are recorded on investments in long-lived assets used in
operations when indicators of impairment are present and the undiscounted
cash flows estimated to be generated by those assets are less than the
assets' carrying amounts.
Significant changes in the factors the Company considers when evaluating
investments for impairment losses, including significant deterioration in
the credit worthiness of individual issuers, could result in a significant
change in impairment losses reported in the unaudited consolidated
financial statements.
Valuation Allowances for Mortgage Loans on Real Estate
The Company provides valuation allowances for impairments of mortgage loans
on real estate based on a review by portfolio managers. Mortgage loans on
real estate are considered impaired 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
the Company determines that a loan is impaired, a provision for loss is
established equal to the difference between the carrying value and the
present value of expected future cash flows discounted at the loan's
effective interest rate, or the fair value of the collateral, if the loan
is collateral dependent. In addition to the valuation allowance on specific
loans, the Company maintains an unallocated allowance for expected losses
incurred as of the balance sheet date, but not yet specifically identified
by loan. Changes in the valuation allowance are recorded in net realized
gains or losses on investments, hedging instruments and hedged items. Loans
in foreclosure are placed on non-accrual status. Interest received on
non-accrual status mortgage loans on real estate is included in net
investment income in the period received.
The valuation allowance account for mortgage loans on real estate is
maintained at a level believed adequate by the Company and reflects the
Company's best estimate of probable credit losses, including losses
incurred at the balance sheet date, but not yet identified by specific
loan. The Company's periodic evaluation of the adequacy of the allowance
for losses is based on past loan loss experience, known and inherent risks
in the portfolio, adverse situations that may affect the borrower's ability
to repay, the estimated value of the underlying collateral, composition of
the loan portfolio, current economic conditions and other relevant factors.
Significant changes in the factors the Company considers in determining the
valuation allowance for mortgage loans on real estate could result in a
significant change in the valuation allowance reported in the unaudited
consolidated financial statements.
Federal Income Taxes
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 significantly change
the provision for federal income taxes recorded in the unaudited
consolidated financial statements.
Pension and Other Postretirement Employee Benefits
Pension and other postretirement employee benefit (OPEB) assumptions are
revised annually in conjunction with preparation of the Company's Annual
Report on Form 10-K. The annual 2003 pension expense for substantially all
of the Company's employees and certain agents totaled $13.2 million. This
was an increase of $3.2 million over the 2002 pension expense of $10.0
million and primarily was due to the impact of low interest rates and
declines in the equity markets in 2002. For the Company's primary pension
plan, the discount rate used to value cash flows was lowered to 6.00% for
2003 expenses from 6.50% for 2002, and the long-term expected rate of
return on plan assets was lowered to 7.75% for 2003 from 8.25% for 2002.
The annual 2003 OPEB expense for substantially all of the Company's
employees, and in 2003 certain agents, totaled $1.1 million, a decrease of
$2.4 million from the annual 2002 OPEB expense of $3.5 million. This
decrease primarily related to reductions in benefits provided by the plan.
The discount rate used to value cash flows was lowered to 6.60% for 2003
expenses from 7.25% in 2002, and the long-term expected rate of return on
plan assets was lowered to 7.50% for 2003 from 7.75% for 2002.
In establishing the discount rate and the long-term expected rate of return
on plan assets, the Company employs a prospective building block approach.
This process is integrated with the determination of other economic
assumptions such as salary scale. For a given measurement date, the
discount rate is set by reference to the yield on high-quality corporate
bonds to approximate the rate at which plan benefits could effectively be
settled. For pension benefits, a downward adjustment in the discount rate
is included for plan administration and other expenses likely to be charged
by an insurer. Since the liability for postretirement benefits includes
both claims and administration expenses, a similar downward adjustment is
not appropriate for the other postretirement benefits discount rate. The
historical real rate of return for the reference bonds is subtracted from
the yield on these bonds to generate an assumed inflation rate. Expected
real rate of return on various asset sub-classes is developed based on
historic risk premiums for those sub-classes. The expected real rates of
return, reduced for investment expenses, are applied to the target
allocation of each asset sub-class to produce an expected real rate of
return for the target portfolio. This expected real rate of return varies
by plan and changes when the plan's target investment portfolio changes.
The expected long-term rate of return for plan assets is the assumed
inflation rate plus the expected real rate of return. This process
effectively sets the expected return for the plan's portfolio at the yield
for the reference bond portfolio, adjusted for expected risk premiums of
the target asset portfolio. Given the prospective nature of this
calculation, short-term fluctuations in the market do not impact the
expected risk premiums. However, as the yield for the reference bonds
fluctuates, the assumed inflation rate and the expected long-term rate are
adjusted in tandem.
The following illustrates the impact of changes in individual assumptions
(without changing any other assumption) on expenses in 2003 and going
forward: (1) a 50 basis point increase in the pension discount rate would
have decreased 2003 pension expense by approximately 10%, and a 50 basis
point increase in the pension long-term expected rate of return would have
decreased 2003 pension expense by approximately 12%; (2) a 50 basis point
increase in the OPEB discount rate would have decreased 2003 OPEB expense
by approximately 14%, and a 50 basis point increase in the OPEB long-term
expected rate of return would have decreased 2003 OPEB expense by
approximately 3%.
RESULTS OF OPERATIONS
Revenues
Total revenues for second quarter 2004 increased slightly to $779.9 million
compared to $775.1 million for the same period in 2003. For the first six
months of 2004 and 2003, total revenues were $1.59 billion and $1.52
billion, respectively. The growth in both 2004 periods primarily was driven
by an increase in policy charges due to improved equity market returns and
a decline in net realized losses on investments, hedging instruments and
hedged items, partially offset by a decline in life insurance premiums.
Policy charges include asset fees, which primarily are earned from separate
account values generated from the sale of individual and group variable
annuities and investment life insurance products; cost of insurance charges
earned on universal life insurance products; administration fees, which
include fees charged per contract on a variety of the Company's products
and premium loads on universal life insurance products; and surrender fees,
which are charged as a percentage of premiums withdrawn during a specified
period for annuity and certain life insurance contracts.
The following table summarizes policy charges for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- -------------------------------
-------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
==============================================================================================================================
==============================================================================================================================
Asset fees $ 146.3 $ 125.3 $ 293.2 $ 241.1
Cost of insurance charges 64.1 62.5 127.6 124.9
Administrative fees 20.6 21.2 44.1 46.1
Surrender fees 23.2 19.9 44.0 39.7
- - ------------------------------------------------------------------------------------------------------------------------------
- - ------------------------------------------------------------------------------------------------------------------------------
Total policy charges $ 254.2 $ 228.9 $ 508.9 $ 451.8
==============================================================================================================================
==============================================================================================================================
Asset fees totaled $146.3 million in second quarter 2004 compared to $125.3
million in second quarter 2003, while year-to-date 2004 asset fees totaled
$293.2 million compared to $241.1 million a year ago. The increases were
due to changes in the market value of the investment options underlying the
account values, which have followed the general upward trends of the equity
markets.
Net investment income includes the investment income earned on investments
supporting fixed annuities, the medium-term note program, certain life
insurance products and invested assets not allocated to product segments,
net of related investment expenses. Net investment income in the second
quarter of 2004 was $12.2 million, or 2%, lower than the same period a year
ago primarily due to lower mortgage loan prepayments and bond call
premiums. Net investment income increased from $980.8 million in the first
six months of 2003 to $985.1 million in the first six months of 2004. The
increase was primarily due to higher mortgage loan prepayments and bond
call premium income in the first quarter of 2004 as a result of the low
interest rate environment.
The Company makes decisions concerning the sale of invested assets based on
a variety of market, business, tax and other factors. All realized gains
and losses generated by these sales, charges related to
other-than-temporary impairments of available-for-sale securities and other
investments, and changes in valuation allowances on mortgage loans on real
estate are included as realized gains and losses on investments, hedging
instruments and hedged items. Also included are changes in the fair values
of derivatives qualifying as fair value hedges; changes in the fair values
of hedged items; the ineffective, or excluded, portion of cash flow hedges;
changes in the fair values of non-qualifying derivatives; and periodic net
coupon settlements on non-qualifying derivatives.
Net realized losses on investments, hedging instruments and hedged items
totaled $27.1 million in second quarter 2004, compared to $21.8 million in
second quarter 2003, and included other-than-temporary impairments of $30.0
million and $33.0 million in the second quarter of 2004 and 2003,
respectively. For the first six months of 2004, net realized losses on
investments, hedging instruments and hedged items totaled $38.6 million
compared to $64.8 million for the first six months of 2003 and included
other-than-temporary impairments of $46.0 million and $96.7 million
respectively. Non-impairment related net realized gains on investments,
hedging instruments and hedged items totaled $2.9 million in second quarter
2004 compared to $11.2 million of net gains in second quarter 2003, while
year-to-date 2004 net realized gains related to non-impairment activity
totaled $7.4 million compared to $31.9 million for the same period a year
ago.
Benefits and Expenses
Interest credited to policyholder account values totaled $312.2 million in
second quarter 2004 compared to $331.1 million in second quarter 2003,
while year-to-date 2004 interest credited totaled $628.0 million compared
to $656.5 million a year ago and principally relates to fixed annuities,
both individual and institutional, funding agreements backing the Company's
medium-term note program and certain life insurance products. The decrease
in interest credited reflects lower crediting rates in the Individual
Investments segment and the private sector in the Retirement Plans segment
in response to lower market interest rates, partially offset by increases
in account values. Crediting rates for fixed individual annuities in second
quarter 2004 were 4.00%, compared to 4.51% a year ago. Crediting rates for
the private sector were 4.29%, compared to 4.82% a year ago. The increase
in market interest rates in second quarter 2004 does not appear immediately
in interest credited due to the timing of rate reset dates, which are
typically annual or quarterly.
Other benefits and claims include policyholder benefits in excess of
policyholder account values for universal life and individual deferred
annuities and net claims and provisions for future policy benefits for
traditional life insurance products and immediate annuities. Other benefits
and claims in the second quarter of 2004 decreased $1.7 million, or 2%,
from the same period a year ago and decreased from $187.1 million in the
first six months of 2003 to $169.9 million in the first six months of 2004.
The declines primarily were due to a decrease in the provision for future
policy benefits for immediate annuities due to lower production.
Policyholder dividends on participating policies increased $1.6 million in
second quarter 2004 primarily due to an increase in dividends within the
group life business. For the first six months of 2004, policyholder
dividends on participating policies decreased slightly due to a reduction
in dividend scale due to lower interest rates.
Amortization of DAC increased to $102.2 million in the second quarter of
2004 compared to $94.2 million in the second quarter of 2003. On a
year-to-date basis, DAC amortization totaled $205.8 million in 2004
compared to $173.5 million in 2003. The increases were driven by higher
amortization expense in the Individual Investments segment due to higher
estimated gross profits on the underlying business.
The increase in interest expense on debt in second quarter 2004 and the
first six months of 2004 relates to the issuance of a $100.0 million
surplus note to NFS in December 2003.
Other operating expenses increased 13% to $150.2 million in second quarter
of 2004 compared to $133.4 million in second quarter 2003. For the first
six months of 2004, operating expenses were $297.1 million, up 11% from
$268.1 million for the first six months of 2003. The increase reflects
higher advertising, promotion and employee compensation and benefits
expenses.
Federal income tax expense was $16.7 million and $25.2 million for second
quarter 2004 and 2003, respectively. These amounts represent effective tax
rates of 16.3% for second quarter 2004 and 23.6% in 2003. The decrease in
the effective tax rate was driven by a release of tax reserves as a result
of a current evaluation of tax exposure items. For the first six months of
2004 and 2003, federal income tax expense was $51.4 million and $42.2
million, representing effective tax rates of 21.2% and 22.2%, respectively.
The year-to-date effective tax rate decreased slightly due to the second
quarter activity mentioned above, partially offset by the fact that
permanent items, primarily the dividends received deduction, grew at a
lesser rate than pre-tax earnings.
Cumulative Effect of Adoption of Accounting Principle
In July 2003, the American Institute of Certified Public Accountants issued
Statement of Position 03-1, Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts (SOP 03-1). SOP 03-1 addresses many topics. The most
significant topic to the Company is the accounting for contracts with
GMDBs. SOP 03-1 requires companies to evaluate the significance of a GMDB
to determine whether a contract should be accounted for as an investment or
insurance contract. For contracts determined to be insurance contracts,
companies are required to establish a reserve to recognize a portion of the
assessment (revenue) that compensates the insurance company for benefits to
be provided in future periods. SOP 03-1 also provides guidance on separate
account presentation, interest in separate accounts, gains and losses on
the transfer of assets from the general account to a separate account,
liability valuation, return based on a contractually referenced pool of
assets or index, annuitization options, and sales inducements to contract
holders. The Company adopted SOP 03-1 effective January 1, 2004, which
resulted in a $3.3 million charge, net of tax, as the cumulative effect of
adoption of this accounting principle. Also, see note 3 to the unaudited
consolidated financials statements included in this report.
Sales
The Company regularly monitors and reports a production volume metric
titled "sales." Sales or similar measures are commonly used in the
insurance industry as a measure of the volume of new and renewal business
generated in a period.
Sales are not derived from any specific GAAP income statement accounts or
line items and should not be viewed as a substitute for any financial
measure determined in accordance with GAAP, including sales as it relates
to non-insurance companies. Additionally, the Company's definition of sales
might differ from that used by other companies. As used in the insurance
industry, sales, or similarly titled measures, generate customer funds
managed and administered, which ultimately drive revenues.
As calculated and analyzed by the Company, statutory premiums and deposits
on individual and group annuities and life insurance products calculated in
accordance with accounting practices prescribed or permitted by regulatory
authorities and deposits on administration-only group retirement plans and
the advisory services program are adjusted as described below to arrive at
sales.
Life insurance premiums determined on a GAAP basis are significantly
different than statutory premiums and deposits. Life insurance premiums
determined on a GAAP basis are recognized as revenue when due, as
calculated on an accrual basis in proportion to the service provided and
performance rendered under the contract. In addition, many life insurance
and annuity products involve an initial deposit or a series of deposits
from customers. These deposits are accounted for as such on a GAAP basis
and therefore are not reflected in the GAAP income statement. On a
statutory basis, life insurance premiums collected (cash basis) and
deposits received (cash basis) are aggregated and reported as revenues in
the line item statutory premiums and deposits.
Sales, as reported by the Company, are stated net of internal replacements,
which the Company believes provides a more meaningful disclosure of
production in a given period. In addition, the Company's definition of
sales excludes funding agreements issued under the Company's medium-term
note program; large case bank-owned life insurance (BOLI); large case
pension plan acquisitions; and deposits into Nationwide employee and agent
benefit plans. Although these products contribute to asset and earnings
growth, they do not produce steady production flow that lends itself to
meaningful comparisons and, therefore, are excluded from sales.
The Company believes that the presentation of sales as measured for
management purposes enhances the understanding of the Company's business
and helps depict longer-term trends that may not be apparent in the results
of operations due to differences between the timing of sales and revenue
recognition.
The Company's flagship products are marketed under The BEST of AMERICA(R)
brand and include individual variable and group annuities, group private
sector retirement plans, and variable life insurance. The BEST of AMERICA
products allow customers to choose from investment options managed by
premier mutual fund managers. The Company has also developed private label
variable and fixed annuity products in conjunction with other financial
services providers that allow those providers to sell products to their own
customer bases under their own brand names.
The Company also markets group deferred compensation retirement plans to
employees of state and local governments for use under Internal Revenue
Code (IRC) Section 457. The Company utilizes its sponsorship by the
National Association of Counties, The United States Conference of Mayors
and the International Association of Firefighters when marketing IRC
Section 457 products.
The following table summarizes sales by product and segment for the periods
indicated.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
=============================================================================================================================
=============================================================================================================================
INDIVIDUAL INVESTMENTS
Individual variable annuities:
The BEST of AMERICA products $ 961.1 $ 1,036.0 $ 1,947.1 $ 2,190.0
Private label annuities 102.3 188.5 254.6 366.0
- - -----------------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------------
Total individual variable annuities 1,063.4 1,224.5 2,201.7 2,556.0
Individual fixed annuities 208.9 422.5 391.1 989.2
In retirement 33.3 36.8 66.1 73.8
Advisory services program 43.9 1.2 66.8 1.7
- - -----------------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------------
Total Individual Investments 1,349.5 1,685.0 2,725.7 3,620.7
- - -----------------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------------
RETIREMENT PLANS Private sector pension plan:
The BEST of AMERICA products 411.6 512.9 916.5 1,135.3
Other 5.9 7.6 15.1 17.1
- - -----------------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------------
Total private sector pension plan 417.5 520.5 931.6 1,152.4
- - -----------------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------------
Public sector pension plan:
IRC Section 457 annuities 366.5 336.7 773.2 679.1
- - -----------------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------------
Total Retirement Plans 784.0 857.2 1,704.8 1,831.5
- - -----------------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------------
INDIVIDUAL PROTECTION
The BEST of AMERICA variable life series 109.8 104.7 217.8 218.6
Corporate-owned life insurance 129.0 94.8 346.9 355.2
Traditional/universal life insurance 84.8 69.5 171.9 137.5
- - -----------------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------------
Total Individual Protection 323.6 269.0 736.6 711.3
- - -----------------------------------------------------------------------------------------------------------------------------
- - -----------------------------------------------------------------------------------------------------------------------------
Total sales $ 2,457.1 $ 2,811.2 $ 5,167.1 $ 6,163.5
=============================================================================================================================
=============================================================================================================================
The Company sells its products through a diverse distribution network.
Unaffiliated entities that sell the Company's products to their own
customer base include independent broker/dealers, financial institutions,
wirehouse and regional firms, pension plan administrators, life insurance
specialists and representatives of certain certified public accounting
(CPA) firms. Representatives of affiliates who market products directly to
a customer base include Nationwide Retirement Solutions, Inc. (NRS),
Nationwide Provident producers, Nationwide agents and TBG Insurance
Services Corporation (TBG Financial). The Company also distributes products
through the agency distribution force of its ultimate parent, NMIC.
The following table summarizes sales by distribution channel for the
periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
===================================================================================================================================
===================================================================================================================================
NON-AFFILIATED:
Independent broker/dealers $ 726.3 $ 734.2 $ 1,543.6 $ 1,623.1
Financial institutions 498.6 870.1 994.3 1,870.7
Wirehouse and regional firms 388.8 415.3 815.4 904.6
Life insurance specialists 101.7 74.7 238.4 237.4
Pension plan administrators 97.1 133.7 215.2 297.3
CPA channel 32.3 1.8 45.1 3.4
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Total non-affiliated sales 1,844.8 2,229.8 3,852.0 4,936.5
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Affiliated:
NRS 373.3 344.6 787.8 696.0
Nationwide agents 169.9 172.0 348.4 332.2
TBG Financial 29.5 20.1 110.7 117.8
Nationwide Provident 39.6 44.7 68.2 81.0
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Total affiliated sales 612.3 581.4 1,315.1 1,227.0
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Total sales $ 2,457.1 $ 2,811.2 $ 5,167.1 $ 6,163.5
===================================================================================================================================
===================================================================================================================================
Sales through the independent broker/dealer channel in the three and six
months ended June 30, 2004 declined 1% and 5%, respectively, compared to
the same periods a year ago, reflecting lower demand for variable annuities
and an intentional reduction in fixed annuity production.
Sales through financial institutions declined 43% in second quarter 2004 to
$498.6 million compared to sales of $870.1 million in second quarter 2003
and declined 47% to $994.3 million for the first six months of 2004,
primarily due to planned reductions in fixed annuity sales and the effects
of changes made to the fixed option of variable annuity products.
Sales generated by wirehouse and regional firms declined 6% in second
quarter 2004 compared to second quarter 2003 and are 10% for the first six
months of 2004, due to lower sales of individual fixed annuities and
private sector retirement sales. Fixed individual annuity wirehouse sales
decreased 70% in second quarter 2004 to $4.5 million compared to sales of
$15.0 million in second quarter 2003 as a result of Company driven actions
to improve the profitability of this business.
Sales generated by life insurance specialists increased 36% in second
quarter 2004 and were flat in the first six months of 2004 compared to the
same periods a year ago. The improvement in sales in the second quarter of
2004 was driven by increased renewal premium from the funding of existing
executive deferred compensation plans. On a year-to-date basis, sales
remain flat as the current unfavorable environment for COLI and executive
deferred compensation programs continues to impact the creation of new
plans and sales.
As the Company's private sector retirement plan business model continues to
evolve, direct production through the pension plan administrators channel
is expected to decline, as more new business opportunities are being
created in conjunction or partnership with the independent broker/dealers,
wirehouse and regional firms and financial institutions relationships. This
is evidenced by the 27% and 28% declines in the second quarter 2004 and
first six months of 2004 sales, respectively, compared to the same periods
a year ago.
Sales generated by the CPA channel increased significantly to $32.3 million
in second quarter 2004 and to $45.1 in the first six months of 2004. The
increase was due to the reclassification of CPA channel sales, which prior
to 2004 were reported with independent broker/dealer sales.
Sales through NRS in the three months ended June 30, 2004 increased 8%
primarily reflecting rollover activity from existing participants' previous
employer sponsored plans into existing accounts, as recent pension reform
legislation has expanded the portability of public sector plan assets.
Year-to-date 2004 sales through this channel increased 13% compared to the
same period a year ago due to the same factors.
Sales generated by Nationwide agents declined 1% in second quarter compared
to 2003. Sales through this channel increased 5% in the first six months of
2004 over the same period a year ago due to an increase in individual
variable annuity sales related to new products, partially offset by an
intentional reduction in fixed annuity production.
Similar to the life specialists channel, sales through TBG Financial
increased 47% in the second quarter of 2004 compared to a year ago due to
higher renewal premiums from the funding of existing executive deferred
compensation plans. For the first six months of 2004, TBG Financial's
production decreased 6% compared to a year ago due to the current
unfavorable environment for COLI and executive deferred compensation
programs, which continues to impact the creation of new plans and sales.
Sales generated by Nationwide Provident declined 11% in second quarter and
16% in the first six months of 2004 compared to the same periods a year ago
as individual investment life sales continue to be adversely impacted by
the consumer preference for fixed products.
BUSINESS SEGMENTS
During the second quarter of 2004, the Company reorganized its segment
reporting structure and now reports four segments: Individual Investments,
Retirement Plans, Individual Protection, and Corporate and Other. The
Company has reclassified segment results for all prior periods presented to
be consistent with the new reporting structure.
The following table summarizes pre-tax operating earnings by segment for
the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
==================================================================================================================================
==================================================================================================================================
Individual Investments $ 55.5 $ 40.0 $ 112.2 $ 74.9
Retirement Plans 34.0 30.2 66.7 59.0
Individual Protection 37.3 39.7 81.0 82.3
Corporate and Other 5.1 23.0 26.4 47.0
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Individual Investments
The Individual Investments segment consists of individual The BEST of
AMERICA and private label deferred variable annuity products, deferred
fixed annuity products, income products, and advisory services program
revenues and expenses. This segment differs from the former Individual
Annuity segment due to the addition of the advisory services program
results. Individual deferred annuity contracts provide the customer with
tax-deferred accumulation of savings and flexible payout options including
lump sum, systematic withdrawal or a stream of payments for life. In
addition, individual variable annuity contracts provide the customer with
access to a wide range of investment options and asset protection in the
event of an untimely death, while individual fixed annuity contracts
generate a return for the customer at a specified interest rate fixed for
prescribed periods.
The following table summarizes selected financial data for the Company's
Individual Investments segment for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------
- -------------------------------
-------------------------------
- -------------------------------
(in millions) 2004 2003 2004 2003
====================================================================================================================================
====================================================================================================================================
STATEMENTS OF INCOME DATA
Revenues:
Policy charges $ 126.0 $ 105.3 $ 249.9 $ 204.8
Net investment income 202.7 201.6 414.3 396.5
Premiums on immediate annuities 20.0 22.8 37.5 49.2
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues 348.7 329.7 701.7 650.5
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account values 143.2 153.7 288.4 299.9
Other benefits 27.2 30.2 51.1 76.0
Amortization of DAC 69.0 57.0 141.2 102.6
Other operating expenses 53.8 48.8 108.8 97.1
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 293.2 289.7 589.5 575.6
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings $ 55.5 $ 40.0 $ 112.2 $ 74.9
====================================================================================================================================
====================================================================================================================================
OTHER DATA
Sales:
Individual variable annuities $ 1,063.4 $ 1,224.5 $ 2,201.7 $ 2,556.0
Individual fixed annuities 208.9 422.5 391.1 989.2
In retirement 33.3 36.8 66.1 73.8
Advisory services program 43.9 1.2 66.8 1.7
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total sales $ 1,349.5 $ 1,685.0 $ 2,725.7 $ 3,620.7
====================================================================================================================================
====================================================================================================================================
Average account values:
General account $ 14,521.2 $ 13,838.4 $ 14,511.9 $ 13,377.8
Separate account 33,020.9 26,798.9 32,718.0 26,591.1
Advisory services program 71.1 1.0 56.2 0.7
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total average account values $ 47,613.2 $ 40,638.3 $ 47,286.1 $ 39,969.6
====================================================================================================================================
====================================================================================================================================
Account values as of period end:
Individual variable annuities $ 38,119.1 $ 33,701.1
Individual fixed annuities 7,733.1 7,119.1
In retirement 1,725.4 1,674.9
Advisory services program 91.2 1.6
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total account values $ 47,668.8 $ 42,496.7
====================================================================================================================================
====================================================================================================================================
GMDB - Net amount at risk, net of reinsurance $ 445.4 $ 1,998.4
GMDB - Reserves, net of reinsurance $ 25.8 $ 21.7
Pre-tax operating earnings to average account values 0.47% 0.39% 0.47% 0.37%
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings totaled $55.5 million in second quarter 2004, up
39% compared to second quarter 2003 earnings of $40.0 million. For the
first six months of 2004, pre-tax operating earnings were $112.2 million
compared to $74.9 million for the first six months of 2003, an increase of
50%. The higher earnings were primarily driven by higher asset fees and
interest spread income, somewhat offset by DAC amortization.
Asset fees increased to $105.8 million in the second quarter of 2004, up
21% from $87.3 million in the same period a year ago. For the first six
months of 2004, asset fees totaled $211.8 million, up 26% from the first
six months of 2003 total of $168.1 million. Asset fees are calculated daily
and charged as a percentage of separate account values. The fluctuations in
asset fees are primarily due to changes in the market value of the
investment options underlying the account values, which have followed the
general trends of the equity markets. Average separate account values
increased 23% to $33.02 billion for the three months ended June 30, 2004
compared to $26.80 billion in the same period a year ago.
Surrender fees increased by $2.9 million to $16.7 million in the second
quarter of 2004, primarily due to a higher level of surrender activity due
in part to a higher base of assets relative to a year ago. For the first
six months of 2004, surrender fees totaled $30.8 million, up 9% from the
first six months of 2003 total of $28.2 million, primarily due to the
competitive market place, the volatile equity markets and the larger
in-force levels.
Premiums on immediate annuities decreased by $2.8 million in the second
quarter of 2004 over 2003. For the first six months of 2004, premiums
totaled $37.5 million, down 24% from the first six months of 2003 total of
$49.2 million. Results for both periods reflect an increasingly competitive
sales environment.
Other benefits reflect decreased GMDB costs in 2004. GMDB exposure, as
measured by the difference between the current contractual death benefit
and account value, net of reinsurance, throughout the first six months of
2004 has fallen from the levels of a year ago. The reduction in other
benefits also reflects decreased provision for future policy benefits for
immediate annuities consistent with the decline in premium income.
Other operating expenses were $53.8 million in second quarter 2004, an
increase of 10% compared to second quarter 2003. During the first six
months of 2004, other operating expenses totaled $108.8 million, an
increase of 12% over the first six months of 2003. The increases were
driven by higher asset-based trail compensation due to growth in account
values. Trail compensation is compensation paid to the Company's producing
firms that is based on the level of assets under management rather than on
the new deposits made in that time period. Instead of paying a one-time
amount at the point of sale, a smaller payment is made each year the
business remains in-force. In some cases, a combination of both is paid.
Interest spread income is comprised of net investment income, excluding
capital charges, less interest credited to policyholder account values.
Interest spread income can vary depending on crediting rates offered by the
Company, performance of the investment portfolio, including the rate of
prepayments, changes in market interest rates, the competitive environment
and other factors.
Interest spread income grew 20% in second quarter 2004, while the growth
was 24% during the first six months of 2004, compared to a year ago. The
growth was driven by a 5% increase in second quarter 2004 and an 8%
increase in first six months of 2004 in average general account assets,
increased prepayment income on mortgage loans and bonds, and the result of
growth in the individual fixed annuity business, which more than offset
decreased customer allocations to the guaranteed fixed options of
individual variable annuities. Allocations to the guaranteed fixed option
related to new domestic individual variable annuity sales during the second
quarter and for the first six months of 2004, totaled 20% and 19%, compared
to 52% and 55% for the same periods a year ago, respectively.
The following table summarizes interest spread on average general account
values for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- --------------------------------
------------------------------- --------------------------------
2004 2003 2004 2003
===================================================================================================================================
===================================================================================================================================
Net investment income 5.74% 6.01% 5.86% 6.13%
Interest credited 3.94% 4.44% 3.97% 4.48%
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Interest spread on average general account values 1.80% 1.57% 1.89% 1.65%
===================================================================================================================================
===================================================================================================================================
In addition to higher general account assets, interest spread margins
widened during the quarter to 180 basis points compared to 157 basis points
a year ago. Included in the current quarter were 7 basis points, or $2.4
million, of prepayment income on mortgage loans and bonds compared to 5
basis points, or $1.8 million, a year ago. For the first six months of
2004, interest spread margins widened to 189 basis points compared to 165
basis points a year ago. Included in the first six months of 2004 were 12
basis points, or $8.9 million, of prepayment income on mortgage loans and
bonds compared to 6 basis points, or $3.8 million, a year ago. The higher
interest rate environment relative to a year ago has eased the pressure on
margins due to the interest rate floors contained in annuity contracts.
For the full year 2004, the Company expects the interest spread margins to
tighten and is currently expecting full year spreads of 170 to 175 basis
points, including a nominal level of prepayment activity.
The Company has taken actions to address low interest rate environments and
the impact on interest spread margins. In 2003, the Company lowered
commission rates for individual fixed annuities and the Company began
invoking contractual provisions during second quarter 2003 that limited the
amount of variable annuity deposits allocated to the guaranteed fixed
option. In addition, the Company re-filed its products with lower floor
guarantees in 2003, and the majority of new business is now written in
these lower floor guarantee products.
Sales totaled $1.35 billion during second quarter 2004, down 20% from $1.69
billion a year ago. Variable annuity production declined in the quarter by
13% to $1.06 billion in 2004, with 20% of new domestic sales allocated to
the guaranteed fixed options. Fixed annuity sales totaled $208.9 million in
second quarter 2004, a 51% decrease from levels reported a year ago. For
the first six months of 2004, sales were $2.73 billion compared to $3.62
billion for the first six months of 2003. A sharp drop-off in sales of
fixed annuities, the result of the actions described above, which are
intended to reduce the level of new individual fixed annuity business due
to the challenging interest rate environment, drove segment sales lower
compared to both second quarter and the first six months of 2003.
Deposits in second quarter 2004 of $1.37 billion offset by withdrawals and
surrenders totaling $1.33 billion generated net flows of $37.7 million
compared to the $581.8 million achieved a year ago. On a year-to-date
basis, net flows generated in 2004 were $53.2 million compared to $1.31
billion in 2003.
The increase in the ratio of pre-tax operating earnings to average account
values in the second quarter and first six months of 2004 compared to 2003
was primarily due to higher interest spreads on average general account
values and decreased variable annuity guaranteed benefit costs.
The following table summarizes selected information about the Company's
deferred individual fixed annuities as of June 30, 2004:
RATCHET RESET
------------------------------- -------------------------------
-----------------------------------------------------------------
(in millions) ACCOUNT WTD. AVG. ACCOUNT WTD. AVG.
VALUE CREDITING VALUE CREDITING
RATE RATE
==================================================================================================================================
==================================================================================================================================
Minimum interest rate of 3.50% or greater $ - N/A $ 939.8 3.50%
Minimum interest rate of 3.00% to 3.49% 3,168.8 4.94% 6,732.0 3.19%
Minimum interest rate lower than 3.00% 706.9 3.06% 268.8 3.54%
MVA with no minimum interest rate guarantee - N/A - N/A
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total deferred individual fixed annuities $ 3,875.7 4.60% $ 7,940.6 3.24%
==================================================================================================================================
==================================================================================================================================
MARKET VALUE
ADJUSTMENT (MVA) TOTAL
------------------------------- -------------------------------
-----------------------------------------------------------------
(in millions) ACCOUNT WTD. AVG. ACCOUNT WTD. AVG.
VALUE CREDITING VALUE CREDITING
RATE RATE
==================================================================================================================================
==================================================================================================================================
Minimum interest rate of 3.50% or greater $ - N/A $ 939.8 3.50%
Minimum interest rate of 3.00% to 3.49% - N/A 9,900.8 3.75%
Minimum interest rate lower than 3.00% - N/A 975.7 3.19%
MVA with no minimum interest rate guarantee 991.7 3.71% 991.7 3.71%
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total deferred individual fixed annuities $ 991.7 3.71% $ 12,808.0 3.69%
==================================================================================================================================
==================================================================================================================================
Retirement Plans
The Retirement Plans segment is comprised of the Company's private and
public sector retirement plans business. The private sector includes IRC
Section 401(k) business and the public sector includes IRC Section 457
business, both in the form of fixed and variable group annuities.
The following table summarizes selected financial data for the Company's
Retirement Plans segment for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------
- --------------------------------
-------------------------------
- --------------------------------
(in millions) 2004 2003 2004 2003
====================================================================================================================================
====================================================================================================================================
STATEMENTS OF INCOME DATA
Revenues:
Policy charges $ 40.1 $ 36.8 $ 80.1 $ 72.1
Net investment income 154.5 161.4 311.1 322.2
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total revenues 194.6 198.2 391.2 394.3
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account values 105.9 111.7 213.6 223.4
Amortization of DAC 10.4 10.2 20.0 21.9
Other operating expenses 44.3 46.1 90.9 90.0
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 160.6 168.0 324.5 335.3
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings $ 34.0 $ 30.2$ 66.7 $ 59.0
====================================================================================================================================
====================================================================================================================================
OTHER DATA
Sales:
Private sector $ 417.5 $ 520.5 $ 931.6 $ 1,152.4
Public sector 366.5 336.7 773.2 679.1
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total sales $ 784.0 $ 857.2 $ 1,704.8 $ 1,831.5
====================================================================================================================================
====================================================================================================================================
Average account values:
General account $ 9,648.6 $ 9,318.2 $ 9,599.6 $ 9,239.1
Separate account 19,238.2 17,076.3 19,294.8 16,978.0
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total average account values $ 28,886.8 $ 26,394.5 $ 28,894.4 $ 26,217.1
====================================================================================================================================
====================================================================================================================================
Account values as of period end:
Private sector $ 14,404.2 $ 14,442.9
Public sector 14,407.4 12,854.7
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total account values $ 28,811.6 $ 27,297.6
====================================================================================================================================
====================================================================================================================================
Pre-tax operating earnings to average account values 0.47% 0.46% 0.46% 0.45%
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings totaled $34.0 million in the second quarter of
2004, up 13% compared to the pre-tax operating earnings of $30.2 million
reported a year ago. Pre-tax operating earnings increased 13% to $66.7
million in the first six months of 2004 compared to the same period a year
ago. In both periods, increased policy charges were partially offset by
lower interest spread income.
Asset fees increased 5% to $34.8 million in the second quarter of 2004
compared to $33.1 million in the quarter a year ago, while year-to-date
2004 asset fees were $70.0 million compared to $64.0 million in 2003. The
increases were driven by a 13% and 14% increase in average separate account
values in the second quarter and first six months of 2004, respectively,
due to market appreciation and new sales.
Surrender charges increased 131% to $3.0 million in second quarter 2004
compared to second quarter 2003. Surrender charges increased 100% to $6.0
million in the first six months of 2004 compared to the same period in 2003
as a higher percentage of the plans surrendering were within the surrender
charge period. The three and six months 2004 increases were due to
increased surrenders of 3% and 15%, respectively, compared to the same
period a year ago.
Interest spread income is comprised of net investment income less interest
credited to policyholder account values. Interest spreads vary depending on
crediting rates offered by the Company, performance of the investment
portfolio, including the rate of prepayments, changes in market interest
rates, the competitive environment and other factors.
Interest spread income was $1.1 million lower in the second quarter of 2004
compared to the second quarter of 2003 and $1.3 million lower for the first
six months of 2004 compared to a year ago, primarily as a result of spread
compression in both the public sector and private sector businesses driven
by higher interest rates and lower prepayment income on mortgage loans and
bonds.
The following table summarizes interest spread on average general account
values for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
------------------------------- -------------------------------
2004 2003 2004 2003
===================================================================================================================================
===================================================================================================================================
Net investment income 6.41% 6.93% 6.48% 6.97%
Interest credited 4.39% 4.79% 4.45% 4.84%
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Interest spread on average general account values 2.02% 2.14% 2.03% 2.13%
===================================================================================================================================
===================================================================================================================================
Interest spread margins declined to 202 basis points in the second quarter
of 2004 compared to 214 basis points a year ago. Interest spread margins
declined to 203 basis points in the first six months 2004 compared to 213
basis points in the same period of 2003. Included in the current quarter
were 10 basis points, or $2.5 million, of prepayment income on mortgage
loans and bonds compared to 12 basis points, or $2.8 million, a year ago.
On a year-to-date basis, prepayment income was 10 basis points, or $7.4
million compared to 11 basis points, or $5.1 million. For the full year
2004, the Company expects the trend of tighter interest spread margins to
continue and is currently expecting full year interest spread margins of
185 to 190 basis points, including a nominal level of prepayment activity.
Other operating expenses declined 4% to $44.3 million in second quarter
2004 due to slight decreases in commissions and general expenses, and
remained flat for the first six months of 2004.
Sales during second quarter 2004 declined 9% to $784.0 million compared to
$857.2 million in second quarter 2003. For the first six months of 2004,
sales declined 7% to $1.70 billion compared to sales of $1.83 billion for
the same period a year ago.
Private sector retirement plan sales in second quarter 2004 totaled $417.5
million, a decline of 20% from a year ago, and totaled $931.6 million for
the first six months of 2004, a decline of 19%. The declines in the second
quarter and first six months of 2004 compared to the same periods in 2003
were due to a shift in business mix toward trust versus group annuity
products.
Public sector retirement plan sales in the second quarter 2004 totaled
$366.5 million, 9% higher than a year ago, and totaled $773.2 million for
the first six months of 2004, an increase of 14%. Higher sales reflect new
deposits and increased rollover activity from existing participants'
previous employer sponsored plans into existing accounts, as recently
implemented pension reform legislation has expanded the portability of
public plan assets.
Deposits in second quarter 2004 of $834.0 million were offset by
participant withdrawals and surrenders totaling $891.7 million, which
generated net flows from participant activity of $(57.7) million.
Year-to-date 2004 net flows declined $263.6 million to $(96.4) million
compared to $167.2 million in 2003.
The ratio of pre-tax operating earnings to average account values remained
consistent at 47 basis points for second quarter 2004 compared to the same
period a year ago as increased asset fees and surrender charges were offset
by lower interest spread income.
Individual Protection
The Individual Protection segment consists of investment life insurance
products, including individual variable life and COLI products, traditional
life insurance products and universal life insurance. This segment is
unchanged from the former Life Insurance segment. Life insurance products
provide a death benefit and generally allow the customer to build cash
value on a tax-advantaged basis.
The following table summarizes selected financial data for the Company's
Individual Protection segment for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- -------------------------------
------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
==================================================================================================================================
==================================================================================================================================
STATEMENTS OF INCOME DATA
Revenues:
Policy charges $ 88.0 $ 86.8 $ 178.7 $ 174.9
Net investment income 80.4 80.8 163.5 161.3
Other 45.6 47.7 93.4 96.6
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total revenues 214.0 215.3 435.6 432.8
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Life benefits and policyholder dividends 116.4 112.1 229.7 222.2
Amortization of DAC 22.8 27.0 44.6 49.0
Other operating expenses 37.5 36.5 80.3 79.3
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 176.7 175.6 354.6 350.5
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings $ 37.3 $ 39.7 $ 81.0 $ 82.3
==================================================================================================================================
==================================================================================================================================
OTHER DATA
Sales:
The BEST of AMERICA variable life series 109.8 $ 104.7 217.8 $ 218.6
Corporate-owned life insurance 129.0 94.8 346.9 355.2
Traditional/universal life insurance 84.8 69.5 171.9 137.5
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total sales $ 323.6 $ 269.0 $ 736.6 $ 711.3
==================================================================================================================================
==================================================================================================================================
Policy reserves as of period end:
Individual investment life insurance $ 2,815.6 $ 2,368.6
Corporate investment life insurance 4,728.1 4,126.3
Traditional life insurance 2,059.3 1,995.4
Universal life insurance 938.9 844.9
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total policy reserves $ 10,541.9 $ 9,335.2
==================================================================================================================================
==================================================================================================================================
Insurance in-force as of period end:
Individual investment life insurance $ 35,650.2 $ 34,169.2
Corporate investment life insurance 9,533.6 9,219.9
Traditional life insurance 21,748.3 23,657.9
Universal life insurance 8,296.3 8,054.3
- -
- ----------------------------------------------------------------------------------------------------------------------------------
- -
- ----------------------------------------------------------------------------------------------------------------------------------
Total insurance in-force $ 75,228.4 $ 75,101.3
==================================================================================================================================
==================================================================================================================================
Pre-tax operating earnings decreased 6% to $37.3 million in second quarter
2004 compared to $39.7 million a year ago. Pre-tax operating earnings
decreased 2% to $81.0 million in the first six months of 2004 compared to
the same period a year ago. The decline in earnings in the second quarter
was driven by weaker earnings in the individual investment life and COLI
business, partially offset by strong growth and improved mortality in the
fixed, or traditional and universal life insurance businesses.
Policy charges increased slightly to $88.0 million in second quarter 2004
compared to $86.8 million in second quarter 2003. Cost of insurance
charges, which are assessed on the amount of insurance in-force in excess
of the related policyholder account value, increased 2% in both the second
quarter of 2004 and the first six months of 2004, compared to the same
periods a year ago. Growth in universal life and individual investment life
products were the primary contributors to the improvement in policy
charges.
Net investment income remained flat in second quarter 2004. For the first
six months of 2004 net investment income increased 1% to $163.5 million,
reflecting growth in the universal life insurance business.
Life benefits and policyholder dividends increased 4% to $116.4 million in
second quarter 2004 compared to second quarter 2003, while the increase in
the first six months of 2004 was 3% compared to the same period a year ago,
due to growth in insurance in-force and higher mortality experience.
Amortization of DAC decreased $4.2 million, or 16%, in second quarter 2004
and $4.4 million, or 9%, in the first six months of 2004 compared to the
same periods a year ago. While DAC amortization increased in the fixed life
businesses, consistent with the higher earnings reported in this business,
slower earnings in the investment life businesses have lead to
correspondingly lower DAC amortization.
Other operating expenses were $37.5 million in second quarter 2004, up 3%
from second quarter 2003, while the first six months of 2004 saw an
increase of 1% over the same period as a year ago. The increase in
operating expenses was primarily driven by higher employee salaries and
incentives and higher employee benefits expenses.
Second quarter 2004 sales totaled $323.6 million, 20% ahead of a year ago.
Sales improved in all product categories in the quarter, with COLI sales
showing the strongest growth, increasing 36% compared to a year ago. The
primary driver of the improved sales in the COLI business was increased
renewal premiums as the funding environment for executive deferred
compensation plans has improved. For the first six months of 2004 COLI
sales declined by 2% as the rebound in this market has been slower than
expected. For the first six months of 2004, sales increased 4% compared to
2003 and totaled $736.6 million. Sales of traditional/universal life
insurance continue to be strong, driving the improvement in year-to-date
sales. Traditional/universal life sales of $171.9 million increased 25%
compared to a year ago, driven by a re-tooled universal life insurance
product portfolio and expanding distribution relationships in the
non-affiliated distribution channels.
Corporate and Other
The Corporate and Other segment includes certain structured products
business, the medium-term note program, net investment income not allocated
to the three product segments, periodic net coupon settlements on
non-qualifying derivatives, unallocated expenses, interest expense on debt,
revenue and expenses of the Company's non-insurance subsidiaries not
reported in other segments, and realized gains and losses related to
securitizations. This segment differs from the former Corporate segment as
it now includes results from the structured products and medium-term note
businesses, but no longer includes results from the advisory services
program.
The following table summarizes selected financial data for the Company's
Corporate and Other segment for the periods indicated:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------
- ------------------------------
---------------------------
- ------------------------------
(in millions) 2004 2003 2004 2003
====================================================================================================================================
====================================================================================================================================
STATEMENTS OF INCOME DATA
Operating revenues $ 52.0 $ 58.0 $ 107.7 $ 114.9
Interest expense on debt, primarily with NFS (15.1) (11.8) (29.4) (23.5)
Other operating expenses (31.8) (23.2) (51.9) (44.4)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings 5.1 23.0 26.4 47.0
Net realized losses on investments hedging
instruments and hedged items1 (29.4) (26.1) (43.8) (73.4)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Loss from continuing operations before federal income taxes $ (24.3) $ (3.1) $ (17.4) $ (26.4)
====================================================================================================================================
====================================================================================================================================
OTHER DATA
Account values as of period end --
Funding agreements backing medium-term notes $ 4,831.4 $ 4,535.9
====================================================================================================================================
====================================================================================================================================
- - -------
1 Excluding periodic net settlements on non-qualifying derivatives.
The decrease in pre-tax operating earnings in the second quarter of 2004
was primarily attributable to a $6.0 million decrease in net investment
income and a $14.1 million increase in other general expenses, partially
offset by a $4.2 million increase in other income from variable interest
entities. The primary drivers in the current quarter were lower spread
income on medium-term note business and increased expenses related to legal
reserves, variable interest entities, advertising and promotion, and
employee compensation and benefits. During the first six months of 2004,
pre-tax operating earnings decreased by 44% due to a $4.6 million decrease
in net investment income and an $18.2 million increase in other general
expenses as described above.
Interest expense on debt increased $3.3 million in the second quarter of
2004 and $5.9 million for the first six months of 2004 due to the issuance
of a $100.0 million surplus note in December 2003.
Net realized losses on investments, hedging instruments and hedged items
excluding periodic net settlements on non-qualifying derivatives totaled
$29.4 million in second quarter 2004 compared to $26.1 million a year ago
and included other-than-temporary impairments of $30.0 million and $33.0
million for second quarter 2004 and 2003, respectively. For the first six
months of 2004, net realized losses on investments, hedging instruments and
hedged items excluding periodic net settlements on non-qualifying
derivatives totaled $43.8 million compared to $73.4 million for the first
six months of 2003 and included other-than-temporary impairments of $46.0
million and $96.7 million, respectively.
The following table summarizes net realized losses on investments, hedging
instruments and hedged items from continuing operations by source for the
periods indicated, including the reclassification of certain items in the
Quarterly Report on Form 10-Q for the period ended March 31, 2004 to
conform to the presentation used for the six months ended June 30, 2004. No
prior year amounts were reclassified.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------- -------------------------------
-------------------------------- -------------------------------
(in millions) 2004 2003 2004 2003
===================================================================================================================================
===================================================================================================================================
Realized gains on sales, net of hedging losses:
Fixed maturity securities available-for-sale $ 7.7 $ 27.5 $ 14.5 $ 50.3
Hedging losses on fixed maturity sales (1.6) (24.4) (5.2)
(30.3)
Equity securities available-for-sale 0.1 - 1.1 0.4
Real estate 2.1 0.6 2.5 0.9
Mortgage loans on real estate 5.6 1.3 5.6 1.4
Mortgage loan hedging losses (0.8) (1.4) (1.3)
(1.4)
Other - - 0.2 -
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Total realized gains on sales 13.1 3.6 17.4 21.3
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Realized losses on sales, net of hedging gains:
Fixed maturity securities available-for-sale (2.3) (8.5) (4.8)
(16.1)
Hedging gains on fixed maturity sales 0.4 1.1 0.8 5.4
Equity securities available-for-sale (0.1) - (0.5)
(0.3)
Real estate - - (1.2)
(0.4)
Mortgage loans on real estate (5.2) (0.7) (5.9)
(0.7)
Mortgage loan hedging gains - - 1.8 -
Other (1.2) (0.5) (1.4)
(1.0)
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Total realized losses on sales (8.4) (8.6) (11.2)
(13.1)
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Other-than-temporary and other investment impairments:
Fixed maturity securities available-for-sale (29.3) (31.7) (40.9)
(90.1)
Equity securities available-for-sale (0.4) - (0.6)
(5.3)
Real estate (0.3) - (2.5) -
Mortgage loans on real estate - (1.3) (2.0)
(1.3)
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Total other-than-temporary and other investment (30.0) (33.0) (46.0)
(96.7)
impairments
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Credit default swaps 0.1 6.4 (2.7) 7.8
Periodic net coupon settlements on non-qualifying derivatives 2.3 4.3 5.2 8.6
Other derivatives (4.2) 5.5 (1.3) 7.3
- -
- -----------------------------------------------------------------------------------------------------------------------------------
- -
- -----------------------------------------------------------------------------------------------------------------------------------
Net realized losses on investments, hedging
instruments and hedged items $ (27.1) $ (21.8) $ (38.6) $
(64.8)
===================================================================================================================================
===================================================================================================================================
The Company has a comprehensive portfolio monitoring process for fixed
maturity and equity securities to identify and evaluate the necessity of
recording impairment losses for other-than-temporary declines in the fair
value of investments. See "Impairment Losses on Investments" in the
"Critical Accounting Policies and Recently Issued Accounting
Pronouncements" section of Part I, Item 2 - Management's Discussion and
Analysis of Financial Condition and Results of Operations (MD&A) of this
report for a complete discussion of this process.
The following table summarizes for the six months ended June 30, 2004 the
Company's largest aggregate loss on sales and write-downs by issuer
(including affiliates), the related circumstances giving rise to the losses
and the circumstances that may have affected other material investments
held:
FAIR VALUE JUNE 30, NET
AT SALE LOSS ON 2004 UNREALIZED
(in millions) (PROCEEDS) SALE WRITE-DOWNS HOLDINGS1 GAIN
(LOSS)
====================================================================================================================================
A collateralized debt obligation. The write-down to
fair value was taken consistent with GAAP due to an adverse
change in expected cash flows of the security. $ - $ - $ (3.0) $ 4.6 $ -
A major U.S. airline. A write-down and sale of certain
holdings of this issuer was completed during the quarter.
Other issues held of this issuer were acquired during the
quarter with the intent of improving the overall collateral
position of the portfolio. The Company holds other
securities issued by this company that it believes are fully
collateralized with no further impairment loss identified. 24.9 (0.7) (10.4) 31.7 (0.2)
Specialty finance company for healthcare providers. Recent
analysis indicated that the underlying collateral has
deteriorated and expected cash flows experienced an adverse
change. Impairment loss taken and security recorded at fair
value. - - (5.9) 12.4 -
Asset-backed structure issued in 2000 which includes credit
default swaps. A write-down and sale of a portion of the
holdings of this issuer was taken during the quarter.
Expected cash flows and fair values of the remaining
holdings are being monitored. No additional impairments on
these holdings are necessary at this time. 4.8 - (4.3) 5.7 (0.2)
"Bank loan" security issued by a steel manufacturer.
The company emerged from bankruptcy in 2003 and finalized
its restructuring plan in second quarter 2004. A loss,
included in "write-downs" in the table, was recorded as part
of this restructure. No further impairment issues at the
balance sheet date. 3.9 - (1.7) 3.9 0.7
United Kingdom-based manufacturer, primarily of buses.
Impaired the first quarter and subsequently sold during the
second quarter of 2004. 1.3 (0.2) (5.8) - -
A structured asset-backed security with home-equity loans as
the underlying collateral. Expected cash flows and fair
value have deteriorated during the quarter. Impairment loss
taken to reduce holding to fair value. - - (5.0) 5.0 -
An asset-backed security with equipment leases as the
underlying collateral. Impaired and sold in the first
quarter of 2004. 0.1 (0.4) (0.6) - -
Collateralized debt obligation investing in high-yield and
distressed collateral. Analysis indicated adverse changes to
cash flow during first quarter 2004 with impairment taken to
fair value. Second quarter analysis indicates stable cash
flows. No additional impairment loss is necessary. - - (1.5) 4.0 (0.5)
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 35.0 $ (1.3) $ (38.2) $ 67.3 $ (0.2)
====================================================================================================================================
- - ---------
1 Holdings represent amortized cost of fixed maturity securities and cost of
equity securities as of the date indicated.
No other issuer had an aggregated loss on sales and write-downs greater
than 2.0% of the Company's total gross loss on sales and write-downs on
fixed maturity and equity securities.
RELATED PARTY TRANSACTIONS
See note 7 to the unaudited consolidated financial statements included in
Part I, Item 1 - Unaudited Consolidated Financial Statements of this report
for a discussion of related party transactions.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following table summarizes the Company's contractual obligations and
commitments due in each period presented:
PAYMENTS DUE IN
- --------------------------------------------------------------
- --------------------------------------------------------------
LESS THAN 1-3 3-5
(in millions) TOTAL 1 YEAR YEARS YEARS THEREAFTER
====================================================================================================================================
====================================================================================================================================
Short-term debt1 $ 257.2 $ 257.2 $ - $ - $ -
Long-term debt, payable to NFS1 700.0 - - - 700.0
Funding agreements backing meduim-term notes1 4,831.4 1,334.8 2,999.0 243.8 253.8
Purchase and lending commitments:
Fixed maturity securities1 84.3 84.3 - - -
Commercial mortgage loans1 559.0 497.2 61.8 - -
Limited partnerships2 44.3 44.3 - - -
- -
- ------------------------------------------------------------------------------------------------------------------------------------
- -
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 6,476.2 $ 2,217.8 $ 3,060.8 $ 243.8 $ 953.8
====================================================================================================================================
====================================================================================================================================
- - --------
1 No contractual provisions exist that could create, increase or accelerate
those obligations presented.
2 Primarily related to investments in low-income-housing tax credit
partnerships. The ultimate call date of these commitments may extend
beyond one year but have been reflected in payments due in less than 1
year due to the call features.
As it relates to policy contract benefits, substantially all remaining
policy and contract benefits to be paid do not have stated maturity dates
and therefore do not lend themselves to meaningful disclosure in the format
required. Furthermore, due to the nature of certain of these liabilities,
they may not result in any ultimate payment requirement. For those that
would result in a payment, the amounts are not readily determinable, as
they are dependent on one or more future actions such as continued premium
payment, death, future contract returns, surrender or annuitization
election. Due to these significant uncertainties, the Company believes that
inclusion of these additional amounts based on a series of estimates, of
which few, if any, can be held out to be a best estimate, would not be
meaningful to investors and may be confusing compared with the discounted
reserve estimates disclosed in the consolidated financial statements.
OFF-BALANCE SHEET TRANSACTIONS
Under the medium-term note program, the Company issues funding agreements,
which are insurance obligations under Ohio law, to an unconsolidated third
party trust to secure notes issued to investors by the trust. The funding
agreements are recorded as a component of future policy benefits and claims
on the consolidated balance sheets. Because the Company is not the primary
beneficiary of, and has no ownership interest in, or control over, the
third party trust that issues the notes, the Company does not include the
trust in its consolidated financial statements. Since the notes issued by
the trust have a secured interest in the funding agreements issued by the
Company, Moody's Investors Service, Inc. and Standard & Poor's Ratings
Services assign the same ratings to the notes and the insurance financial
strength of the Company.
As of June 30, 2004 and 2003, the Company had received $818.9 million and
$1.30 billion, respectively, of cash collateral on securities lending and
$456.0 million and $580.0 million, respectively, of cash for derivative
collateral. The Company invested the proceeds in short-term investments,
which are reflected on the consolidated balance sheets, and a corresponding
liability was established to reflect the return of the collateral. The
Company also held $135.0 million and $127.0 million of securities as
off-balance sheet collateral on derivative transactions as of June 30, 2004
and 2003, respectively.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks have not changed materially from those disclosed in the
Company's 2003 Annual Report on Form 10-K.
ITEM 4 CONTROLS AND PROCEDURES
(a) The Company's Chief Executive Officer and Chief Financial Officer
have evaluated the effectiveness of the Company's disclosure
controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934). Based on
such evaluation, such officers have concluded that the Company's
disclosure controls and procedures are effective as of the end of
the period covered by this report.
(b) There have been no changes during the Company's second fiscal
quarter to its internal control over financial reporting that
have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
The Company is a party to litigation and arbitration proceedings in the
ordinary course of its business. It is not possible to determine the
ultimate outcome of the pending investigations and legal proceedings or to
provide reasonable ranges of potential losses. Some of the matters referred
to below are in very preliminary stages, and the Company does not have
sufficient information to make an assessment of plaintiffs' claims for
liability or damages. In some of the cases seeking to be certified as class
actions, the court has not yet decided whether a class will be certified or
(in the event of certification) the size of the class and class period. In
many of the cases, plaintiffs are seeking undefined amounts of damages or
other relief, including punitive damages and equitable remedies, that are
difficult to quantify and cannot be defined based on the information
currently available. The Company does not believe, based on information
currently known by the Company's management, that the outcomes of such
pending investigations and legal proceedings are likely to have a material
adverse effect on the Company's consolidated financial position. However,
given the large and/or indeterminate amounts sought in certain of these
matters and inherent unpredictability of litigation, it is possible that an
adverse outcome in certain matters could have a material adverse effect on
the Company's consolidated financial results in a particular quarterly or
annual period.
In recent years, life insurance companies have been named as defendants in
lawsuits, including class action lawsuits relating to life insurance and
annuity pricing and sales practices. A number of these lawsuits have
resulted in substantial jury awards or settlements.
The financial services industry, including mutual fund, variable annuity
and distribution companies, has been the subject of increasing scrutiny by
regulators, legislators and the media over the past year. Numerous
regulatory agencies, including the Securities and Exchange Commission
(SEC), the National Association of Securities Dealers and the New York
State Attorney General, have commenced industry-wide investigations
regarding late trading and market timing in connection with mutual funds
and variable insurance contracts, and have commenced enforcement actions
against some mutual fund companies on those issues. Investigations and
enforcement actions have also been commenced, on a smaller scale, regarding
the sales practices of mutual fund and variable annuity distributors. These
legal proceedings are expected to continue in the future. These
investigations and proceedings could result in legal precedents and new
industry-wide legislation, rules or regulations that could significantly
affect the financial services industry, including variable annuity
companies. The Company has been contacted by regulatory agencies for
information relating to market timing, late trading, distribution and
service provider compensation arrangements, and sales practices. The SEC,
in conjunction with the New York State Attorney General, is conducting an
investigation of market timing in certain international and global mutual
funds offered in insurance products sponsored by the Company. The Company
is cooperating with these regulatory agencies and is responding to those
information requests.
On April 13, 2004, NLIC was named in a class action lawsuit filed in
Circuit Court, Third Judicial Circuit, Madison County, Illinois entitled
Woodbury v. Nationwide Life Insurance Company. The plaintiff purports to
represent a class of persons in the United States who, through their
ownership of a Nationwide annuity or insurance product, held units of any
Nationwide sub-account invested in mutual funds which included foreign
securities in their portfolios and which allegedly experienced market
timing trading activity. The complaint contains allegations of negligence,
reckless indifference and breach of fiduciary duty. The plaintiff seeks to
recover compensatory and punitive damages in an amount not to exceed
$75,000 per plaintiff or class member. NLIC removed this case to the United
States District Court for the Southern District of Illinois on June 1,
2004. The plaintiffs moved to remand on June 28, 2004. This lawsuit is in a
preliminary stage, and NLIC intends to defend it vigorously.
On January 21, 2004, the Company was named in a lawsuit filed in the United
States District Court for the Northern District of Mississippi entitled
United Investors Life Insurance Company v. Nationwide Life Insurance
Company and/or Nationwide Life Insurance Company of America and/or
Nationwide Life and Annuity Insurance Company and/or Nationwide Life and
Annuity Company of America and/or Nationwide Financial Services, Inc.
and/or Nationwide Financial Corporation, and John Does A-Z. In its
complaint, plaintiff United Investors alleges that the Company and/or its
affiliated life insurance companies caused the replacement of variable
insurance policies and other financial products issued by United Investors
with policies issued by the Nationwide defendants. The plaintiff raises
claims for (1) violations of the Federal Lanham Act, and common law unfair
competition and defamation, (2) tortious interference with the plaintiff's
contractual relationship with Waddell & Reed, Inc. and/or its affiliates,
Waddell & Reed Financial, Inc., Waddell & Reed Financial Services, Inc. and
W&R Insurance Agency, Inc., or with plaintiff's contractual relationships
with its variable policyholders, (3) civil conspiracy, and (4) breach of
fiduciary duty. The complaint seeks compensatory damages, punitive damages,
pre- and post-judgment interest, a full accounting, and costs and
disbursements, including attorneys' fees. The Company filed a motion to
dismiss the complaint on June 1, 2004. The Company intends to defend this
lawsuit vigorously.
On October 31, 2003, the Company was named in a lawsuit seeking class
action status filed in the United States District Court for the District of
Arizona entitled Robert Helman et al v. Nationwide Life Insurance Company
et al. The suit challenges the sale of deferred annuity products for use as
investments in tax-deferred contributory retirement plans. On April 8,
2004, the plaintiff filed an amended class action complaint on behalf of
all persons who purchased an individual variable deferred annuity contract
or a certificate to a group variable annuity contract issued by NLIC or
Nationwide Life and Annuity Insurance Company which were allegedly used to
fund certain tax-deferred retirement plans. The amended class action
complaint seeks unspecified compensatory damages. NLIC filed a motion to
dismiss the complaint on May 24, 2004. On July 27, 2004, the court granted
NLIC's motion to dismiss. The plaintiff has appealed that dismissal to the
United States Court of Appeals for the Ninth Circuit. NLIC intends to
defend this lawsuit vigorously.
On May 1, 2003, NLIC was named in a class action lawsuit filed in the
United States District Court for the Eastern District of Louisiana entitled
Edward Miller, Individually, and on behalf of all others similarly
situated, v. Nationwide Life Insurance Company. The complaint alleges that
in 2001, plaintiff Edward Miller purchased three group modified single
premium variable annuities issued by NLIC. The plaintiff alleges that NLIC
represented in its prospectus and promised in its annuity contracts that
contract holders could transfer assets without charge among the various
funds available through the contracts, that the transfer rights of contract
holders could not be modified and that NLIC's expense charges under the
contracts were fixed. The plaintiff claims that NLIC has breached the
contracts and violated federal securities laws by imposing trading fees on
transfers that were supposed to have been without charge. The plaintiff
seeks compensatory damages and rescission on behalf of himself and a class
of persons who purchased this type of annuity or similar contracts issued
by NLIC between May 1, 2001 and April 30, 2002 inclusive and were allegedly
damaged by paying transfer fees. NLIC's motion to dismiss the complaint was
granted by the Court on October 28, 2003. The plaintiff has appealed that
dismissal to the United States Court of Appeals for the Fifth Circuit. The
Company intends to defend this lawsuit vigorously.
On August 15, 2001, the Company was named in a lawsuit filed in the United
States District Court for the District of Connecticut entitled Lou Haddock,
as trustee of the Flyte Tool & Die, Incorporated Deferred Compensation
Plan, et al v. Nationwide Financial Services, Inc. and Nationwide Life
Insurance Company. The plaintiffs first amended their complaint on
September 5, 2001 to include class action allegations and have subsequently
amended their complaint three times. As amended, in the current complaint
the plaintiffs seek to represent a class of ERISA qualified retirement
plans that purchased variable annuities from NLIC. The plaintiffs allege
that they invested ERISA plan assets in their variable annuity contracts
and that the Company breached ERISA fiduciary duties by allegedly accepting
service payments from certain mutual funds. The complaint seeks
disgorgement of some or all of the payments allegedly received by the
Company, other unspecified relief for restitution, declaratory and
injunctive relief, and attorneys' fees. On December 13, 2001, the
plaintiffs filed a motion for class certification. The plaintiffs filed a
supplement to that motion on September 19, 2003. The Company opposed that
motion on December 24, 2003. On January 30, 2004, the Company filed a
Revised Memorandum in Support of Summary Judgment. The plaintiffs have
opposed that motion. The Company intends to defend this lawsuit vigorously.
ITEM 2 CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES
Omitted due to reduced disclosure format.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
Omitted due to reduced disclosure format.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted due to reduced disclosure format.
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1 364-Day Credit Agreement dated May 17, 2004 among
Nationwide Financial Services, Inc., Nationwide Life
Insurance Company, Nationwide Mutual Insurance Company,
the banks party thereto, Bank One, NA, as agent, and
Citicorp USA, Inc., as syndication agent (previously filed
as Exhibit 10.1 to Form 10-Q, Commission File Number
1-12785, filed August 6, 2004, and incorporated herein by
reference).
10.2 Five-Year Credit Agreement dated May 17, 2004 among
Nationwide Financial Services, Inc., Nationwide Life
Insurance Company, Nationwide Mutual Insurance Company,
the banks party thereto, Bank One, NA, as agent, and
Citicorp USA, Inc., as syndication agent (previously filed
as Exhibit 10.2 to Form 10-Q, Commission File Number
1-12785, filed August 6, 2004, and incorporated herein by
reference).
10.3 Employment Agreement dated January 1, 2004 and fully
executed on April 7, 2004 between Mark R. Thresher and
Nationwide Financial Services, Inc. (previously filed as
Exhibit 10.3 to Form 10-Q, Commission File Number 1-12785,
filed August 6, 2004, and incorporated herein by
reference).
31.1 Certification of W.G. Jurgensen pursuant to 18 U.S.C.
section 1350, as adopted pursuant to section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of M. Eileen Kennedy pursuant to 18 U.S.C.
section 1350, as adopted pursuant to section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of W.G. Jurgensen pursuant to 18 U.S.C.
section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002 (this exhibit is intended to be
furnished in accordance with Regulation S-K, Item
601(b)(32)(ii) and shall not be deemed "filed" for
purposes of Section 18 of the Securities Exchange Act of
1934 or incorporated by reference into any document filed
under the Securities Act of 1933, except as shall be
expressly set forth by specific reference to such filing).
32.2 Certification of M. Eileen Kennedy pursuant to 18 U.S.C.
section 1350, as adopted pursuant to section 906 of the
Sarbanes-Oxley Act of 2002 (this exhibit is intended to be
furnished in accordance with Regulation S-K, Item
601(b)(32)(ii) and shall not be deemed "filed" for
purposes of Section 18 of the Securities Exchange Act of
1934 or incorporated by reference into any document filed
under the Securities Act of 1933, except as shall be
expressly set forth by specific reference to such filing).
(b) Reports on Form 8-K:
On May 5, 2004, the Company filed a Current Report on Form 8-K
announcing the new management team and segment structure for
Nationwide Financial Services, Inc. (NFS).
On May 27, 2004, the Company filed a Current Report on Form 8-K
announcing that Standard and Poor's Ratings Services (S&P) issued
a press release announcing that it had affirmed its `AA-'
counterparty credit and financial strength ratings on Nationwide
Life Insurance Company, Nationwide Life and Annuity Insurance
Company, Nationwide Life Insurance Company of America and
Nationwide Life and Annuity Company of America, all of which are
wholly-owned subsidiaries of NFS. At the same time, S&P also
affirmed its `A-` counterparty credit and financial strength
ratings on NFS.
SIGNATURE
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.
NATIONWIDE LIFE INSURANCE COMPANY
(Registrant)
Date: August 6, 2004 /s/ M. Eileen Kennedy
-------------------------------------------------
M. Eileen Kennedy,
Senior Vice President -- Chief Financial
Officer