-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, StVNF+Plkl9oPCQFxYqAsvfgiI03T2TzbRODjlcgFWwajmWQ8vn2+xY4s5qBlWMA lyDIw9Swbl/vhHgw1bIuCQ== 0000070684-99-000002.txt : 19990402 0000070684-99-000002.hdr.sgml : 19990402 ACCESSION NUMBER: 0000070684-99-000002 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL WESTERN LIFE INSURANCE CO CENTRAL INDEX KEY: 0000070684 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 840467208 STATE OF INCORPORATION: CO FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 002-17039 FILM NUMBER: 99582294 BUSINESS ADDRESS: STREET 1: 850 E ANDERSON LN CITY: AUSTIN STATE: TX ZIP: 78752-1602 BUSINESS PHONE: 5128361010 10-K405 1 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, 1998 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________ Commission File Number: 2-17039 NATIONAL WESTERN LIFE INSURANCE COMPANY (Exact name of Registrant as specified in its charter) COLORADO 84-0467208 (State of Incorporation) (I.R.S. Employer Identification Number) 850 EAST ANDERSON LANE AUSTIN, TEXAS 78752-1602 (512) 836-1010 (Address of Principal Executive Offices) (Telephone Number) Securities registered pursuant to Section 12(b) of the Act: NONE Securities registered pursuant to Section 12(g) of the Act: EXEMPT 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ X ] The aggregate market value of the common stock (based upon the closing price) held by non-affiliates of the Registrant at March 15, 1999, was approximately $230,494,000. As of March 15, 1999, the number of shares of Registrant's common stock outstanding was: Class A - 3,298,128 and Class B - 200,000. PART I ITEM 1. BUSINESS (a) General Development of Business Life Insurance and Annuity Operations National Western Life Insurance Company (hereinafter referred to as "National Western," "Company," or "Registrant") is a life insurance company, chartered in the State of Colorado in 1956, and doing business in forty-three states and the District of Columbia. National Western also accepts applications from and issues policies to residents of various countries in Central and South America, the Caribbean, and the Pacific Rim. Such policies are accepted and issued in the United States. The Company's operations are generally segmented as follows: domestic life insurance, international life insurance, and annuity operations. During 1998, the Company recorded approximately $521 million in premium revenues, universal life, and investment annuity contract deposits. New life insurance issued during 1998 approximated $1.8 billion, and the total amount in force at year-end 1998 was $9.4 billion. As of December 31, 1998, the Company had total consolidated assets of $3.5 billion. Competition: The life insurance business is highly competitive, and National Western competes with approximately 1,600 stock and mutual companies. Best's Agents Guide To Life Insurance Companies, an authoritative life insurance publication, lists companies by total admitted assets and life insurance in force. As of December 31, 1997, the most recent date for which information is available, National Western ranked 151 in total admitted assets, 220 in net premiums written, and 232 in life insurance in force among approximately 1,600 life insurance companies domiciled in the United States. Life insurance companies compete not only on product design and price, but increasingly on policyowner service and marketing and sales efforts. National Western believes that its products, premium rates, policyowner service, and marketing efforts are generally competitive with those of other life insurance companies selling similar types of insurance. Mutual insurance companies may have certain competitive advantages over stock companies in that the policies written by them are participating policies and their profits inure to the benefit of their policyholders. The Company no longer writes participating policies, and such policies represent a minor portion of the Company's life insurance in force at December 31, 1998. There has been an ongoing consolidation of companies within the life insurance industry in recent years. It appears this consolidation process will continue as entities acquire other insurance companies, blocks of insurance business, or even related businesses. The reasons for the consolidations are numerous and include, among others, strengthening market share, diversifying into other lines of insurance, improving marketing and distribution channels, and economies of scale. For whatever reasons, this consolidation trend in the insurance industry will likely continue to affect competition. In addition to competition within the life insurance industry, National Western and other insurance companies face competition from other industries. Banks, brokerage firms, and other financial institutions also market insurance products or other competing products such as mutual funds. The continued growth and popularity of mutual funds has attracted large amounts of investment funds, particularly during periods of declining or low market interest rates. Many mutual funds also allow tax deferred features through individual retirement accounts, 401(k) plans, and other qualified methods which compete directly with the Company's tax deferred annuity products. Financial strength ratings of insurance companies also directly affect competitive positions within the industry. Most insurance companies obtain one or more ratings from independent rating agencies. National Western is rated "A- (excellent)" by A.M. Best Company. A.M. Best's ratings evaluate factors affecting the overall performance of an insurance company in order to provide an opinion of the Company's financial strength, operating performance, and ability to meet its obligations to policyholders. Ratings range from A++ (superior) to F (in liquidation). The "A-" rating identifies companies which have, on balance, demonstrated excellent financial strength, operating performance, and market profile when compared to the standards established by A.M. Best. These companies, in the opinion of A.M. Best, have a strong ability to meet their ongoing obligations to policyholders. National Western has also been assigned an "A+ (strong)" by Standard and Poor's Corporation. A Standard & Poor's rating is an opinion of the financial security characteristics of an insurance organization with respect to its ability to pay under its insurance policies and contracts in accordance with their terms. Ratings range from AAA (extremely strong) to CC (extremely weak) and R (regulatory action regarding solvency). In general, the above described ratings are developed and based on factors that are of more importance to policyholders, agents, and marketing organizations than to investors. In recent years, there has been increased emphasis and use of these financial strength ratings in the marketing efforts for insurance companies. While upgrades in ratings could be very positive for marketing efforts, declines in ratings could adversely affect product sales and persistency of policies currently in force. Agents and Employees: National Western has 249 employees at its principal executive office. Its insurance operations are conducted primarily through broker-agents, which numbered 10,395 at December 31, 1998. The agency operations are supervised by Senior Vice Presidents of domestic and international marketing. The Company's agents are independent contractors who are compensated on a commission basis. General agents receive overriding first-year and renewal commissions on business written by agents under their supervision. Many of the domestic marketing agents are contracted through independent marketing organizations. These organizations have well developed agent networks and extensive experience, financial resources, and success in marketing life insurance and annuity products. The international marketing broker-agents are a significantly smaller group than the domestic force. However, these broker-agents have been carefully selected and are proven producers, many of whom have been with the Company for 20 or more years. A significant portion of the Company's universal life and investment annuity contracts were sold through three marketing agencies in recent years. Combined business from these agencies accounted for approximately 30% of total direct premium revenues and universal life and investment annuity contract deposits for 1998. These same three marketing agencies accounted for 22% and 16% of total direct premium revenues and universal life and investment annuity contract deposits for 1997 and 1996, respectively. Types of Insurance Written: National Western offers a broad portfolio of individual whole life, universal life and term insurance plans, endowments, and annuities, including standard supplementary riders. Annuities sold include flexible premium deferred annuities, single premium deferred annuities, and single premium immediate annuities. These products can be tax qualified or nonqualified annuities. Although the Company introduced an equity-indexed annuity in 1997, no variable life or annuity products are currently offered. Except for a small employee health plan and a small number of existing individual accident and health policies, the Company does not write any new policies in the accident and health markets. Distributions of the Company's direct premium revenues and deposits by types of products are provided below:
Years Ended December 31, 1998 1997 1996 (In thousands) Investment annuities: Single premium deferred $ 131,716 195,752 234,335 Flexible premium deferred 278,605 32,702 35,813 Single premium immediate 20,682 12,533 3,054 Total annuities 431,003 240,987 273,202 Universal life insurance 69,647 65,862 67,438 Traditional life and other 20,237 21,506 23,135 Total direct premiums collected $ 520,887 328,355 363,775
Years Ended December 31, 1998 1997 1996 (In thousands) First year and single premiums: Investment annuities $ 412,443 218,203 243,686 Life insurance 22,145 19,045 20,509 Total first year and single 434,588 237,248 264,195 Renewal premiums: Investment annuities 18,560 22,784 29,516 Life insurance 67,739 68,323 70,064 Total renewal 86,299 91,107 99,580 Total direct premiums collected $ 520,887 328,355 363,775
The underwriting policy of the Company requires medical examination of applicants for ordinary insurance in excess of certain prescribed limits. These limits are graduated according to the age of the applicant and the amount of insurance desired. The Company has no maximum for issuance of life insurance on any one life. However, the Company's general policy is to reinsure that portion of any risk in excess of $200,000 on the life of any one individual. Also, following general industry practice, policies are issued on substandard risks. Geographical Distribution of Business: For the year 1998, insurance and annuity policies held by residents of the State of Texas accounted for 13% of premium revenues, universal life, and investment annuity contract deposits from direct business, while policies held by residents of Michigan, Florida, and California accounted for approximately 9%, 8%, and 7%, respectively. All other states of the United States accounted for 51% of premium revenues and deposits from direct business. The remaining 12% of premium revenues and deposits were derived from the Company's policies issued to foreign nationals, primarily in Central and South America, almost all of which was for individual life insurance. A distribution of the Company's direct premium revenues and deposits by domestic and international markets is provided below:
Years Ended December 31, 1998 1997 1996 (In thousands) United States domestic market: Investment annuities $ 429,309 239,338 273,057 Life insurance 30,878 31,248 34,029 Total domestic market 460,187 270,586 307,086 International market: Investment annuities 1,694 1,649 145 Life insurance 59,006 56,120 56,544 Total international market 60,700 57,769 56,689 Total direct premiums collected $ 520,887 328,355 363,775
Approximately 66% of the direct life insurance premiums collected during 1998 was sold through international insurance brokers acting as independent contractors. Foreign business is solicited by various independent brokers, primarily in Central and South America, and forwarded to the United States for acceptance and issuance. The Company maintains strict controls on the business it accepts from such foreign independent brokers, as well as its underwriting procedures for such business. Except for a small block of business, a currency clause is included in each foreign policy stating that premium and claim "dollars" refer to lawful currency of the United States. Traditional and universal life products are sold in the international market to individuals in upper socioeconomic classes. By marketing exclusively to this group, sales typically produce a higher average policy size, strong persistency, and claims experience similar to that in the United States. Investments: State insurance statutes prescribe the nature, quality, and percentage of the various types of investments which may be made by insurance companies and generally permit investments in qualified state, municipal, federal, and foreign government obligations, corporate bonds, preferred and common stock, real estate, and real estate first lien mortgages where the value of the underlying real estate exceeds the amount of the mortgage lien by certain required percentages. The following table shows the distribution of the Company's investments:
December 31, 1998 1997 1996 1995 1994 Securities held to maturity 64.7% 65.2% 67.6% 62.6% 68.5% Securities available for sale 23.4 22.6 19.0 22.9 15.1 Mortgage loans 5.6 6.3 7.0 7.3 8.1 Policy loans 4.0 4.7 5.1 5.6 6.5 Other investments 2.3 1.2 1.3 1.6 1.8 Totals 100.0% 100.0% 100.0% 100.0% 100.0%
The following table shows investment results for the periods indicated:
Net Realized Unrealized Invested Investment Gains (Losses) Gains Year Assets Income (A) On Investments (Losses) (B) (In thousands) 1998 $ 3,138,084 233,844 2,384 2,218 1997 2,877,340 217,446 (1,588) 3,929 1996 2,770,931 214,302 1,612 (5,342) 1995 2,624,596 201,816 (2,415) 17,394 1994 2,343,827 190,021 1,626 (1,942) Notes to Table: (A) Net investment income is after deduction of investment expenses, but before realized gains (losses) on investments and Federal income taxes. (B) Unrealized gains and losses, net of effects of deferred policy acquisition costs and taxes, relate only to those investment securities classified as available for sale.
Regulation: The Company is subject to regulation by the supervisory agency of each state or other jurisdiction in which it is licensed to do business. These agencies have broad administrative powers, including the granting and revocation of licenses to transact business, the licensing of agents, the approval of policy forms, the form and content of mandatory financial statements, capital, surplus, and reserve requirements, as well as the previously mentioned regulation of the types of investments which may be made. The Company is required to file detailed financial reports with each state or jurisdiction in which it is licensed, and its books and records are subject to examination by each. In accordance with the insurance laws of the various states in which the Company is licensed and the rules and practices of the National Association of Insurance Commissioners, examination of the Company's records routinely takes place every three to five years. These examinations are supervised by the Company's domiciliary state, with representatives from other states participating. The most recent completed examination of National Western was finalized in 1994 and covered the six-year period ended December 31, 1992. The states of Colorado and Delaware participated. A final report disclosing the examination results was received by the Company in March, 1995. The report contained no adjustments or issues which had a significant, negative impact on the operations of the Company. The Company is currently under routine examination for the five-year period ended December 31, 1997. The examination has been substantially completed and the final report is expected in 1999. No significant adjustments or issues have been communicated to the Company as a result of the examination in progress. Regulations that affect the Company and the insurance industry are often the result of efforts by the National Association of Insurance Commissioners (NAIC). The NAIC is an association of state insurance commissioners, regulators, and support staff that acts as a coordinating body for the state insurance regulatory process. The NAIC and state insurance regulators periodically re-examine existing laws and regulations. The NAIC has recently completed a comprehensive process of codifying statutory accounting practices and procedures. Other than specific individual state laws, the codification results will be the only source of prescribed statutory accounting practices. Insurance companies must adopt these new statutory accounting practices in 2001, which may result in significant changes to existing practices used in the preparation of statutory financial statements. Based on a preliminary review, National Western does not currently anticipate a material impact to its capital and surplus position as a result of implementation of the new prescribed statutory accounting procedures. Also of particular importance, the NAIC has established risk-based capital (RBC) requirements to help state regulators monitor the financial strength and stability of life insurers by identifying those companies that may be inadequately capitalized. Under the NAIC's requirements, each insurer must maintain its total capital above a calculated threshold or take corrective measures to achieve the threshold. The threshold of adequate capital is based on a formula that takes into account the amount of risk each company faces on its products and investments. The RBC formula takes into consideration four major areas of risk which are: (i) asset risk which primarily focuses on the quality of investments; (ii) insurance risk which encompasses mortality and morbidity risk; (iii) interest rate risk which involves asset/liability matching issues; and (iv) other business risks. The Company has calculated its RBC level and has determined that its capital and surplus is significantly in excess of the threshold requirements. In addition to RBC requirements, insurance companies are also monitored by the NAIC through its Insurance Regulatory Information System (IRIS). IRIS consists of two systems, the original IRIS system and the Financial Analysis and Solvency Tracking System. The original IRIS consists of two phases. The first is a statistical phase during which key financial ratio results are generated from the NAIC data base, which contains financial information obtained from insurers' statutory annual statements. The second, an analytical phase, is a review of the annual statements and financial ratios by experienced financial examiners. The ratios of companies are compared against usual ranges to identify trends or areas requiring additional review or analysis. All of the Company's ratios for 1998 were within usual ranges, with one exception. National Western exceeded a ratio which measures the percentage change in premiums collected from 1997 to 1998. Based on statutory financial statements, the Company's 1998 change in premiums ratio reflected an increase of 59%, which exceeded the upper IRIS threshold of 50%. Although this ratio did exceed the IRIS ranges, the significant increase positively reflects the Company's successful year for premium growth. The RBC regulation and IRIS system developed by the NAIC are examples of its involvement in the regulatory process. Additionally, new regulations are routinely published by the NAIC as model acts or model laws. The NAIC encourages adoption of these model acts by all states to provide uniformity and consistency among state insurance regulations. While the insurance industry is primarily regulated by state governments, federal regulation also affects the industry in various areas such as pension regulations, securities laws, and federal taxation. For example, annuity and insurance products have certain income tax advantages for policyholders compared to other savings investments such as certificates of deposits and taxable bonds. Unlike many other investments, increases in the contract values of annuity and life insurance products are not subject to income taxation until these values are actually paid to and received by the policyholder. At various times, the federal government has considered revising or eliminating this income tax deferral. Such a change, if ever enacted, could have an adverse effect on the Company's ability to sell certain annuity and insurance products. Additionally, tax legislation has reduced the individual capital gains tax rate from 28% to 20%. Because many consumers purchase annuities and life insurance for their tax deferral advantages over other investments or retirement products, a reduction in the Federal income tax rate for capital gains could increase the attractiveness of competing products. Although National Western has not experienced any negative impact on its sales, changes such as these have the potential to adversely impact Company and industry wide sales. There have also been numerous proposals in recent years to modify the existing federal income tax laws. Some proposals outline measures to implement a "flat tax" structure that would lower the marginal tax rates for many taxpayers. Other proposals call for eliminating the existing income tax and implementing a "consumption based tax." Adoption of any of these new methods, particularly the consumption based tax, could have adverse effects on the insurance industry, as the value of annuity and life insurance products with income tax deferral advantages would be lessened or minimized. However, it is impossible to predict what changes, if any, will be made to the existing federal income tax structure and the timing of any such changes. Discontinued Brokerage Operations In addition to life insurance and annuity operations, the Company had a brokerage operations segment through its wholly owned subsidiary, The Westcap Corporation (Westcap). However, during 1995 Westcap closed its sales offices and approved a plan to cease all brokerage operations. Declines in both sales revenues and earnings were the principal reasons for ceasing brokerage operations. The declines resulted primarily from adverse bond market conditions and adverse publicity about litigation. Subsequently on April 12, 1996, Westcap and its wholly owned subsidiary, Westcap Enterprises, Inc., separately filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code. The bankruptcy reorganization was completed in January, 1999, National Western retained 100% continuing ownership of the reorganized Westcap, and the subsidiary is now operating as a real estate management company. The brokerage segment is reported as discontinued operations throughout this report and in the accompanying financial statements. The bankruptcy and ultimate settlement are more fully described in Item 3, Legal Proceedings, and in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations. (b) Financial Information About Industry Segments A summary of financial information for the Company's industry segments follows:
Domestic International Life Life All Insurance Insurance Annuities Others Totals (In thousands) Revenues, excluding realized gains (losses): 1998 $ 51,257 62,578 214,049 3,346 331,230 1997 50,555 61,914 198,619 2,774 313,862 1996 52,648 58,152 199,447 (650) 309,597 Segment earnings: (A) 1998 $ 6,395 6,397 27,508 2,224 42,524 1997 5,901 7,143 28,389 1,821 43,254 1996 8,710 7,150 29,550 (425) 44,985 Segment assets: (B) 1998 $ 412,538 373,201 2,692,330 19,285 3,497,354 1997 405,427 359,986 2,429,998 14,058 3,209,469 1996 400,747 345,834 2,353,445 6,074 3,106,100 Notes to Table: (A) These amounts exclude realized gains and losses on investments and losses from discontinued operations, net of taxes. (B) These amounts exclude assets of discontinued operations and other unallocated assets.
Additional information concerning these industry segments is included in Item 1.(a). (c) Narrative Description of Business Included in Item 1.(a). (d) Financial Information About Foreign and Domestic Operations and Export Sales Included in Item 1.(a). ITEM 2. PROPERTIES The Company leases approximately 72,000 square feet of office space in Austin, Texas, for $477,600 per year plus taxes, insurance, maintenance, and other operating costs. This lease expires in 2000. National Western is currently negotiating to extend this existing lease. Lease costs and related operating expenses for office facilities of the Company's subsidiaries are not significant in relation to the Company's consolidated financial statements. ITEM 3. LEGAL PROCEEDINGS The Westcap Corporation Bankruptcy Proceedings By order dated August 28, 1998, the United States Bankruptcy Court, Southern District of Texas, Houston Division, confirmed and approved the Third Amended Joint Consensual Plan of Reorganization (the Plan) of The Westcap Corporation and its wholly owned subsidiary, Westcap Enterprises, Inc. (jointly Westcap). Westcap is a wholly owned subsidiary of National Western Life Insurance Company (National Western). Pursuant to the Plan, National Western received credit for $1,000,000 previously contributed to Westcap in bankruptcy in March, 1997, and paid an additional $14,125,000 to compromise and settle (i) all claims of Westcap against National Western, and (ii) all claims and litigation of certain settling creditors of Westcap who have alleged federal or state securities law "control person" violations by National Western relating to Westcap's brokerage business, in exchange for full and complete releases from all of such claims, litigation, and alleged violations. Of the $14,125,000, amounts totaling $7,284,000 were paid and transmitted to a Disbursing Trust Committee on behalf of Westcap for payment to holders of allowed claims against the Westcap debtors, and National Western paid $6,841,000 to settling Westcap creditors with allowed claims against the Westcap debtors who also settled and released National Western from alleged federal or state securities law "control person" violations relating to Westcap. The settling creditors were: City of Tracy, California; Michigan South Central Power Agency; Covafer, S.A. and Sergio Covarrubias; Sheriff of Palm Beach County, Florida; San Antonio River Authority; Tom Green County, Texas; Eduardo and Antonietta Saad; City of La Mesa; Darlington County, South Carolina; Greenwood County, South Carolina; Bernice and Sarah Finger; Winston-Salem State University Foundation; Mary Robin Christison; Mason Tenders; Clerk of the Circuit Court of St. Lucie County, Florida. Pursuant to the Plan, National Western retained 100% continuing ownership of the reorganized Westcap. Westcap will no longer engage in brokerage operations, but will operate as a real estate management company. Community College District No. 508, County of Cook and State of Illinois (The City Colleges), was excluded from the compromise and settlement by National Western with the settling creditors, but participated with all creditors in the distribution from Westcap. In addition to the amounts described above, included in the distribution to the Disbursing Trust were $48,000 of Westcap assets. The City Colleges had previously obtained a bankruptcy court judgment for approximately $56 million against the Westcap debtors (which was subsequently reduced to approximately $52 million). Under the Plan, The City Colleges participated in the $7,332,000 creditor distribution relating to an allowed $30 million claim, with any distribution relating to the remaining $26 million claim in dispute pending an appeal by Westcap of the bankruptcy judgment. Should Westcap prevail in the appeal, National Western will be entitled to recover 23.1% of the reduced amount of The City Colleges judgment, but not to exceed $600,000. Should Westcap lose the appeal, The City Colleges will receive a higher prorata percentage of the $7,332,000 creditor distribution. However, pursuant to the Plan, National Western will have no additional liability for settlement payments in excess of the $14,125,000 as described above. Under the Plan, National Western will pay all of the attorneys' fees and court costs incurred by Westcap in the appeal of The City Colleges' judgment. The $14,125,000 was paid by National Western on January 13, 1999. However, the settlement payment has been accrued in other liabilities as of December 31, 1998, and reflected as a 1998 loss from discontinued operations in the accompanying financial statements. The $1,000,000 previously contributed to Westcap in bankruptcy was also reflected as a loss from discontinued operations in 1997. Any additional losses will depend on the results of The City Colleges lawsuit filed against National Western on March 28, 1994, for alleged federal or state securities law "control person" violations relating to Westcap, and which is pending in the United States District Court, Western District of Texas. National Western believes it has reasonable and adequate defenses to this suit, and, accordingly, no amounts have been accrued in National Western's financial statements for potential losses relating to such suit. Westcap Related Litigation On March 28, 1994, the Community College District No. 508, County of Cook and State of Illinois (The City Colleges), filed a complaint in the United States District Court for the Northern District of Illinois, Eastern Division, against National Western Life Insurance Company (the Company or National Western) and subsidiaries of The Westcap Corporation (Westcap), a wholly owned subsidiary of the Company. The suit sought rescission of securities purchase transactions by The City Colleges from Westcap between September 9, 1993, and November 3, 1993, alleged compensatory damages, punitive damages, injunctive relief, declaratory relief, fees, and costs. National Western was named as a "controlling person" of the Westcap defendants. Westcap filed Chapter 11 bankruptcy, and The City Colleges filed a claim in the bankruptcy court against Westcap. The claim was tried before the bankruptcy court, and in September, 1997, a $56,173,000 judgment was entered against Westcap favorable to The City Colleges. Westcap appealed this decision to the United States District Court for the Southern District of Texas (Houston Division). On July 24, 1998, the United States District Court affirmed the orders of the bankruptcy court with respect to their underlying conclusion that Westcap is liable to The City Colleges under the Texas Securities Act, but the Court vacated the orders and remanded them to the bankruptcy court to determine the correct amount of damages in a manner consistent with the Court's opinion and the Texas Securities Act. The bankruptcy court on November 16, 1998, entered an order allowing a claim of The City Colleges against the Westcap estate of $51,738,868. Westcap will appeal the bankruptcy court's and District Court's judgment to the Fifth Circuit Court of Appeals. While Westcap is a wholly owned subsidiary of the Company, the Company is not a party to the bankruptcy or the judgment against Westcap by the bankruptcy court or the United States District Court. The lawsuit against the Company was stayed in September, 1994, pending resolution of The City Colleges' claim against Westcap. Following the judgment against Westcap in the bankruptcy court, on December 2, 1997, the stay was lifted by the United States District Court in Illinois, and The City Colleges filed an amended complaint seeking to hold the Company liable for the claim allowed in the bankruptcy court against Westcap under the "control person" provision of the Texas Securities Act. The suit seeks approximately $56 million plus fees and costs. The Company filed jurisdictional and venue motions to have the case transferred to the United States District Court for the Western District of Texas, which motions were agreed to by the Plaintiff, and the case is now pending in the United States District Court for the Western District of Texas, where the parties are engaged in discovery activities. The Company believes it has reasonable and adequate defenses to the suit. Although the alleged damages, if sustained, would be material to the Company's financial statements, a reasonable estimate of any actual losses which may result from the suit cannot be made at this time. Accordingly, no provision for any liability that may result from this suit has been recognized in the accompanying financial statements. On July 5, 1995, San Patricio County, Texas, filed suit in the District Court of San Patricio County, Texas, against National Western Life Insurance Company (the Company) and its chief executive officer, Robert L. Moody. The suit arose from derivative investments purchased by San Patricio County from Westcap Securities, L.P. or Westcap Government Securities, Inc., affiliates of The Westcap Corporation. The suit alleged that the Westcap affiliates were controlled by the Company and Mr. Moody and that they were responsible for the alleged wrongful acts of the Westcap affiliates in selling the securities to the Plaintiff. Plaintiff alleged that the Westcap affiliates violated duties and responsibilities owed to the Plaintiff related to the investment recommendations and decisions made by Plaintiff, and alleged that the Plaintiff was financially damaged by such actions of Westcap. The suit was settled effective March 9, 1998, with a payment of $200,000 by National Western to San Patricio County and with no admission of liability. In exchange for the payment, National Western and Robert L. Moody received a general release of all claims asserted, including all claims that have been asserted against Westcap Securities, L.P., or could have been asserted in another court against Westcap Securities, L.P., and the lawsuit was dismissed. The $200,000 settlement payment was recorded as other operating expenses in 1998. Class Action Litigation National Western Life Insurance Company (the Company or National Western) and National Annuity Programs, Inc. (NAP), have been sued in the District Court of Travis County, Texas, by a former agent of the Company, eight plaintiffs, and fourteen intervenors, being present and past annuity policyholders of the Company, and on behalf of an asserted class of annuity policyholders of the Company, and alleged that, in the sale of certain Company annuities to the plaintiffs and intervenors, the Company and NAP (i) had violated the Texas Deceptive Trade Practices-Consumer Protection Act, statutes in the Texas Insurance Code, and certain rules and regulations of the Texas Department of Insurance; (ii) committed common law fraud; (iii) were negligent; (iv) had breached a duty of good faith and fair dealing; (v) made negligent misrepresentations; (vi) committed a civil conspiracy to commit fraud; and (vii) breached policy contracts. The plaintiffs seek (i) certification of one or more classes; and (ii) recovery of unspecified actual damages, monies paid by plaintiffs, attorneys' fees, prejudgment and postjudgment interests and costs, increased or treble damages, punitive damages, and general relief as awarded by the Court. NAP was an independent marketing general agency under contract with the Company that hired and supervised the agents marketing the annuity products on behalf of the Company. On September 8, 1998, National Western, NAP, and the policyholder plaintiffs, intervenors, and class-representatives in this class action litigation filed with the Court a joint motion for preliminary approval of a Settlement Agreement among the parties. The parties requested the Court to review the Settlement Agreement and make a preliminary determination that it is fair, adequate, and reasonable to the members of the proposed classes and that the proposed classes are capable of being certified for settlement purposes, to approve the form of the notices of the settlement to the classes, and to set a class certification and fairness hearing on the settlement. In exchange for a final order and judgment dismissing with prejudice the claims asserted against National Western and NAP by all members of the settlement classes, National Western will contribute approximately $5 million to the proposed settlement, and NAP will pay $750,000 to the settlement. Approximately $3,850,000 will be made available for the members of the various classes that qualify for payments, and $1,900,000 will be paid for attorneys' fees and expenses. There is a possibility that National Western's total payment to members of the classes could increase, but it is believed that the amount would not be material. In the settlement, National Western guarantees that at least $900,000 will be paid out to approved claims by members of the classes, and any unclaimed amounts are to be returned to National Western. Additionally, National Western has agreed to pay the costs of notice to the class and administration of the settlement claims process, estimated to be approximately $250,000. National Western has also agreed to guarantee minimum interest rates of 3% and 5% in the future on certain settlement options under specified annuity policies which are the subject matter of the litigation and to provide additional incidental settlement benefits, all as detailed in the motion and Settlement Agreement. The plaintiffs estimate that the aggregate value of all of the settlement benefits, including the $5,750,000 settlement payments and potential future benefits to be derived by policyholders under certain policy settlement elections, is approximately $10 million. On September 9, 1998, the District Court entered an order temporarily certifying a settlement class, preliminarily approved the Settlement Agreement between the parties, determined that it is appropriate to send notice to the proposed class members of the Settlement Agreement, approved the form and content of the notices to the members of the class, authorized National Western to retain an administrator to supervise the Settlement Agreement offer to members of the class, set a "fairness hearing" on the Settlement Agreement for January 20, 1999, and enjoined other actions. National Western proceeded with notification of class members and preliminary administration of the claims process during late 1998 and January, 1999. Estimated costs for this process totaling $250,000 were accrued as other operating expenses as of December 31, 1998, in the accompanying financial statements. On January 20, 1999, the Court held a "fairness hearing" and approved the Settlement Agreement. As a result, National Western also accrued the estimated $5,000,000 settlement as other operating expenses as of December 31, 1998. The actual settlement payments are expected to be paid during 1999. Other Pending Litigation On December 31, 1997, National Western Life Insurance Company (National Western) filed a declaratory judgment action against National Annuity Programs, Inc. (NAP) and Robert L. Myer (Myer) for construction of a General Agent Manager Contract and amendments thereto between National Western and NAP, a declaration that the contract is enforceable, and for an award for damages. The contract was entered into in 1983 and amended in 1994, by which NAP was to market insurance and annuity products issued by National Western. The suit alleges that during the course of the contract NAP violated its terms and conditions, violated the insurance laws and regulations of the State of Texas, misrepresented the terms and conditions of National Western's insurance and annuity products, induced National Western's policyholders to relinquish or terminate its policies of insurance or annuities, and failed to use reasonable efforts to conserve its insurance and annuity products. National Western seeks (i) to withhold, deduct, and/or terminate the payment of agency commissions under the contract to NAP, which are based on future premiums received and policies maintained in force; (ii) damages from breach of the contract; (iii) recovery of damages from Robert L. Myer for tortious interference with National Western's contractual relations with its policyholders; (iv) recovery of damages from Robert L. Myer for conspiracy to cause NAP to breach its contract with National Western and to induce its policyholders to terminate their policies with National Western; and (v) reasonable attorneys' fees, costs, and expenses. The parties have started discovery proceedings. National Western Life Insurance Company is also currently a defendant in several other lawsuits, substantially all of which are in the normal course of business. In the opinion of management, the liability, if any, which may arise from these lawsuits would not have a material adverse effect on the Company's financial position. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the Company's security holders during the fourth quarter of 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS (a) Market Information The principal market on which the common stock of the Company is traded is The Nasdaq Stock Market under the symbol NWLIA. The high and low sales prices for the common stock for each quarter during the last two years are shown in the following table:
High Low 1998: First Quarter $ 106-5/8 95-1/4 Second Quarter 118-7/8 101-5/8 Third Quarter 158-7/8 108 Fourth Quarter 125-1/8 108 1997: First Quarter $ 91-1/4 79 Second Quarter 91-1/2 81-1/2 Third Quarter 103 85-3/4 Fourth Quarter 107-1/2 93-3/4
(b) Equity Security Holders The number of stockholders of record on December 31, 1998, was as follows: Class A Common Stock 6,146 Class B Common Stock 2
(c) Dividends The Company has never paid cash dividends on its common stock. Payment of dividends is within the discretion of the Company's Board of Directors and will depend on factors such as earnings, capital requirements, and the operating and financial condition of the Company. Presently, the Company's capital requirements are such that it intends to follow a policy of retaining any earnings in order to finance the development of business and to meet regulatory requirements for capital. A strong capital position is important not only for the protection of existing policyholders, but also in the successful marketing of Company products to new customers. ITEM 6. SELECTED FINANCIAL DATA The following five-year financial summary includes comparative amounts taken from the audited financial statements. Earnings Information:
Years Ended December 31, 1998 1997 1996 1995 1994 (In thousands except per share amounts) Revenues: Life and annuity premiums $ 13,165 15,812 16,611 17,390 18,938 Universal life and investment annuity contract revenues 83,169 80,250 75,966 69,783 64,711 Net investment income 233,844 217,446 214,302 201,816 190,021 Other income 1,052 354 2,718 661 1,462 Realized gains (losses) on investments 2,384 (1,588) 1,612 (2,415) 1,626 Total revenues 333,614 312,274 311,209 287,235 276,758 Expenses: Policyholder benefits 32,441 35,285 33,313 37,336 32,790 Amortization of deferred policy acquisition costs 40,415 39,934 30,361 33,675 32,131 Universal life and investment annuity contract interest 158,889 145,200 151,475 142,940 129,064 Other operating expenses 35,504 27,560 25,722 27,084 29,394 Total expenses 267,249 247,979 240,871 241,035 223,379 Earnings before Federal income taxes and discontinued operations 66,365 64,295 70,338 46,200 53,379 Federal income taxes 17,347 21,723 24,123 10,566 16,207 Earnings from continuing operations 49,018 42,572 46,215 35,634 37,172 Losses from discontinued operations (14,125) (1,000) - (16,350) (2,936) Net earnings $ 34,893 41,572 46,215 19,284 34,236 Diluted Earnings Per Share: (A) Earnings from continuing operations $ 13.87 12.09 13.17 10.20 10.66 Losses from discontinued operations (4.00) (0.28) - (4.68) (0.84) Net earnings $ 9.87 11.81 13.17 5.52 9.82 Balance Sheet Information: Total assets $ 3,518,003 3,225,563 3,120,829 2,958,459 2,915,054 Total liabilities $ 3,079,638 2,824,700 2,767,969 2,646,472 2,639,920 Stockholders' equity $ 438,365 400,863 352,860 311,987 275,134 Note to Table: (A) - Amounts have been restated in accordance with the implementation of Statement of Financial Accounting Standards No. 128, "Earnings Per Share."
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL National Western Life Insurance Company is a life insurance company, chartered in the State of Colorado in 1956, and doing business in forty-three states and the District of Columbia. It also accepts applications from and issues policies to residents of various Central and South American, Caribbean, and Pacific Rim countries. A distribution of the Company's direct premium revenues and deposits by domestic and international markets is provided below:
Years Ended December 31, 1998 1997 1996 United States domestic market: Investment annuities 82.4% 72.9% 75.1% Life insurance 5.9 9.5 9.3 Total domestic market 88.3 82.4 84.4 International market: Investment annuities 0.3 0.5 0.1 Life insurance 11.4 17.1 15.5 Total international market 11.7 17.6 15.6 Total direct premiums collected 100.0% 100.0% 100.0%
Insurance Operations - Domestic The Company's domestic operations concentrate marketing efforts on federal employees, seniors, and specific employee groups in private industry, as well as individual sales. The products marketed are annuities, universal life insurance, and traditional life insurance, which includes both term and whole life products. The majority of products sold are the Company's annuities, which include single and flexible premium deferred annuities, single premium immediate annuities, and equity-indexed annuities. Most of these annuities can be sold as tax qualified or nonqualified products. National Western markets and distributes its domestic products primarily through independent marketing organizations (IMOs). These IMOs assist the Company in recruiting, contracting, and managing agents. The Company currently has over 80 IMOs contracted for sales of life and annuity products. This represents a significant increase from 1997, as numerous organizations were added in 1998 that should be able to meet the Company's minimum production standards. Insurance Operations - International The Company's international operations focus marketing efforts on foreign nationals in upper socioeconomic classes with substantial financial resources. Insurance sales are from countries in Central and South America, the Caribbean, and the Pacific Rim. Marketing to numerous countries in these different regions provides diversification that helps to minimize large fluctuations in sales that can occur due to various economic, political, and competitive pressures that may occur from one country to another. Products sold in the international market are almost entirely universal life and traditional life insurance products. However, certain annuity and investment contracts are also available in this market. International sales production is from broker-agents, many of whom have been selling National Western products for 20 or more years. The Company continues to expand its sales networks in specifically targeted South American and Pacific Rim countries which have higher growth potential than other countries. There are inherent risks of conducting international business that are not present within the domestic market. The risks involved with international business are reduced substantially by the Company in several ways. As previously described, the Company focuses its marketing efforts on a specific niche group, which is foreign nationals in upper socioeconomic classes who have substantial financial resources. This targeted customer base coupled with National Western's conservative, yet competitive, underwriting practices have historically resulted in claims experience similar to that in the United States. The Company also minimizes exposure to foreign currency risks, as almost all foreign policies require payment of premiums and claims in United States dollars. Finally, the Company's experience in the international market and its strong broker-agent relationships, which in many cases exceed 20 years, help minimize risks and problems when selling products to foreign nationals. Other In addition to the life insurance business, the Company had a brokerage operations segment through its wholly owned subsidiary, The Westcap Corporation (Westcap). However, during 1995 Westcap closed its sales offices and approved a plan to cease all brokerage operations. Subsequently on April 12, 1996, Westcap and its wholly owned subsidiary, Westcap Enterprises, Inc., separately filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code. The bankruptcy reorganization was completed in January, 1999, National Western retained 100% continuing ownership of the reorganized Westcap, and the subsidiary is now operating as a real estate management company. However, the brokerage segment is reported as discontinued operations throughout this report and in the accompanying financial statements. INVESTMENTS IN DEBT AND EQUITY SECURITIES Investment Philosophy The Company's investment philosophy is to maintain a diversified portfolio of investment grade debt and equity securities that provide adequate liquidity to meet policyholder obligations and other cash needs. The prevailing strategy within this philosophy is the intent to hold investments in debt securities to maturity. However, the Company manages its portfolio, which entails monitoring and reacting to all components which affect changes in the price, value, or credit rating of investments in debt and equity securities. Investments in debt and equity securities are classified and reported as either securities held to maturity or securities available for sale. The Company does not maintain a portfolio of trading securities. The reporting category chosen for the Company's securities investments depends on various factors including the type and quality of the particular security and how it will be incorporated into the Company's overall asset/liability management strategy. At December 31, 1998, approximately 26% of the Company's total debt and equity securities, based on fair values, were classified as securities available for sale. These holdings provide flexibility to the Company to react to market opportunities and conditions and to practice active management within the portfolio to provide adequate liquidity to meet policyholder obligations and other cash needs. Securities the Company purchases with the intent to hold to maturity are classified as securities held to maturity. Because the Company has strong cash flows and matches expected maturities of assets and liabilities, the Company has the ability to hold the securities, as it would be unlikely that forced sales of securities would be required prior to maturity to cover payments of liabilities. As a result, securities held to maturity are carried at amortized cost less declines in value that are other than temporary. However, certain situations may change the Company's intent to hold a particular security to maturity, the most notable of which is a deterioration in the issuer's creditworthiness. Accordingly, a security may be sold to avoid a further decline in realizable value when there has been a significant change in the credit risk of the issuer. Securities that are not classified as held to maturity are reported as securities available for sale. These securities may be sold if market or other measurement factors change unexpectedly after the securities were acquired. For example, opportunities arise that allow the Company to improve the performance and credit quality of the investment portfolio by replacing an existing security with an alternative security while still maintaining an appropriate matching of expected maturities of assets and liabilities. Examples of such improvements are as follows: improving the yield earned on invested assets, improving the credit quality, changing the duration of the portfolio, and selling securities in advance of anticipated calls or other prepayments. Securities available for sale are reported in the Company's financial statements at fair value. Any unrealized gains or losses resulting from changes in the fair value of the securities are reflected in accumulated other comprehensive income. As an integral part of its investment philosophy, the Company performs an ongoing process of monitoring the creditworthiness of issuers within the investment portfolio. Review procedures are also performed on securities that have had significant declines in fair value. The Company's objective in these circumstances is to determine if the decline in fair value is due to changing market expectations regarding inflation and general interest rates or other factors. Additionally, the Company closely monitors financial, economic, and interest rate conditions to manage prepayment and extension risks in its mortgage-backed securities portfolio. The Company's overall conservative investment philosophy is reflected in the allocation of its investments which is detailed below as of December 31, 1998 and 1997. The Company emphasizes investment grade debt securities, with smaller holdings in mortgage loans and real estate.
Percent of Investments 1998 1997 Debt securities 87.6% 87.3% Mortgage loans 5.6 6.3 Policy loans 4.0 4.7 Index options 0.8 - Equity securities 0.5 0.5 Real estate 0.4 0.5 Other 1.1 0.7 Totals 100.0% 100.0%
Portfolio Analysis The Company maintains a diversified debt securities portfolio which consists of various types of fixed income securities including primarily corporate, mortgage-backed securities, and public utilities. Investments in mortgage-backed securities include primarily U.S. government agency pass-through securities and collateralized mortgage obligations (CMOs). As of December 31, 1998, 1997, and 1996, the Company's debt securities portfolio consisted of the following mix of securities based on amortized cost:
Percent of Debt Securities 1998 1997 1996 Corporate 53.9% 50.1% 45.5% Mortgage-backed securities 22.5 27.9 33.5 Public utilities 13.3 13.3 15.1 Asset-backed securities 7.0 4.5 1.0 Foreign governments 1.9 2.0 2.2 States & political subdivisions 1.1 1.1 1.1 U.S. government 0.3 1.1 1.6 Totals 100.0% 100.0% 100.0%
The amortized cost and estimated fair values of investments in debt securities at December 31, 1998, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Amortized Fair Cost Value (In thousands) Due in one year or less $ 7,005 6,995 Due after one year through five years 386,762 395,497 Due after five years through ten years 1,251,817 1,318,770 Due after ten years 267,880 291,256 1,913,464 2,012,518 Mortgage and asset-backed securities 800,579 832,072 Totals $ 2,714,043 2,844,590
An important aspect of the Company's investment philosophy is managing the cash flow stability of the portfolio. Because expected maturities of securities may differ from contractual maturities due to prepayments, extensions, and calls, the Company takes steps to manage and minimize these risks. The Company continues to reduce its exposure to prepayment and extension risks by lowering its holdings of mortgage-backed securities. This strategy began in 1994 when mortgage-backed securities totaled 47.6% of the entire portfolio, but now total only 22.5% at December 31, 1998. The majority of this reduction has been achieved by shifting investments into corporate securities, as corporate holdings have increased from 32.5% in 1994 to 53.9% in 1998. Also, most of these additions have been noncallable corporates which help reduce prepayment and call risks. As indicated above, the Company's holdings of mortgage-backed securities are also subject to prepayment risk, as well as extension risk. Both of these risks are addressed by specific portfolio management strategies. The Company has substantially reduced both prepayment and extension risks by investing primarily in collateralized mortgage obligations which have more predictable cash flow patterns than pass-through securities. These securities, known as planned amortization class I (PAC I) CMOs, are designed to amortize in a more predictable manner than other CMO classes or pass-throughs. Using this strategy, the Company can more effectively manage and reduce prepayment and extension risks, thereby helping to maintain the appropriate matching of the Company's assets and liabilities. As of December 31, 1998, CMOs represent approximately 92% of the Company's mortgage-backed securities. The CMOs in the Company's portfolio have been modeled and subjected to detailed, comprehensive analysis by the Company's investment staff. The overall structure of the CMO as well as the individual tranche being considered for purchase have been evaluated to ensure that the security fits appropriately within the Company's investment philosophy and asset/liability management parameters. The Company's investment mix between mortgage-backed securities and other fixed income securities helps effectively balance prepayment, extension, and credit risks. In addition to managing prepayment, extension, and call risks, the Company closely manages the credit quality of its investments in debt securities. Thorough credit analysis is performed on potential corporate investments including examination of a Company's credit and industry outlook, financial ratios and trends, and event risks. The Company continues to follow its conservative investment philosophy by minimizing its holdings of below investment grade debt securities, as these securities generally have greater default risk than higher rated corporate debt. These issuers usually are more sensitive to adverse industry or economic conditions than are investment grade issuers. The Company's small holdings of below investment grade debt securities are summarized below.
Below Investment Grade Debt Securities % of Carrying Market Invested Value Value Assets (In thousands except percentages) December 31, 1998 $ 44,974 45,317 1.4% December 31, 1997 $ 41,149 41,969 1.4% December 31, 1996 $ 38,696 38,784 1.4%
The Company's strong credit risk management and commitment to quality has resulted in minimal defaults in the debt securities portfolio in recent years. In fact, at December 31, 1998 and 1997, no securities were in default and on nonaccrual status, and at December 31, 1996, securities totaling only $2,945,000 were in such status. The Company's commitment to high quality investments in debt securities is also reflected in the portfolio's high average credit rating. In the table below, investments in debt securities are classified according to credit ratings by Standard and Poor's (S&P), a nationally recognized statistical rating organization (NRSRO). If securities were not rated by S&P, the equivalent rating of another NRSRO or the National Association of Insurance Commissioners was used.
December 31, 1998 1997 AAA and U.S. government 29.7% 33.3% AA 8.0 6.5 A 34.4 33.1 BBB 26.2 25.4 BB and other below investment grade 1.7 1.7 100.0% 100.0%
At December 31, 1998, unrealized gains in the Company's debt and equity securities portfolios were as follows:
Fair Amortized Unrealized Value Cost Gains (In thousands) Securities held to maturity: Debt securities $ 2,124,715 2,029,728 94,987 Securities available for sale: Debt securities 719,875 684,315 35,560 Equity securities 15,712 12,018 3,694 Totals $ 2,860,302 2,726,061 134,241
As detailed above, debt securities classified as held to maturity comprise the majority of the Company's securities portfolio, while equity securities continue to be a small component of the portfolio. Unrealized gains totaling $134,241,000 on the securities portfolio at December 31, 1998, is a reflection of market interest rates at year-end. The fair values, or market values, of fixed income debt securities correlate to external market interest rate conditions. Because the interest rates are fixed on almost all of the Company's debt securities, market values typically increase when market interest rates decline, and decrease when market interest rates rise. This correlation between market values and interest rates is reflected in the tables below.
December 31, 1998 1997 1996 (In thousands except percentages) Fair value $ 2,844,590 2,588,326 2,406,855 Amortized cost $ 2,714,043 2,482,806 2,365,111 Fair value as a percentage of amortized cost 104.8 % 104.3 % 101.8 % Unrealized gains at year-end $ 130,547 105,520 41,744 Ten-year U.S. Treasury bond - change in yield for the year (1.0)% (0.7)% 0.9 %
Unrealized Gains Increase in At At Unrealized December 31, December 31, Gains 1998 1997 During 1998 (In thousands) Securities held to maturity: Debt securities $ 94,987 75,233 19,754 Securities available for sale: Debt securities 35,560 30,287 5,273 Equity securities 3,694 3,175 519 Totals $ 134,241 108,695 25,546
As reflected above, changes in interest rates of 100 basis points or even less can have a significant impact on the market values of the Company's debt securities. The Company would expect similar results in the future from any significant upward or downward movement in market rates. However, because the majority of the Company's debt securities are classified as held to maturity, the changes in market values have had relatively small effects on the Company's financial statements. Changes in fair values of securities due to changes in market interest rates is an example of market risk. Market risk is the risk of change in market values of financial instruments due to changes in interest rates, currency exchange rates, commodity prices, or equity prices. The most significant market risk exposure for National Western is interest rate risk. The Company manages interest rate risk through on-going cash flow testing required for insurance regulatory purposes. Computer models are used to perform cash flow testing under various commonly used stress test interest rate scenarios to determine if existing assets would be sufficient to meet projected liability outflows. Management strives to closely match the durations of its assets and liabilities. Sensitivity analysis allows the Company to measure the potential gain or loss in fair value of its interest-sensitive instruments and to seek to protect its economic value and achieve apredictable spread between what is earned on invested assets and what is paid on liabilities. The Company seeks to minimize the impact of interest risk through surrender charges that are imposed to discourage policy surrenders. Interest rate changes can be anticipated and risk may be limited due to management actions regarding asset and liability instruments. However, potential changes in the values of financial instruments indicated by hypothetical interest changes will likely be different from actual changes experienced, and the differences may be material. Market risk-sensitive assets include debt securities, equity securities which are almost entirely preferred stocks, mortgage loans, policy loans, and index options. The Company does not maintain a securities trading portfolio. Market risk-sensitive liabilities include policy liabilities for deferred and immediate investment annuity contracts and supplemental contracts. Sensitivity analysis expresses the potential gain or loss in fair value, over a selected time period, from one or more selected hypothetical changes in interest rates which are reasonably possible in the near term. The following table illustrates the market risk sensitivity of the Company's interest rate- sensitive assets. The table measures the effect of a change in interest rates on the fair value of the portfolio. The data is prepared using models that measure the change in fair value arising from an immediate and sustained change in interest rates in increments of 100 basis points.
Fair Values Changes in Interest Rates in Basis Points - 100 0 + 100 + 200 (In thousands) Assets: Debt and equity securities $ 2,990,901 2,860,302 2,724,249 2,589,637 Mortgage loans 193,126 186,161 179,632 173,480 Policy loans 161,890 150,583 140,517 131,519 Index options 23,613 23,900 24,185 24,467
The debt securities portfolio includes primarily noncallable corporate bonds, mortgage-backed securities, and asset-backed securities. Expected maturities of debt securities may differ from contractual maturities due to call or prepayment provisions. The model assumes that prepayments on mortgage-backed securities are influenced by agency and pool types, the level of interest rates, loan age, refinancing incentive, month of the year, and underlying coupon. During periods of declining interest rates, principal payments on mortgage-backed securities and collateralized mortgage obligations increase as the underlying mortgages are prepaid. Conversely, during periods of rising interest rates, the rate of prepayment slows. Both of these situations can expose the Company to the possibility of asset/liability cash flow and yield mismatch. The model uses a proprietary method of sampling interest rate paths along with a mortgage prepayment model to derive future cash flows. The initial interest rates used are based on the current U.S. Treasury yield curve as well as current mortgage rates for the various types of collateral in the portfolio. Mortgage loans were modeled by discounting scheduled cash flows through the scheduled maturities of the loans, starting with interest rates currently being offered for similar loans to borrowers with similar credit ratings. Policy loans were modeled by discounting estimated cash flows using U.S. Treasury Bill interest rates as the base rates at December 31, 1998. The estimated cash flows include assumptions as to whether such loans will be repaid by the policyholders or settled upon payment of death or surrender benefits on the underlying insurance contracts. As a result, these assumptions incorporate both Company experience and mortality assumptions associated with such contracts. In addition to the securities analyzed above, the Company invests in index options which are derivative financial instruments used to hedge the equity return component of the Company's equity-indexed annuities. The values of these options are primarily impacted by equity price risk, as the options' fair values are dependent on the performance of the S&P 500 Composite Stock Price Index (S&P 500 Index). However, increases or decreases in investment returns from these options are directly offset by corresponding increases or decreases in amounts paid to equity-indexed annuity policyholders. The Company's market risk liabilities, which include policy liabilities for investment annuity and supplemental contracts, are managed for interest rate risk through cash flow testing as previously described. As part of this cash flow testing, the Company has analyzed the potential impact on net earnings of a 100 basis point decline in the U.S. Treasury yield curve as of December 31, 1998. This interest rate decline would reduce net earnings for 1999 by less than $200,000 based on the Company's projections. This estimated earnings decline is net of tax benefits determined at a tax rate of 35%. The Company has modeled this scenario, as a decline in market interest rates could pose potential risks to the current profitability levels of this business. A downward movement in interest rates is also a reasonably possible near-term scenario. The risks from such a change are primarily due to possible lower interest rate spreads which are the differences between investment income earned and credited interest paid to policyholders. However, the relatively small projected impact to earnings of the interest rate change is a reflection on the effectiveness of the Company's asset/liability and interest risk management. The above-described scenario produces estimated changes in cash flows as well as cash flow reinvestment projections. Estimated cash flows in the Company's model assume cash flow reinvestments which are representative of the Company's current investment strategy. Calls and prepayments include scheduled maturities and those expected to occur which would benefit the security issuers. Assumed policy surrenders consider differences and relationships between credited interest rates and market interest rates as well as surrender charges on individual policies. The impact to earnings also includes the expected effects on amortization of deferred policy acquisition costs. The model considers only investment annuity and supplemental contracts in force at December 31, 1998, and does not consider new product sales or the possible impact of interest rate changes on sales. MORTGAGE LOANS AND REAL ESTATE Investment Philosophy In general, the Company seeks loans on high quality, income-producing properties such as shopping centers, freestanding retail stores, office buildings, industrial and sales or service facilities, selected apartment buildings, motels, and health care facilities. The location of these loans is typically in growth areas that offer a potential for property value appreciation. These growth areas are found primarily in major metropolitan areas, but occasionally in selected smaller communities. The Company seeks to minimize the credit and default risk in its mortgage loan portfolio through strict underwriting guidelines and diversification of underlying property types and geographic locations. In addition to being secured by the property, mortgage loans with leases on the underlying property are often guaranteed by the lessee, in which case the Company approves the loan based on the credit strength of the lessee. This approach has proven to result in higher quality mortgage loans with fewer defaults. The Company's direct investments in real estate are not a significant portion of its total investment portfolio, and the majority of real estate owned was acquired through mortgage loan foreclosures. However, the Company also participates in several real estate joint ventures and limited partnerships. The joint ventures and partnerships invest primarily in income-producing retail properties. While not a significant portion of the Company's investment portfolio, these investments have produced favorable returns and significantly increased investment income in 1996 as several of these interests in real estate joint ventures were sold. The sales resulted in additional investment income totaling approximately $2,300,000 in 1996. No real estate joint ventures were sold in 1997 or 1998. Portfolio Analysis The Company held net investments in mortgage loans totaling $174,921,000 and $181,878,000, or 5.6% and 6.3% of total invested assets, at December 31, 1998 and 1997, respectively. The loans are real estate mortgages, substantially all of which are related to commercial properties and developments and have fixed interest rates. The diversification of the mortgage loan portfolio by geographic region of the United States and by property type as of December 31, 1998 and 1997, was as follows:
December 31, 1998 1997 West South Central 57.1% 54.9% Mountain 19.4 11.3 Pacific 7.7 8.0 South Atlantic 4.8 11.4 East South Central 4.6 5.2 West North Central 3.0 2.9 All other 3.4 6.3 Totals 100.0% 100.0%
December 31, 1998 1997 Retail 56.7% 62.2% Office 21.0 16.6 Hotel/Motel 7.9 7.9 Apartment 4.2 4.1 Land/Lots 4.1 3.3 Nursing homes 3.0 3.2 All other 3.1 2.7 Totals 100.0% 100.0%
As of December 31, 1998, the allowance for possible losses on mortgage loans was $4,640,000. No additions were made to the allowance during 1998. Additions to the allowance totaling $1,133,000 were recognized as realized losses on investments in the Company's 1997 financial statements. Management believes that the allowance for possible losses is adequate. However, while management uses available information to recognize losses, future additions to the allowance may be necessary based on changes in economic conditions, particularly in the West South Central region which includes Texas, Louisiana, Oklahoma, and Arkansas, as this area contains the highest concentrations of the Company's mortgage loans. The Company currently places all loans past due three months or more on nonaccrual status, thus recognizing no interest income on the loans. At December 31, 1998 and 1997, the Company had no mortage loan principal balances on nonaccrual status. The Company had mortgage loan principal balances with restructured terms totaling approximately $12,096,000 and $12,463,000 at December 31, 1998 and 1997, respectively. For the years ended December 31, 1998 and 1997, the reductions in interest income due to nonaccrual and restructured mortgage loans were not significant. The contractual maturities of mortgage loan principal balances at December 31, 1998, are as follows:
Principal Due (In thousands) Due in one year or less $ 13,233 Due after one year through five years 83,986 Due after five years through ten years 66,687 Due after ten years through fifteen years 17,067 Due after fifteen years 97 Total $ 181,070
The Company owns real estate that was acquired through foreclosure and through direct investment totaling approximately $13,553,000 and $15,027,000 at December 31, 1998 and 1997, respectively. This small concentration of properties represents less than one percent of the Company's entire investment portfolio. The real estate holdings consist primarily of income-producing properties which are being operated by the Company. The Company recognized operating income on these properties of approximately $740,000 and $716,000 for the years ended December 31, 1998 and 1997, respectively. The Company does not anticipate significant changes in these operating results in the near future. The Company monitors the conditions and market values of these properties on a regular basis. The Company makes repairs and capital improvements to keep the properties in good condition and will continue this maintenance as needed. No realized losses were recognized due to declines in values of properties during 1998. However, realized losses recognized due to declines in values of properties totaled $46,000 for the year ended December 31, 1997. RESULTS OF OPERATIONS Consolidated Operations Summary of Consolidated Operating Results A summary of operating results, net of taxes, for the years ended December 31, 1998, 1997, and 1996 is provided below:
Years Ended December 31, 1998 1997 1996 (In thousands except per share data) Revenues: Insurance revenues excluding realized gains (losses) on investments $ 331,230 313,862 309,597 Realized gains (losses) on investments 2,384 (1,588) 1,612 Total revenues $ 333,614 312,274 311,209 Earnings: Earnings from continuing operations, excluding realized gains(losses) on investments $ 47,468 43,604 45,167 Losses from discontinued brokerage operations (14,125) (1,000) - Net realized gains (losses) on investments 1,550 (1,032) 1,048 Net earnings $ 34,893 41,572 46,215 Basic Earnings Per Share: Earnings from continuing operations, excluding realized gains (losses) on investments $ 13.58 12.49 12.94 Losses from discontinued brokerage operations (4.04) (0.29) - Net realized gains (losses) on investments 0.44 (0.29) 0.30 Net earnings $ 9.98 11.91 13.24 Diluted Earnings Per Share: Earnings from continuing operations, excluding realized gains (losses) on investments $ 13.43 12.38 12.87 Losses from discontinued brokerage operations (4.00) (0.28) - Net realized gains (losses) on investments 0.44 (0.29) 0.30 Net earnings $ 9.87 11.81 13.17
1998 Consolidated Operating Results: For the year ended December 31, 1998, the Company recorded net earnings of $34,893,000 compared to net earnings of $41,572,000 for 1997. Earnings were lower due to nonrecurring items, the most significant of which was the bankruptcy settlement of the Company's wholly owned subsidiary, The Westcap Corporation, totaling $14,125,000. This settlement was reflected as a loss from discontinued brokerage operations in 1998. Losses on discontinued brokerage operations totaled $1,000,000 in 1997. Net earnings for 1998 also include a lawsuit settlement as previously reported by the Company on September 28, 1998. Parties involved in the Diffie, et al vs. National Western Life Insurance Company and National Annuity Programs, Inc. class action litigation filed a joint motion in District Court for preliminary approval of a settlement agreement among the parties. This settlement was approved by the Court in January, 1999, and, as a result, the Company will pay $5,000,000 to settle the litigation. This amount was accrued in the Company's financial statements in 1998, thereby reducing earnings $3,250,000, after taxes. Also during 1998, the Company transferred pension obligations and administrative responsibilities of its nonqualified defined benefit plan to a pension administration firm. The financial effects of the transaction resulted in additional pension expense in 1998 totaling $1,653,000, net of taxes, as the amount paid upon transfer exceeded the recorded pension liabilities as required for financial reporting purposes. However, as a result of the transfer, substantially all future pension and administrative liabilities and expenses under the plan are now the responsibility of the new firm. Excluding the nonrecurring items and related tax effects described above, 1998 earnings actually exceeded comparable 1997 earnings by over 17%. The higher earnings are due primarily to increases in universal life and annuity contract revenues, increases in investment income over policy contract interest, and decreases in life insurance benefit claims. Universal life and annuity contract revenues increased almost $3,000,000 from $80,250,000 in 1997 to $83,169,000 in 1998. This increase is almost entirely from increases in cost of insurance revenues. Life insurance benefit claims were lower in 1998, decreasing $2,480,000, or 10.2%, from 1997. The Company also recorded realized gains on investments of $1,550,000 in 1998 compared to realized losses of $1,032,000 in 1997, net of taxes. 1997 and 1996 Consolidated Operating Results: For the year ended December 31, 1997, the Company recognized net earnings totaling $41,572,000, a decrease of 10.0% from 1996 earnings. The lower earnings in 1997 compared to 1996 were primarily due to higher life insurance benefit claims and amortization of deferred policy acquisition costs. Deferred policy acquisition costs, which are primarily capitalized agents' commissions, are amortized in direct relation to anticipated future gross profits on applicable life and annuity business. Increases in anticipated future gross profits resulted in retrospective adjustments to deferred policy acquisition costs, which lowered the amortization in 1996 relative to 1997 amounts. Additionally, other income in 1997 declined $1.5 million, net of taxes, as 1996 included nonrecurring income primarily due to litigation-related recoveries. Net earnings for 1997 also included losses from discontinued brokerage operations totaling $1,000,000 and realized losses on investments, net of taxes, totaling $1,032,000. No losses from discontinued brokerage operations were reported in 1996, but realized gains on investments totaling $1,048,000, net of taxes, were recorded. Net Investment Income: A detail of net investment income is provided below:
Years Ended December 31, 1998 1997 1996 (In thousands) Investment income: Debt securities $ 195,425 184,870 176,825 Mortgage loans 16,943 18,659 19,851 Policy loans 9,252 9,764 10,645 Index options 8,057 18 - Other investment income 7,783 6,742 10,082 Total investment income 237,460 220,053 217,403 Investment expenses 3,616 2,607 3,101 Net investment income $ 233,844 217,446 214,302
As indicated by the table above, net investment income increased substantially in 1998 from the prior two years. However, excluding index options, net investment income during 1998 actually increased only 3.8% from 1997, while invested assets rose 8.2%. The lower investment income growth is attributable to several factors. As in previous years, market interest rates have continued to decline, which has affected yields on purchases of new debt securities. Mortgage loans have typically had significantly higher yields than the Company's investments in debt securities. However, mortgage loans continue to decline as a percentage of the investment portfolio and in actual amounts from previous years. Also, matured or prepaid mortgage loans are typically replaced with loans with lower interest rates. As the Company is now selling equity-indexed annuities, net investment income for 1998 includes income from index options which totaled $8,057,000. The index options are derivative financial instruments used to hedge the equity return component of the Company's equity-indexed annuity products. Any gains or losses from the sale or expiration of the options, as well as period-to- period changes in fair values, are reflected as net investment income. The income from these options substantially offset the change in the related policyholder liabilities for the equity-indexed annuity products during 1998. Investment income from index options totaled only $18,000 in 1997, as the Company introduced the new equity-indexed products in the fourth quarter of 1997 and sales were minimal. Net investment income from 1996 reflects higher other investment income than 1997 and 1998. The higher income is primarily from gains from real estate joint ventures. NWL Investments I, L.P. sold several real estate joint venture interests during 1996, and the sales resulted in additional investment income totaling $2,300,000. An analysis of net investment income also involves a review of market interest rates. Interest rates continued to decline in 1998 and 1997 from 1996 rates. Detailed below is the Company's investment performance for 1998, 1997, and 1996, and the changes in the Company's yields reflect the changes in market interest rates. However, changes in market rates affect the Company's portfolio yield slowly because of the relatively small volume of new investment purchases during a year in comparison to the size of the overall investment portfolio. Yields in 1998 and 1997 were also somewhat affected by the change in the mix of the investment portfolio and by lower returns from real estate joint ventures as previously described above. The analysis below excludes index options, as these derivative financial instruments are used solely for hedging purposes for the Company's equity-indexed annuity products. Income from the options directly offset interest credited to policyholders for the equity return component on these products.
Years Ended December 31, 1998 1997 1996 (In thousands except percentages) Net investment income, excluding index options $ 225,787 217,428 214,302 Average invested assets, at amortized cost $ 2,986,350 2,798,957 2,652,232 Yield on average invested assets 7.56% 7.77% 8.08%
Realized Gains and Losses on Investments: The Company realized gains of $2.4 million in 1998 compared to realized losses of $1.6 million in 1997 and gains of $1.6 million in 1996. The gains in 1998 were primarily from gains on debt securities totaling $1.3 million, substantially all of which related to securities that were called. Realized gains in 1998 also include a gain of $300,000 related to a deficiency settlement agreement on a mortgage loan that was foreclosed in 1994. The losses in 1997 were primarily from net losses on debt securities totaling $1.2 million and writedowns on real estate and mortgage loans totaling $1.2 million, primarily related to a single foreclosure. The gains in 1996 were primarily from sales of investments in debt securities and real estate. The 1996 gains are also net of writedowns on real estate and mortgage loans totaling $1,026,000. Universal Life and Investment Annuity Contract Interest: The Company closely monitors its credited interest rates, taking into consideration such factors as profitability goals, policyholder benefits, product marketability, and economic market conditions. Rates are established or adjusted after careful consideration and evaluation of these factors against established objectives. Average credited rates, calculated based on policy reserves for the Company's universal life and investment annuity business, have declined since 1996, which is consistent with declines in market interest rates. As market interest rates fluctuate, the Company's credited interest rates are often adjusted accordingly, while also taking into consideration other factors as described above. Although credited rates are lower, contract interest increased significantly during 1998. Contract interest totaled $158.9 million, $145.2 million, and $151.5 million in 1998, 1997, and 1996, respectively. The increase is primarily attributable to interest totaling $12,980,000 for the Company's new equity-indexed annuity products. As previously described, the Company purchases index options to provide the potential higher interest to be credited on these products. The income provided by the index options substantially offsets the interest credited to the policyholders. Because of this hedging program, the Company separately analyzes average credited rates on its other products. Excluding the Company's equity-indexed annuity products, average credited rates for 1998, 1997, and 1996 were 5.67%, 5.68%, and 6.15%, respectively. The declines in average credited rates over the past three years is also consistent with the Company's lower yields on average invested assets. The difference between yields earned over credited rates, often referred to as the interest spread, has remained relatively consistent at approximately 2% in 1998, 1997, and 1996. Federal Income Taxes: Federal income taxes on earnings from continuing operations for 1998, 1997, and 1996 reflect effective tax rates of 26.1%, 33.8%, and 34.3%, respectively, which are lower than the expected Federal rate of 35%. The 1998 and 1997 effective tax rates are significantly lower due to tax benefits totaling $4,944,000 and $350,000, respectively, resulting from the Company's subsidiary brokerage losses. Correspondingly, losses on discontinued operations for 1998 and 1997 totaling $14,125,000 and $1,000,000 do not include any tax benefits relating to the brokerage subsidiary. This tax reporting treatment is in accordance with the Company's tax allocation agreement with its subsidiaries. On a consolidated basis, Federal income taxes reflect consistent effective tax rates of 33.2%, 34.3%, and 34.3% for 1998, 1997, and 1996, respectively. Discontinued Brokerage Operations: On April 12, 1996, The Westcap Corporation and its wholly owned subsidiary, Westcap Enterprises, Inc., separately filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court, Southern District of Texas, Houston Division. As a result of brokerage losses and the resulting bankruptcy, National Western's investment in Westcap was completely written off during 1995. However, a $1,000,000 cash infusion was made to Westcap on March 18, 1997, for operational expenses incurred during its bankruptcy. This contribution was reflected as a loss from discontinued operations in 1997. Losses from the discontinued brokerage operations have been reflected separately from continuing operations of the Company in the accompanying consolidated financial statements. As more fully described in Item 3, Legal Proceedings, of this Form 10-K, by order dated August 28, 1998, the United States Bankruptcy Court, Southern District of Texas, Houston Division, confirmed and approved the Third Amended Joint Consensual Plan of Reorganization (the Plan) of The Westcap Corporation and Westcap Enterprises, Inc. Pursuant to the Plan, National Western received credit for the $1,000,000 previously contributed to Westcap in bankruptcy in March, 1997, and paid an additional $14,125,000 to compromise and settle (i) all claims of Westcap against National Western, and (ii) all claims and litigation of certain settling creditors of Westcap who have alleged federal or state securities law "control person" violations by National Western relating to Westcap's brokerage business, in exchange for full and complete releases from all of such claims, litigation, and alleged violations. The bankruptcy reorganization was completed in January, 1999, National Western retained 100% continuing ownership of the reorganized Westcap, and the subsidiary is now operating as a real estate management company. Although the $14,125,000 settlement was paid by National Western on January 13, 1999, the settlement payment has been reflected in the accompanying 1998 financial statements as a loss from discontinued operations. Any additional losses will depend on the results of The City Colleges lawsuit filed against National Western on March 28, 1994, for alleged federal or state securities law "control person" violations relating to Westcap, and which is pending in the United States District Court, Western District of Texas. National Western believes it has reasonable and adequate defenses to this suit and, accordingly, no amounts have been accrued in National Western's financial statements for potential losses relating to such suit. Segment Operations Summary of Segment Earnings A summary of segment earnings from continuing operations for the years ended December 31, 1998, 1997, and 1996 is provided below. The segment earnings exclude realized gains and losses on investments, net of taxes, and discontinued brokerage operations.
Domestic International Life Life All Insurance Insurance Annuities Others Totals (In thousands) Segment earnings (losses): 1998 $ 6,395 6,397 27,508 2,224 42,524 1997 5,901 7,143 28,389 1,821 43,254 1996 8,710 7,150 29,550 (425) 44,985
Domestic Life Insurance Operations The Company's domestic life insurance operations concentrate marketing efforts on federal employees, seniors, and specific employee groups in private industry, as well as individual sales. The products marketed are universal life insurance and traditional life insurance, which includes both term and whole life products. National Western markets and distributes its domestic products primarily through independent agents and brokers and independent marketing organizations (IMOs). The IMOs also assist the Company in recruiting, contracting, and managing agents as well as providing additional financial resources for product marketing. Geographically, the domestic life insurance operations market products in most of the United States, which encompasses 43 states and the District of Columbia. The states in which the Company does not conduct business are primarily in the northeast and include Connecticut, Delaware, Massachusetts, New Hampshire, New Jersey, New York, and Vermont. Earnings for the domestic life insurance operating segment were $6,395,000, $5,901,000, and $8,710,000 for 1998, 1997, and 1996, respectively. The decline in 1997 earnings is primarily attributable to higher other operating expenses. The slight increase in earnings in 1998 is due to increases in revenues and other income and lower amortization of deferred policy acquistion costs. However, these items were offset substantially by increases in other operating expenses and life insurance benefit claims. A detailed analysis of significant revenues and expenses for this segment is provided below. Revenues from domestic life insurance operations include life insurance premiums on traditional type products and revenues from universal life insurance. The Company's current marketing efforts focus more on universal life insurance, and, as a result, revenues from these products continue to increase over traditional products. Revenues from traditional products are simply premiums collected, while revenues from universal life insurance consist of policy charges for the cost of insurance, policy administration fees, and surrender charges assessed during the period. A comparative detail of premiums and contract revenues is provided below:
Years Ended December 31, 1998 1997 1996 (In thousands) Universal life insurance: Cost of insurance $ 10,684 9,519 9,057 Surrender charges 2,040 2,161 2,485 Policy fees and other revenues 1,503 1,058 893 Traditional life insurance premiums 10,069 10,901 12,072 Totals $ 24,296 23,639 24,507
Actual universal life insurance deposits collected for the years ended December 31, 1998, 1997, and 1996 are detailed below. Deposits collected on these nontraditional products are not reflected as revenues in the Company's statements of earnings, as they are recorded directly to policyholder liabilities upon receipt, in accordance with generally accepted accounting principles.
Years Ended December 31, 1998 1997 1996 (In thousands) Universal life insurance: First year and single premiums $ 6,944 5,929 7,416 Renewal premiums 14,014 14,198 14,383 Totals $ 20,958 20,127 21,799
Other income for 1998, 1997, and 1996 totaled $750,000, $43,000, and $375,000, respectively. The significant increase in 1998 was primarily due to proceeds totaling $444,000 received from the U.S. government in 1998 related to previous litigation involving a failed savings and loan institution. The litigation involved the Company's previous investment in bonds of the financial institution and subsequent losses incurred upon its failure. The financial institution had also purchased life insurance from National Western, the cash values of which served as collateral for the bonds. Significant expenses for domestic life insurance operations are summarized below:
Years Ended December 31, 1998 1997 1996 (In thousands) Life insurance benefit claims $ 15,321 14,356 14,369 Universal life insurance contract interest 9,963 9,687 9,694 Amortization of deferred policy acquisition costs 2,954 5,058 5,467 Other operating expenses 10,786 8,588 6,920
Life insurance benefit claims were significantly higher in 1998 at $15.3 million compared to $14.4 million in 1997 and 1996. Mortality claims experience fluctuates from period to period, and such deviations are not uncommon in the life insurance industry. Over extended periods of time, higher claims experience tends to be offset by periods of lower claims experience. Additionally, the Company utilizes reinsurance to help minimize its exposure to adverse mortality experience. The Company's general policy is to reinsure amounts in excess of $200,000 on the life of any one individual. Universal life insurance contract interest has remained relatively constant at $9.7 million in 1996 and 1997 and $10.0 million in 1998. Although credited rates have declined somewhat over this time period, which is consistent with declines in market interest rates, the small growth in this block of business has resulted in relatively stable overall interest. Amortization of deferred policy acquisition costs has decreased from $5.5 million in 1996 to $5.1 million and $3.0 million in 1997 and 1998, respectively. These expenses represent the amortization of the costs of acquiring or producing new business, which consists primarily of agents' commissions. The majority of such costs are amortized in direct relation to the anticipated future gross profits of the applicable blocks of business. Amortization is also impacted by the level of policy surrenders. Other operating expenses increased significantly in 1998, totaling $10.8 million compared to $8.6 million and $6.9 million in 1997 and 1996, respectively. The increase in expenses is due to higher pension expenses from the transfer of the Company's nonqualified defined benefit plan as previously described and other increases primarily in salaries, agent conventions, and marketing related expenses such as travel and printing costs. International Life Insurance Operations The Company's international life insurance operations focus marketing efforts on foreign nationals in upper socioeconomic classes with substantial financial resources. Insurance sales are primarily in countries in Central and South America, the Caribbean, and the Pacific Rim. Marketing to numerous countries in these different regions provides diversification that helps to minimize large fluctuations in sales that can occur due to various economic, political, and competitive pressures that may occur from one country to another. Historically, the top three countries in insurance sales have often been Argentina, Chile, and Peru. Products sold in the international market include both universal life and traditional life insurance products. The Company minimizes exposure to foreign currency risks, as almost all foreign policies require payment of premiums and claims in United States dollars. Sales production from the international market is from independent broker-agents, many of whom have been selling National Western products for 20 or more years. Earnings for the international life insurance operating segment were $6,397,000, $7,143,000, and $7,150,000 for 1998, 1997, and 1996, respectively. Earnings in 1998 were lower primarily due to higher operating expenses, reinsurance costs, and amortization of deferred policy acquisition costs offset significantly by lower life insurance benefit claims. A detailed analysis of significant revenues and expenses for this segment is provided below. As with domestic operations, revenues from the international life insurance segment include both premiums on traditional type products and revenues from universal life insurance. The international operations' marketing efforts are also focused more on universal life insurance, and, as a result, revenues from these products continue to increase over traditional products. A comparative detail of premiums and contract revenues is provided below:
Years Ended December 31, 1998 1997 1996 (In thousands) Universal life insurance: Cost of insurance $ 27,508 25,258 23,209 Surrender charges 6,359 6,661 6,318 Policy fees and other revenues 3,726 3,698 2,705 Traditional life insurance premiums 3,013 4,812 4,421 Totals $ 40,606 40,429 36,653
Actual universal life insurance deposits collected for the years ended December 31, 1998, 1997, and 1996 are detailed below. Deposits collected on these nontraditional products are not reflected as revenues in the Company's statements of earnings, as they are recorded directly to policyholder liabilities upon receipt, in accordance with generally accepted accounting principles.
Years Ended December 31, 1998 1997 1996 (In thousands) Universal life insurance: First year and single premiums $ 13,575 11,412 11,196 Renewal premiums 35,114 34,323 34,443 Totals $ 48,689 45,735 45,639
Significant expenses for international life insurance operations are summarized below:
Years Ended December 31, 1998 1997 1996 (In thousands) Life insurance benefit claims $ 9,296 13,515 10,600 Universal life insurance contract interest 13,432 12,575 11,853 Amortization of deferred policy acquisition costs 15,836 13,608 10,264 Other operating expenses 9,573 7,749 7,541
Life insurance benefit claims were abnormally high in 1997 at $13.5 million compared to $10.6 million in 1996 and $9.3 million in 1998. As previously described for domestic life insurance operations, mortality claims fluctuate from period to period. These deviations, which can at times be significant, are not uncommon in the life insurance industry. Universal life insurance contract interest has increased steadily from $11.9 million in 1996 to $12.6 million and $13.4 million in 1997 and 1998, respectively. The increases in contract interest are consistent with growth in the universal life insurance business. The increases have been tempered somewhat by declines in policyholder credited rates due to declines in market interest rates, which also lower the Company's net investment income. Amortization of deferred policy acquisition costs were significantly lower in 1996, totaling $10.3 million compared to $13.6 million and $15.8 million in 1997 and 1998, respectively. Increases in anticipated future gross profits resulted in retrospective adjustments to deferred policy acquisition costs which lowered amortization in 1996 relative to 1997 and 1998. Other operating expenses totaled $9.6 million, $7.7 million, and $7.5 million in 1998, 1997, and 1996, respectively, which reflects a significant increase in 1998. The increase in expenses is attributable to the same reasons as previously described for domestic life insurance operations. Annuity Operations The Company's annuity operations are almost exclusively in the United States. Like the Company's domestic life insurance operations, annuities are marketed in 43 states and the District of Columbia using independent agents, brokers, and independent marketing organizations (IMOs). In fact, many of the agents, brokers, and IMOs that sell life insurance also sell annuities for National Western. For most of these organizations, annuity sales are much more significant and are the primary focus of their business operations. Although some of the Company's annuities are available in the international market, current sales are insignificant to total annuity sales. Annuities sold include flexible premium deferred annuities, single premium deferred annuities, and single premium immediate annuities. These products can be tax qualified or nonqualified annuities. In recent years the majority of annuities sold have been nonqualified deferred annuities. The Company also continues to collect additional premiums on existing two-tier annuities, as a large portion of the two-tier block of business are flexible premium annuities on which renewal premiums continue to be collected. However, the Company has not sold two-tier annuities since 1992. Earnings for the annuity operating segment were $27,508,000, $28,389,000, and $29,550,000 for 1998, 1997, and 1996, respectively. Earnings for 1998 were down significantly from 1997 and 1996 primarily due to nonrecurring items, which increased other operating expenses as more fully described below. Also, over the past several years, sales in the annuity business have been declining. However, during 1998 annuity deposits have increased substantially primarily due to sales of the Company's equity-indexed annuity products. A detailed analysis of significant revenues and expenses for this segment is provided below. Revenues from annuity operations include primarily surrender charges and recognition of deferred revenues relating to immediate or payout annuities. Annuitizations result in transfers of policies from deferred to immediate or payout status. The deferred revenues related to these annuities are amortized into income during the payout period. A comparative detail of the components of premiums and annuity contract revenues is provided below.
Years Ended December 31, 1998 1997 1996 (In thousands) Surrender charges: Two-tier annuities $ 17,898 19,940 22,679 Single-tier annuities 6,799 5,185 3,459 Total surrender charges 24,697 25,125 26,138 Payout annuity and other revenues 6,652 6,770 5,161 Traditional annuity premiums 83 99 118 Totals $ 31,432 31,994 31,417
Actual annuity deposits collected for the years ended December 31, 1998, 1997, and 1996 are detailed below. Deposits collected on these nontraditional products are not reflected as revenues in the Company's statements of earnings, as they are recorded directly to policyholder liabilities upon receipt, in accordance with generally accepted accounting principles.
Years Ended December 31, 1998 1997 1996 (In thousands) Deferred annuities: Equity-indexed $ 222,486 6,004 - Other 187,835 222,450 270,148 Total deferred annuities 410,321 228,454 270,148 Immediate annuities 20,682 12,533 3,054 Totals $ 431,003 240,987 273,202
Although annuity sales declined in 1996 and 1997 from previous levels, the Company is again experiencing significant growth in annuity production in 1998. The growth is primarily attributable to the Company's new equity- indexed annuities. In fact, the growth has been dramatic, as annuity production increased 79% from $240,987,000 in 1997 to $431,003,000 in 1998. The Company diversified its annuity products offered to customers by introducing an equity-indexed annuity in late 1997. This product is a flexible premium deferred annuity which combines the features associated with traditional fixed annuities, with the option to have interest rates that are linked in part to an equity index, the S&P 500 Composite Stock Price Index. This new annuity is a long-term contract designed as a planning vehicle for retirement security. Sales totaling $222 million in 1998 indicate that this product is attractive to customers, as it has guaranteed minimum interest rates, coupled with the potential for significantly higher returns based on an equity index component. Also, because the Company does not offer variable products or mutual funds, this new product provides a key equity-based alternative to the Company's existing fixed annuity products. The Company has implemented an investment hedging program to offset the potential higher returns required to be paid on these products. Specifically, the Company purchases index options from highly rated banks and brokerage firms. These index options act as hedges to match closely the returns based on the S&P 500 Composite Stock Price Index which may be paid to policyholders. Net investment income for 1998, 1997, and 1996 totaled $182,347,000, $166,348,000, and $165,943,000, respectively. Amounts for 1997 and 1996 were consistent, as premiums were lower in 1997, impacting invested asset growth. Market interest rates as well as investment yields have also decreased since 1996, tempering investment income increases. The large increase in net investment income in 1998 is due to the substantial increase in premium production, primarily from sales of the Company's new equity-indexed annuities, which resulted in increases in invested assets. Net investment income also includes $8,057,000 of income from index options. Investment income from index options totaled only $18,000 in 1997, as sales of equity- indexed annuities were minimal in 1997. Other income was relatively insignificant in 1998 and 1997, totaling $270,000 and $277,000, respectively. However, other income for 1996 totaled $2,087,000, which includes $1.3 million in income relating to litigation involving an independent marketing organization. The litigation is more fully described in Item 3, Legal Proceedings. Significant expenses for annuity operations are summarized below:
Years Ended December 31, 1998 1997 1996 (In thousands) Annuity contract interest $ 135,494 122,938 129,928 Amortization of deferred policy acquisition costs 21,625 21,268 14,630 Other operating expenses 15,145 11,223 11,261
Annuity contract interest was $129.9 million in 1996 compared to $122.9 million in 1997. As previously described for consolidated operations, the decrease is due to lower average credited rates on policies, which is consistent with declines in market interest rates. While the lower market and credited rates have continued into 1998, annuity contract interest has increased substantially, totaling $135.5 million in 1998. The increase is largely due to increases in annuities in force from sales of equity-indexed annuities and higher credited rates that can be paid on these policies. Contract interest on equity-indexed annuities totaled $12,980,000 in 1998. Amounts for 1997 were insignificant, as sales of these annuities were minimal in 1997. Although contract interest is higher due to equity-indexed annuities, net investment income also includes an additional $8,057,000 from index options which are used to hedge the equity return component of these products. Differences between income from index options and contract interest credited to policyholders will occur for several reasons. The most significant reason is the costs of the index options are essentially amortized against net investment income as the options are marked to fair value each reporting period. The costs of options are covered by additional income earned on debt securities purchased with equity-indexed annuity premiums. Other differences are due to asset fees charged against policyholder contract interest, surrenders and death benefits on annuities within the annual hedging period, and inherent differences between index option fair values and policy liability reserving requirements such as minimum guaranteed interest rates. Amortization of deferred policy acquisition costs represents the amortization of the costs of acquiring or producing new business, primarily agents' commissions, the majority of which are amortized in direct relation to the anticipated future gross profits of the applicable blocks of business. Amortization is also impacted by the level of policy surrenders. Amortization for 1998, 1997, and 1996 was $21.6 million, $21.3 million, and $14.6 million, respectively. Increases in anticipated future gross profits resulted in retrospective adjustments to deferred policy acquisition costs which lowered the amortization in 1996 relative to 1997 and 1998 amounts. Additionally, increases in policy surrenders since 1996 contributed to higher amortization in 1997 and 1998. Other operating expenses totaled $15,145,000, $11,223,000, and $11,261,000 for 1998, 1997, and 1996, respectively. Expenses for 1998 were unusually high primarily due to two nonrecurring items as previously described in the summary of consolidated operating results. Additional pension expenses were incurred in 1998 related to the Company's transfer of its nonqualified defined benefit plan to a pension administration firm. Also included in 1998 expenses is a $5,000,000 lawsuit settlement for the Diffie, et al vs. National Western Life Insurance Company and National Annuity Programs, Inc. class action litigation. The litigation involved various issues regarding sales of the Company's annuities. Other Operations National Western's primary business encompasses its domestic and international life insurance operations and its annuity operations. However, National Western also has small real estate and other investment operations through the following wholly owned subsidiaries: NWL Investments, Inc., NWL Properties, Inc., NWL 806 Main, Inc., NWL Services, Inc., and NWL Financial, Inc. Earnings for these operations totaled $2,224,000 and $1,821,000 for 1998 and 1997, respectively. Operating results for 1996 reflected losses totaling $425,000. The increase in earnings since 1996 is due to the transfer of an asset from National Western to one of the subsidiaries as described in detail below. Most of the income from the Company's subsidiaries is from a life interest in the Libbie Shearn Moody Trust. This asset was owned by National Western Life Insurance Company during 1996 but was transferred to NWL Services, Inc., in 1997. Gross income distributions from the Trust totaled $3,451,000, $3,335,000, and $3,252,000 in 1998, 1997, and 1996, respectively. The distributions for 1998 and 1997 were paid to NWL Services, Inc., and, therefore, are included in other operations for these periods. The 1996 distribution was paid to National Western Life Insurance Company. As a result, this income was allocated among the insurance segments, domestic life insurance, international life insurance, and annuity operations, for 1996. LIQUIDITY AND CAPITAL RESOURCES Liquidity The liquidity requirements of the Company are met primarily by funds provided from operations. Premium deposits and revenues, investment income, and investment maturities are the primary sources of funds, while investment purchases and policy benefits are the primary uses of funds. Primary sources of liquidity to meet cash needs are the Company's securities available for sale portfolio, net cash provided by operations, and bank line of credit. The Company's investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs. The Company may also borrow up to $60 million on its bank line of credit for short-term cash needs. A primary liquidity concern for the Company's insurance operations is the risk of early policyholder withdrawals. Consequently, the Company closely evaluates and manages the risk of early surrenders or withdrawals. The Company includes provisions within annuity and universal life insurance policies, such as surrender charges, that help limit early withdrawals. The Company also prepares cash flow projections and performs cash flow tests under various market interest rate scenarios to assist in evaluating liquidity needs and adequacy. The Company currently expects available liquidity sources and future cash flows to be adequate to meet the demand for funds. In the past, cash flows from the Company's insurance operations have been more than adequate to meet current needs. Cash flows from operating activities were $131 million, $144 million, and $145 million in 1998, 1997, and 1996, respectively. Net cash flows from the Company's deposit product operations, which include universal life and investment annuity products, totaled $113 million in 1998 and $16 million in 1996. However, these operations incurred net cash outflows in 1997 totaling $51 million. The cash outflows in 1997 were due to low annuity production along with increased policy surrenders. Although surrenders increased again in 1998, strong equity-indexed annuity production generated the strong positive cash flow in 1998. The Company also has significant cash flows from both scheduled and unscheduled investment security maturities, redemptions, and prepayments. These cash flows totaled $159 million, $144 million, and $117 million in 1998, 1997, and 1996, respectively. The Company again expects significant cash flows from these sources in 1999 at levels similar to the past two years. Capital Resources The Company relies on stockholders' equity for its capital resources, as there has been no long-term debt outstanding in 1998 or recent years. The Company does not anticipate the need for any long-term debt in the near future. There are also no current or anticipated material commitments for capital expenditures in 1999. Stockholders' equity totaled $438 million at December 31, 1998, reflecting an increase of $38 million from 1997. The increase in capital is primarily from net earnings of $35 million. Net unrealized gains on investment securities totaling $2.2 million also contributed to the rise in stockholders' equity. Book value per share at December 31, 1998, was $125.31, reflecting a 9.2% increase for the year. CHANGES IN ACCOUNTING PRINCIPLES Insurance Related Assessments In December, 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 97-3, which provides guidance on accounting by insurance and other enterprises for assessments related to insurance activities. The SOP provides: (1) guidance for determining when an entity should recognize a liability for guaranty fund and other insurance related assessments, (2) guidance on how to measure the liability, including discounting of the liability if the amount and timing of the cash payments are fixed or reliably determinable, (3) guidance on when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges, and (4) requirements for disclosure of certain information. The Company anticipates that this SOP will not have a significant effect on its reporting of liabilities for guaranty fund assessments, as the Company is currently applying accounting procedures similar to those in the new statement. SOP 97- 3 is effective for financial statements for fiscal years beginning after December 15, 1998. The Company currently expects to implement the SOP in the first quarter of 1999. Deposit Accounting In October, 1998, the AICPA issued SOP 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." The SOP specifies classifications for insurance and reinsurance contracts for which deposit accounting is appropriate and specifies accounting methods for each. For each insurance and reinsurance contract accounted for under deposit accounting, a deposit asset or liability should be recognized at inception and should be measured based on consideration paid or received, less any premiums or fees to be retained by the insurer or reinsurer, irrespective of the experience of the contract. The Company anticipates that this SOP will not have a significant effect on its financial statements, as the Company's current insurance and reinsurance contracts all transfer insurance risk. SOP 98-7 is effective for all fiscal years beginning after June 15, 1999. The Company currently plans to implement the SOP in the first quarter of 2000. Derivative Instruments and Hedging Activities In June, 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS No. 133 defines several designations of derivatives based on the instrument's intended use and specifies the appropriate accounting treatment for changes in the fair value of the derivative based on its resulting designation. The statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company currently sells equity-indexed annuities that contain an equity return component for policyholders which is an embedded derivative instrument. The Company purchases index options, which are also derivative instruments, to hedge this equity return component. The index options are reported at fair value in the Company's financial statements, which is in accordance with SFAS No. 133 requirements. The Company also uses a fair value approach in recording policy liabilities for the equity-indexed annuities. However, there is currently no specific, authoritative interpretation of SFAS No. 133 with respect to accounting for equity-indexed annuity liabilities. Additional guidance in 1999 regarding this issue may result in a definitive method significantly different from that currently used by the Company. As a result, the ultimate implementation of SFAS No. 133 could have a significant effect on the Company's results of operations. The Company expects to implement the new statement in the first quarter of 2000. REGULATORY AND OTHER ISSUES Statutory Accounting Practices Regulations that affect the Company and the insurance industry are often the result of efforts by the National Association of Insurance Commissioners (NAIC). The NAIC is an association of state insurance commissioners, regulators, and support staff that acts as a coordinating body for the state insurance regulatory process. The NAIC has recently completed a comprehensive process of codifying statutory accounting practices and procedures. Other than specific individual state laws, the codification results will be the only source of prescribed statutory accounting practices. Insurance companies must adopt these new statutory accounting practices in 2001, which may result in significant changes to existing practices used in the preparation of statutory financial statements. Based on a preliminary review, National Western does not currently anticipate a material impact to its capital and surplus position as a result of implementation of the new prescribed statutory accounting procedures. Risk-Based Capital Requirements The NAIC established risk-based capital (RBC) requirements to help state regulators monitor the financial strength and stability of life insurers by identifying those companies that may be inadequately capitalized. Under the NAIC's requirements, each insurer must maintain its total capital above a calculated threshold or take corrective measures to achieve the threshold. The threshold of adequate capital is based on a formula that takes into account the amount of risk each company faces on its products and investments. The RBC formula takes into consideration four major areas of risk which are: (i) asset risk which primarily focuses on the quality of investments; (ii) insurance risk which encompasses mortality and morbidity risk; (iii) interest rate risk which involves asset/liability matching issues; and (iv) other business risks. Due to statutory laws prohibiting public dissemination of certain RBC information, the Company has chosen not to publish its RBC ratios or levels. However, the Company's current statutory capital and surplus is significantly in excess of the threshold RBC requirements. Year 2000 Issues The Year 2000 problem, also known as Y2K, is the result of concerns that many computer software systems today cannot distinguish the year 2000 from the year 1900. The Year 2000 problem arose because many existing computer programs use only the last two digits to refer to a year, resulting in these programs' inability to recognize "00" in the date field as the year 2000. If not corrected, many computer systems may be unable to process date-sensitive data accurately beyond the year 1999, resulting in possible system failures or generation of erroneous results. National Western has been cognizant of these problems for many years, as life insurance and annuity products can have very long life spans. Thus, many of our systems have been developed to process and administer our insurance products into the next century. National Western has been working to alleviate or eliminate Year 2000 problems for many years and has assigned the responsibility for the analysis of the problem to its Senior Vice President-Information Services, who deemed the most complete and cost- effective approach to the problem was to use existing staff and facilities. Accordingly, the Company's Year 2000 plan includes staff review and analysis of internal systems, embedded chip technology, and external vendor interfaces as described below. National Western's primary internal software systems include its policy administration system and investment accounting system. The policy administration system is an important software system for National Western, as it is a comprehensive system involving the following functions: policy issuance, maintenance, and accounting, cash receipts, cash disbursements, general ledger, agent commissions, and various other accounting functions. While this policy administration system was not developed by National Western, several key employees of the National Western Information Services department were involved in the system's original development process. As a result, National Western does not maintain a service agreement with the original developer but, rather, maintains and services the system internally. National Western has performed an assessment of this system regarding Year 2000 issues, which revealed that there is some exposure to insufficient date processing that must be corrected. However, the assessment also revealed that much of the date-sensitive data is already in four-digit format, which avoids the Year 2000 processing problems. Accordingly, National Western commenced a project to perform a comprehensive review of the entire policy administration system. This project has been substantially completed and changes are currently being made to correct any software coding problems. All changes that were made as of December 31, 1998, have been tested and implemented. Testing will continue throughout 1999. Final implementation of any additional necessary system changes is currently planned for mid-year 1999 based on anticipated favorable results of testing. The Company's investment accounting system is also a critical system, as it provides accounting, analysis, and transaction processing for the Company's bond and stock securities which comprise most of its investments. Like the Company's policy administration system, this system was developed by a third- party software vendor. However, National Western does maintain a product support agreement with the original vendor. Maintenance and changes to this investment system are the responsibility of the vendor in accordance with this support agreement. National Western has addressed Year 2000 issues with the vendor, and the vendor has provided assurance that their system has been subjected to significant review for any problems. The review included assessment, correction, and testing of date-sensitive problems, and the vendor has provided us written acknowledgment that we should encounter no significant Year 2000 related problems. The Company is using the vendor's Year 2000 modified software release for current processing and has not encountered any problems. National Western does have some exposure to date-sensitive embedded technology such as microcontrollers, but the Company views this exposure as minimal. Unlike other industries that may be equipment intensive, such as manufacturing, National Western is a financial services company providing insurance and annuities to its customers. As such, the primary equipment and electronic devices used are computers and telephone-related equipment. This type of hardware can have date-sensitive embedded technology which could be subject to Year 2000 problems. Because of this exposure, National Western has reviewed its computer hardware and telephone systems, with assistance from the applicable vendors, and has replaced or is in the process of replacing any items that will not properly process date-sensitive data in the Year 2000 or beyond. This project was substantially completed as of December 31, 1998. The final area of concern is the Company's use of third-party systems or interfaces with vendor systems. National Western's most significant interfaces and uses of third-party vendor systems are in the bank and trust services area. The Company utilizes various banks to handle numerous types of financial transactions. Several of these banks also provide trustee and custodial services for National Western's investment holdings and transactions. These services are critical to a financial service company such as National Western, as its business centers around cash receipts and disbursements to policyholders and the investment of policyholder funds. As a result, National Western has received written confirmation from its vendor banks regarding their status on Year 2000 issues. The banks indicate their dedication to resolving any Year 2000 issues related to their systems and services prior to the critical date. These banks have completed assessments of their exposure to Year 2000 issues and are in problem resolution and testing phases of their Y2K projects. In reviewing the Year 2000 issue, National Western has identified various risks to the Company that could impact daily operations and its ability to satisfactorily transact business with its primary customers and vendors. Risks related to servicing our customers are inabilities to process policyholder and agent commission-related transactions timely, which could lead to some loss of business. The accuracy of policyholder transactions should not be affected, as the Company's policy administration system already uses four-digit year data for policy calculations. Risks in the investment accounting area center around accuracy of accounting for investments but should not actually impact cash receipt and disbursement transactions. However, the Company has various controls which should identify and enable correction of such issues should they arise. Risks in interfaces with third-party systems, which are primarily banking systems for National Western, include the inability to timely and accurately receive and disburse cash and process investment-related transactions. This could affect the Company's service to its policyholders if cash flow issues arise due to delays in bank processing. Based on information from the Company's banks, National Western does not anticipate significant Year 2000 issues relating to bank processing. Based on its analysis, the Company believes it is on schedule with its Year 2000 plan so that any disruptions by Year 2000 will be minimal. National Western recognizes, however, that it is virtually impossible to assure that the Company will be 100% compliant until Year 2000 is here. We anticipate there will be problems that will have to be resolved in the ordinary course of business on and after Year 2000. However, the Company does not believe that the problems will have a material effect on the Company's operations or financial condition. Under a worst case scenario, where systems do not function adequately on or after Year 2000, the Company intends to place all available resources it can to remedy any problems as soon as possible. The resources include National Western staff as well as outside consulting services. The Company has reviewed Year 2000-related costs incurred to date and is monitoring potential future costs to complete its Year 2000 plan. Such costs are not expected to exceed $200,000. A significant amount of these costs have not and will not be incremental costs to the Company, as internal resources are primarily being used and will continue to be utilized and reallocated as needed. Also, for externally developed systems under licensing contracts, costs are primarily borne by the software developer. Costs already incurred as of December 31, 1998, related to the Year 2000 plan total approximately $150,000. FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information contained herein or in other written or oral statements made by or on behalf of National Western Life Insurance Company or its subsidiaries are or may be viewed as forward-looking. Although the Company has used appropriate care in developing any such information, forward-looking information involves risks and uncertainties that could significantly impact actual results. These risks and uncertainties include, but are not limited to, matters described in the Company's SEC filings such as exposure to market risks, anticipated cash flows, future capital needs, and Year 2000 issues. However, National Western, as a matter of policy, does not make any specific projections as to future earnings, nor does it endorse any projections regarding future performance that may be made by others. Whether or not actual results differ materially from forward- looking statements may depend on numerous foreseeable and unforeseeable events or developments. Also, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future developments, or otherwise. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This information is included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, in the Investments in Debt and Equity Securities section. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is reported in Attachment A beginning on page __. See Index to Financial Statements and Schedules on page __ for a list of financial information included in Attachment A. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE There have been no changes in auditors or disagreements with auditors which are reportable pursuant to Item 304 of Regulation S-K. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Identification of Directors The following information as of January 31, 1999, is furnished with respect to each director. All terms expire in June of 1999.
Principal Occupation During Last Five First Name of Director Years and Directorships Elected Age Robert L. Moody Chairman of the Board and (1) (3) (4) (5) Chief Executive 1963 63 Officer of the Company; Investments, Galveston, Texas Ross R. Moody President and Chief Operating (1) (3) Officer of the 1981 36 Company, Austin, Texas Arthur O. Dummer President, The Donner Company, 1980 65 (1) (2) (3) Salt Lake City, Utah Harry L. Edwards Retired; Former President and Chief 1969 77 Operating Officer of the Company, Austin, Texas E. Douglas McLeod Director of Development, The Moody 1979 57 (4) Foundation, Galveston, Texas Charles D. Milos, Jr. Senior Vice President of the Company, 1981 53 (1) (3) Galveston, Texas Frances A. Moody Executive Director, 1990 29 The Moody Foundation, Dallas, Texas, 1997 - present; Investments, Dallas, Texas, 1992 - 1997 Russell S. Moody Investments, Austin, Texas 1988 37 (4) Louis E. Pauls, Jr. President, Louis Pauls & Company; 1971 63 (2) Investments, Galveston, Texas E. J. Pederson Executive Vice President, 1992 51 (2) The University of Texas Medical Branch, Galveston, Texas (1) Member of Executive Committee; (2) Member of Audit Committee; (3) Member of Investment Committee; (4) Director of American National Insurance Company of Galveston, Texas; (5) Director of The Moody National Bank of Galveston, Texas.
Family relationships among the directors are: Mr. Robert Moody and Mr. McLeod are brothers-in-law and Mr. Robert Moody is the father of Ms. Frances Moody, Mr. Ross Moody, and Mr. Russell Moody. (b) Identification of Executive Officers The following is a list of the Company's executive officers, their ages, and their positions and offices as of January 31, 1999.
Name of Officer Age Position (Year elected to position) Robert L. Moody 63 Chairman of the Board and Chief Executive Officer (1963-1968, 1971-1980, 1981), Director Ross R. Moody 36 President and Chief Operating Officer (1992), Director Robert L. Busby, III 61 Senior Vice President - Chief Administrative Officer, Chief Financial Officer and Treasurer (1992) Charles P. Baley 60 Senior Vice President - Information Services (1990) Richard M. Edwards 46 Senior Vice President - International Marketing (1990) Paul D. Facey 47 Senior Vice President - Chief Actuary (1992) Charles D. Milos, Jr. 53 Senior Vice President - Investment Analyst (1990), Director James P. Payne 54 Senior Vice President - Secretary (1998) Arthur W. Pickering 57 Senior Vice President - Domestic Marketing (1994) Patricia L. Scheuer 47 Senior Vice President - Chief Investment Officer (1992) Robert J. Antonowich 52 Vice President - Marketing (1995) Scott E. Arendale 54 Vice President - International Sales Development (1998) Mark K. Fisher 46 Vice President - Marketing (1998) Carol Jackson 63 Vice President - Human Resources (1990) Vincent L. Kasch 37 Vice President - Controller and Assistant Treasurer (1992) Doris Kruse 53 Vice President - Policy Benefits (1990) Paul G. McGillivray 45 Vice President - Marketing (1998) James R. Naiser 56 Vice President - Systems Development (1984) Al R. Steger 56 Vice President - Risk Selection (1992) B. Ben Taylor 56 Vice President - Actuarial Services (1990) Larry D. White 53 Vice President - Policyowner Services (1990)
(c) Identification of Certain Significant Employees None. (d) Family Relationships There are no family relationships among the officers listed except that Mr. Robert Moody is the father of Mr. Ross Moody. There are no arrangements or understandings pursuant to which any officer was elected. All officers hold office for one year and until their successors are elected and qualified, unless otherwise specified by the Board of Directors. (e) Business Experience All of the executive officers listed above have served in various executive capacities with the Company for more than five years, with the exception of the following: Mr. Payne was staff attorney with the Kansas Insurance Department from 1972 to 1975. From 1975-1983, he was Vice President, Secretary & General Counsel for Lone Star Life Insurance Company; from 1983-1990, he was Vice President, Secretary and General Counsel for Reserve Life Insurance Company; from 1990-1991 he was President and CEO of Great Republic Insurance Company; and from 1991-1993 he was Vice President - Government Relations for United American Insurance Company. From 1993 until October, 1994, he was in private practice in Dallas, Texas. Mr. Pickering was Agency Vice President of the Western Division with Integon Life Insurance Company from 1981 to 1987. From 1987 to 1990, he served as Regional Vice President of United Pacific Life Insurance Company. In 1990, he began work for Conseco/Western National Life Insurance Company as Vice President Marketing until May, 1994. Mr. Antonowich was Regional Vice President of Security Life of Denver Insurance Company from 1982 to 1991. From 1991 to December, 1993, he was Vice President, Marketing, of Guarantee Mutual Life Company, and from 1994 to June, 1995, he was Senior Vice President, Sales, of Lamar Life Insurance Company. Mr. Arendale was Division Manager of Seguros Pan American, S.A., in Caracas, Venezuela, from January, 1971, to October, 1992. From October, 1992, to June, 1993, he was General Manager of International SOS Assistance in Caracas; and in July, 1993, he joined National Western as an Assistant Vice President and was promoted to Vice President in May, 1998. Mr. Fisher served as an agent, Sales Manager, and Associate Agency Manager of Jefferson-Pilot Life from 1983 to 1993. From January, 1991 to December, 1993, he was Vice President - Marketing of First Life Insurance Company, Arlington, Texas; from January, 1994, to September, 1994, he was a Regional Director of Life Insurance Company of Georgia; and from February, 1995, to February, 1998, he was Vice President - Marketing of Texas Life Insurance Company, Waco, Texas. Mr. McGillivray was employed as an attorney in 1979. He was a special agent for Northwestern Mutual Life from 1980-1982, and he was Vice President - Marketing of Allied Life Insurance Co. from 1982-1997. (f) Involvement in Certain Legal Proceedings There are no events pending, or during the last five years, under any bankruptcy act, criminal proceedings, judgments, or injunctions material to the evaluation of the ability and integrity of any director or executive officer except as described below: In January, 1994, a United States District Court Judge vacated and withdrew the judgment which had been entered in Case No. H-86-4269, W. Steve Smith, Trustee vs. Shearn Moody, Jr., et al, United States District Court for the Southern District of Texas. The Judge also dismissed the case with prejudice. The judgment had been entered against Robert L. Moody and The Moody National Bank of Galveston, of which he was Chairman of the Board. Robert L. Moody is also Chairman of the Board of National Western Life Insurance Company. The case arose out of complex bankruptcy and related proceedings involving Robert L. Moody's brother, Shearn Moody, Jr. Subsequently, a global settlement of Shearn Moody, Jr.'s bankruptcy and related legal proceedings was reached and executed. As part of the global settlement, the Bankruptcy Trustee recommended, and other interested parties agreed not to oppose or object to, the Judge's vacating and withdrawing the judgment and dismissing the case with prejudice. This case and settlement did not involve the Company and had no effect on its financial statements. ITEM 11. EXECUTIVE COMPENSATION (b) Summary Compensation Table
Long Term Compensation No. of Securities Annual Compensation Underlying All Other Name and Salary Bonus Options Compensation Principal Position Year (A) (B) (C) (D) 1Robert L. Moody 1998 $1,124,174 $ - 13,000 $ 254,333 Chairman of the Board 1997 1,077,350 - 10,000 194,684 and Chief Executive 1996 1,026,964 - 14,400 160,064 Officer 2Ross R. Moody 1998 422,496 25,000 12,500 64,457 President and Chief 1997 411,198 - 500 50,683 Operating Officer 1996 400,334 - 5,500 32,366 3Arthur W. Pickering 1998 124,735 126,526 2,500 15,049 Senior Vice President 1997 124,445 105,687 1,500 13,781 Domestic Marketing 1996 119,137 117,888 2,000 15,516 4Robert L. Busby, III 1998 193,889 - 1,500 11,576 Senior Vice President 1997 178,518 - 1,000 10,654 Chief Administrative 1996 168,579 - 1,000 11,050 Officer, Chief Financial Officer and Treasurer 5Robert J. Antonowich 1998 78,792 100,229 500 6,400 Vice President- 1997 79,566 27,916 250 4,288 Marketing 1996 79,566 30,000 - 3,345 Notes to Summary Compensation Table: (A) Salary includes directors' fees from National Western Life Insurance Company and its subsidiaries. (B) Bonuses include employment and performance related bonuses which are occasionally granted. (C) Represents stock options granted under the National Western Life Insurance Company 1995 Stock and Incentive Plan. (D) All other compensation includes primarily employer contributions made to the Company's 401(k) Plan and Non-Qualified Deferred Compensation Plan on behalf of the employee. However, this item also includes taxable income for Robert L. Moody, related to his assignment of excess insurance on the Libbie Shearn Moody Trust of approximately $232,000, $173,000, and $138,000 in 1998, 1997, and 1996, respectively. This item also includes various expense allowances for Ross R. Moody in 1998, 1997, and 1996 of approximately $42,000, $34,000, and $6,000, respectively.
(c) Option/SAR Grants Table During 1995 the Company adopted the National Western Life Insurance Company 1995 Stock and Incentive Plan (the Plan). The purpose of the Plan is to align the personal financial incentives of key personnel with the long-term growth of the Company and the interests of the Company's stockholders through the ownership and performance of the Company's Class A, $1.00 par value, common stock, to enhance the Company's ability to retain key personnel, and to attract outstanding prospective employees and directors. The Plan is effective as of April 21, 1995, and will terminate on April 20, 2005, unless terminated earlier by the Board of Directors. The number of shares of Class A, $1.00 par value, common stock which may be issued under the Plan, or as to which stock appreciation rights or other awards may be granted, may not exceed 300,000. These shares may be authorized and unissued shares or treasury shares. All of the employees of the Company and its subsidiaries are eligible to participate in the Plan. In addition, directors of the Company, other than Compensation and Stock Option Committee members, are eligible for restricted stock awards, incentive awards, and performance awards. Company directors, including members of the Compensation and Stock Option Committee, are eligible for nondiscretionary stock options. The Committee approved the issuance of nonqualified stock options to selected officers of the Company during 1998, 1997, and 1996 totaling 48,500, 21,900, and 33,000, respectively. Additionally, during 1998 the Committee granted 10,000 nonqualified, nondiscretionary stock options to Company directors. The directors' stock options vest 20% annually following one full year of service to the Company from the date of grant. The officers' stock options vest 20% annually following three full years of service to the Company from the date of grant. The exercise prices of the stock options were set at the fair market values of the common stock on the dates of grant. Stock options granted to the named executive officers during 1998 are as follows:
Potential % of Realizable Total Value at Assumed Options Annual Granted Rates of Number to Stock Price of Employees Appreciation Securities and for Under- Directors Option Term lying in Options Fiscal Exercise Expiration Name Granted Year Price Date 5% 10% 1 Robert L. Moody 12,000 20.5% $105.250 4-16-08 $794,294 $2,012,897 1,000 1.7 112.375 6-19-08 70,672 179,097 2 Ross R. Moody 11,500 19.7 105.250 4-16-08 761,198 1,929,026 1,000 1.7 112.375 6-19-08 70,672 179,097 3 Arthur W. Pickering 2,500 4.3 105.250 4-16-08 165,478 419,353 4 Robert L. Busby, III 1,500 2.6 105.250 4-16-08 99,286 251,612 5 Robert J. Antonowich 500 0.9 105.250 4-16-08 33,096 83,871
(d) Aggregated Option/SAR Exercises and Fiscal Year-End Option/SAR Value Table
Number of Securities Value of Underlying Unexercised Unexercised In-The-Money Shares Options Options Acquired On Value Exercis- Unexerci- Exercis- Unexercis- Name Exercise Realized able able able able 1 Robert L. Moody - $ - 5,000 57,400 $396,875 $2,819,375 2 Ross R. Moody 1,800 128,458 - 25,700 - 1,022,438 3 Arthur W. Pickering 500 36,158 - 8,000 - 342,938 4 Robert L. Busby, III 800 81,253 - 6,700 - 357,250 5 Robert J. Antonowich - - - 750 - 14,219
(e) Long-Term Incentive Plan Awards Table None. (f) Defined Benefit or Actuarial Plan Disclosure The Company currently has two employee defined benefit plans for the benefit of its employees and officers. A brief description and formulas by which benefits are determined for each of the plans are detailed as follows: Qualified Defined Benefit Plan - This plan covers all full-time employees and officers of the Company and provides benefits based on the participant's years of service and compensation. The Company makes annual contributions to the plan that comply with the minimum funding provisions of the Employee Retirement Income Security Act. Annual pension benefits for those employees who became eligible participants prior to January 1, 1991, are calculated as the sum of the following: (1) 50% of the participant's final 5-year average annual compensation at December 31, 1990, less 50% of their primary social security benefit determined at December 31, 1990; this net amount is then prorated for less than 15 years of benefit service at normal retirement date. This result is multiplied by a fraction which is the participant's years of benefit service at December 31, 1990, divided by the participant's years of benefit service at normal retirement date. (2) 1.5% of the participant's compensation earned during each year of benefit service after December 31, 1990. Annual pension benefits for those employees who become eligible participants on or subsequent to January 1, 1991, are calculated as 1.5% of their compensation earned during each year of benefit service. Non-Qualified Defined Benefit Plan - This plan covers those officers who were in the position of senior vice president or above prior to 1991 and other employees who have been designated by the President of the Company as being in the class of persons who are eligible to participate in the plan. This plan also provides benefits based on the participant's years of service and compensation. However, no minimum funding standards are required. The benefit to be paid pursuant to this Plan to a Participant who retires at his normal retirement date shall be equal to (a) minus (b) minus (c) where: (a) is the benefit which would have been payable at the participant's normal retirement date under the terms of the Qualified Defined Benefit Plan as of December 31, 1990, as if that Plan had continued without change, and, (b) is the benefit which actually becomes payable under the terms of the Qualified Defined Benefit Plan at the participant's normal retirement date, and, (c) is the actuarially equivalent life annuity which may be provided by an accumulation of 2% of the participant's compensation for each year of service on or after January 1, 1991, accumulated at an assumed interest rate of 8.5% to his normal retirement date. In no event will the benefit be greater than the benefit which would have been payable at normal retirement date under the terms of the Qualified Defined Benefit Plan as of December 31, 1990, as if that plan had continued without change. The estimated annual benefits payable to the named executive officers upon retirement, at normal retirement age, for the Company's defined benefit plans are as follows:
Estimated Annual Benefits Qualified Non-Qualified Defined Defined Name Benefit Plan Benefit Plan Totals 1 Robert L. Moody $ 125,335 367,155 492,490 2 Ross R. Moody 87,868 - 87,868 3 Arthur W. Pickering 28,305 - 28,305 4 Robert L. Busby, III 47,907 32,004 79,911 5 Robert J. Antonowich 36,707 - 36,707
During 1998 the Company transferred the pension obligations and administrative responsibilities of the non-qualified defined benefit plan to a pension administration firm. Upon transfer, the Company made a payment to the firm to cover current and future liabilities and administration of the plan. However, as more fully described in Note 7, Pension Plans, of the accompanying financial statements, National Western retains certain contingent liabilities with respect to the plan. (g) Compensation of Directors All directors of the Company currently receive $15,000 a year and $500 for each board meeting attended. They are also reimbursed for actual travel expenses incurred in performing services as directors. An additional $500 is paid for each committee meeting attended. However, a director attending multiple meetings on the same day receives only one meeting fee. The amounts paid pursuant to these arrangements are included in the summary compensation table under Item 11(b). The directors and their dependents are also insured under the Company's group insurance program. During 1995 the Company adopted the National Western Life Insurance Company 1995 Stock and Incentive Plan (the Plan), as more fully described in Item 11(c). Directors of the Company, other than Compensation and Stock Option Committee members, are eligible for restricted stock awards, incentive awards, and performance awards. Nonemployee directors, including members of the Compensation and Stock Option Committee, are eligible for nondiscretionary stock options. On May 19, 1995, the Committee approved the issuance of 7,000 nonqualified, nondiscretionary stock options to nonemployee Company directors, with each such director receiving 1,000 stock options. On June 19, 1998, the stockholders approved the issuance of 10,000 nonqualified, nondiscretionary stock options to Company directors, with each such director receiving 1,000 stock options. Directors who are also employees of the Company were granted additional stock options as disclosed in the table in Item 11(c). Directors of the Company's subsidiary, NWL Investments, Inc., receive $250 annually. Nonemployee directors of the Company's subsidiary, NWL Services, Inc., receive $1,000 per board meeting attended. (h) Employment Contracts and Termination of Employment and Change-in-Control Arrangements None. (i) Report on Repricing of Options/SARs None. (j) Compensation Committee Interlocks and Insider Participation The Company's Board of Directors determines and approves executive compensation. No compensation committee interlocks exist with other unaffiliated companies. Mr. Robert Moody, Mr. Ross Moody, and Mr. Charles Milos serve as directors and also serve as officers and employees of National Western Life Insurance Company. Mr. Ross Moody serves as an officer and director and Mr. Charles Milos serves as an officer of the Company's wholly owned subsidiaries, The Westcap Corporation, NWL 806 Main, Inc., NWL Investments, Inc., NWL Properties, Inc., NWL Financial, Inc., and NWL Services, Inc. Additionally, Mr. Robert Moody is an officer and Mr. Arthur Dummer is an officer and director of NWL Services, Inc. Mr. Harry Edwards was formerly an officer of National Western Life Insurance Company. The Donner Company, 100% owned by Mr. Dummer, who is a director of National Western Life Insurance Company and an officer and director of NWL Services, Inc., was paid $84,895 in 1998 pursuant to an agreement between The Donner Company and a reinsurance intermediary relating to a reinsurance contract between the Company and certain life insurance reinsurers. (k) Board Compensation Committee Report on Executive Compensation The Company's Board of Directors performs the functions of an executive compensation committee. The Board is responsible for developing and administering the policies that determine executive compensation. Executive compensation, including that of the chief executive officer, is comprised primarily of a base salary. The salary is adjusted annually based on a performance review of the individual as well as the performance of the Company as a whole. The president and chief executive officer make recommendations annually to the Board of Directors regarding such salary adjustments. The review encompasses the following factors: (1) contributions to the Company's short and long-term strategic goals, including financial goals such as Company revenues and earnings, (2) achievement of specific goals within the individual's realm of responsibility, (3) development of management and employees within the Company, and (4) performance of leadership within the industry. These policies are reviewed periodically by the Board of Directors to ensure the support of the Company's overall business strategy and to attract and retain key executives. A separate Compensation and Stock Option Committee, comprised of outside, independent directors, determines compensation for the three highest-paid Company executives. The committee also performs various projects relating to executive compensation at the request of the Board of Directors. Those directors serving on the committee include the following: Arthur O. Dummer Harry L. Edwards E. J. Pederson The policies used by the Compensation and Stock Option Committee in determining compensation are similar to those described above for all other Company executives. (1) Performance Graph The following graph compares the change in the Company's cumulative total stockholder return on its common stock with the Nasdaq - U.S. Companies Index and the Nasdaq Insurance Stock Index. The graph assumes that the value of the Company's common stock and each index was $100 at December 31, 1993, and that all dividends were reinvested. For the purpose of this electronic filing, the coordinates of the graph have been provided below:
December 31 1993 1994 1995 1996 1997 1998 National Western Life $100 78.1 125.8 195.5 228.1 264.0 NASDAQ - US Companies 100 97.8 138.3 170.0 208.6 293.2 NASDAQ - Insurance Stock Index 100 94.1 133.7 152.4 223.6 198.8
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a) Security Ownership of Certain Beneficial Owners Set forth below is certain financial information concerning persons who are known by the Company to own beneficially more than 5% of any class of the Company's common stock on December 31, 1998:
Amount and Nature of Name and Address Title Beneficial Ownership Percent of of Record and of Beneficial Owners Class Beneficially Class Robert L. Moody Class A Common 1,160,896 35.20% 2302 PostOffice Street, Class B Common 198,074 99.04% Suite 702 Galveston, Texas Westport Asset Class A Common 352,400 10.68% Management, Inc. 253 Riverside Avenue Westport, Connecticut Tweedy Browne Company Class A Common 288,128 8.74% 52 Vanderbilt Avenue New York, New York FMR Corp. Class A Common 170,000 5.15% 82 Devonshire Street Boston, Massachusetts
(b) Security Ownership of Management The following table sets forth as of December 31, 1998, information concerning the beneficial ownership of the Company's common stock by all directors, named officers, and all directors and officers of the Company as a group:
Title Amount and Nature of Percent Directors of Beneficial Ownership of and Officers Class Record and Beneficially Class Directors and Named Officers: Robert L. Moody Class A Common 1,160,896 35.20% Class B Common 198,074 99.04% Ross R. Moody Class A Common 625 .02% Class B Common 482 .24% Directors: Arthur O. Dummer Class A Common 15 - Class B Common - - Harry L. Edwards Class A Common 20 - Class B Common - - E. Douglas McLeod Class A Common 10 - Class B Common - - Charles D. Milos, Jr. Class A Common 528 .02% Class B Common - - Frances A. Moody Class A Common 2,475 .08% Class B Common 482 .24% Russell S. Moody Class A Common 2,475 .08% Class B Common 482 .24% Louis E. Pauls, Jr. Class A Common 10 - Class B Common - - E. J. Pederson Class A Common 100 - Class B Common - - Named Officers: Robert J. Antonowich Class A Common - - Class B Common - - Robert L. Busby, III Class A Common 4 - Class B Common - - Arthur W. Pickering Class A Common - - Class B Common - - Directors and Class A Common 1,168,293 35.42% Officers as a Group Class B Common 199,520 99.76%
(c) Changes in Control None. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (a) Transactions with Management and Others The Donner Company, 100% owned by Mr. Arthur Dummer, who is a director of National Western Life Insurance Company, was paid $84,895 in 1998 pursuant to an agreement between The Donner Company and a reinsurance intermediary relating to a reinsurance contract between the Company and certain life insurance reinsurers. (b) Certain Business Relationships None. (c) Indebtedness of Management The Company holds three mortgage loans issued to Gal-Tex Hotel Corporation, which is owned 50% by the Libbie Shearn Moody Trust and 50% by The Moody Foundation. The first mortgage loan in the amount of $2,254,000 was issued in 1988 and originally matured in May of 1998. It was extended during 1998 to May of 2003 and pays interest of 8%. The loan is secured by property consisting of a hotel located in Kingsport, Tennessee. The second mortgage loan in the amount of $8,164,000 was issued in 1994, will mature in October of 2004, and pays interest of 8.75%. The loan is secured by property consisting of a hotel located in Houston, Texas. The third mortgage loan in the amount of $1,789,000 was issued in 1995, will mature in January of 2006, and pays interest of 9%. The loan is secured by property consisting of a hotel located in Woodstock, Virginia. The Company's wholly owned subsidiary, NWL Services, Inc., is the beneficial owner of a life interest (1/8 share), previously owned by Mr. Robert L. Moody, in the trust estate of Libbie Shearn Moody. The trustee of this estate is The Moody National Bank of Galveston. The Moody Foundation is a private charitable foundation governed by a Board of Trustees of three members. Mr. Robert L. Moody and Mr. Ross R. Moody are members of the Board of Trustees. (d) Transactions with Promoters None. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) 1. Listing of Financial Statements See Attachment A, Index to Financial Statements and Schedules, on page __ for a list of financial statements included in this report. (a) 2. Listing of Financial Statement Schedules See Attachment A, Index to Financial Statements and Schedules, on page __ for a list of financial statement schedules included in this report. All other schedules are omitted because they are not applicable, not required, or because the information required by the schedule is included elsewhere in the financial statements or notes. (a) 3. Listing of Exhibits Exhibit 2 - Order Confirming Third Amended Joint Consensual Plan Of Reorganization Proposed By The Debtors And The Official Committee Of Unsecured Creditors (As Modified As Of August 28, 1998) (incorporated by reference to Exhibit 2 to the Company's Form 8-K dated August 28, 1998). Exhibit 3(a) - Restated Articles of Incorporation of National Western Life Insurance Company dated April 10, 1968 (incorporated by reference to Exhibit 3(a) to the Company's Form 10-K for the year ended December 31, 1995). Exhibit 3(b) - Amendment to the Articles of Incorporation of National Western Life Insurance Company dated July 29, 1971 (incorporated by reference to Exhibit 3(b) to the Company's Form 10-K for the year ended December 31, 1995). Exhibit 3(c) - Amendment to the Articles of Incorporation of National Western Life Insurance Company dated May 10, 1976 (incorporated by reference to Exhibit 3(c) to the Company's Form 10-K for the year ended December 31, 1995). Exhibit 3(d) - Amendment to the Articles of Incorporation of National Western Life Insurance Company dated April 28, 1978 (incorporated by reference to Exhibit 3(d) to the Company's Form 10-K for the year ended December 31, 1995). Exhibit 3(e) - Amendment to the Articles of Incorporation of National Western Life Insurance Company dated May 1, 1979 (incorporated by reference to Exhibit 3(e) to the Company's Form 10-K for the year ended December 31, 1995). Exhibit 3(f) - Bylaws of National Western Life Insurance Company as amended through April 24, 1987 (incorporated by reference to Exhibit 3(f) to the Company's Form 10-K for the year ended December 31, 1995). Exhibit 10(a) - National Western Life Insurance Company Non-Qualified Defined Benefit Plan dated July 26, 1991 (incorporated by reference to Exhibit 10(a) to the Company's Form 10-K for the year ended December 31, 1995). Exhibit 10(b) - National Western Life Insurance Company Officers' Stock Bonus Plan effective December 31, 1992 (incorporated by reference to the Company's Form S-8 registration dated January 27, 1994). Exhibit 10(c) - National Western Life Insurance Company Non-Qualified Deferred Compensation Plan, as amended and restated, dated March 27, 1995 (incorporated by reference to Exhibit 10(c) to the Company's Form 10-K for the year ended December 31, 1995). Exhibit 10(d) - First Amendment to the National Western Life Insurance Company Non-Qualified Deferred Compensation Plan effective July 1, 1995 (incorporated by reference to Exhibit 10(d) to the Company's Form 10-K for the year ended December 31, 1995). Exhibit 10(e) - National Western Life Insurance Company 1995 Stock and Incentive Plan (incorporated by reference to Exhibit 10(e) to the Company's Form 10-K for the year ended December 31, 1995). Exhibit 10(f) - First Amendment to the National Western Life Insurance Company Non-Qualified Defined Benefit Plan effective December 17, 1996 (incorporated by reference to Exhibit 10(f) to the Company's Form 10-K for the year ended December 31, 1996). Exhibit 10(g) - Second Amendment to the National Western Life Insurance Company Non-Qualified Defined Benefit Plan effective December 17, 1996 (incorporated by reference to Exhibit 10(g) to the Company's Form 10-K for the year ended December 31, 1996). Exhibit 10(h) - Second Amendment to the National Western Life Insurance Company Non-Qualified Deferred Compensation Plan effective December 17, 1996 (incorporated by reference to Exhibit 10(h) to the Company's Form 10-K for the year ended December 31, 1996). Exhibit 10(i) - Third Amendment to the National Western Life Insurance Company Non-Qualified Deferred Compensation Plan effective December 17, 1996 (incorporated by reference to Exhibit 10(i) to the Company's Form 10-K for the year ended December 31, 1996). Exhibit 10(j) Fourth Amendment to the National Western Life Insurance Company Non-Qualified Deferred Compensation Plan effective June 20, 1997 (incorporated by reference to Exhibit 10(j) to the Company's Form 10-K for the year ended December 31, 1997). Exhibit 10(k) - First Amendment to the National Western Life Insurance Company 1995 Stock and Incentive Plan effective June 19, 1998 (incorporated by reference to Exhibit 10(k) to the Company's Form 10-Q for the quarter ended June 30, 1998). Exhibit 10(l) - Joint Motion For Preliminary Approval Of Settlement Agreement, To Authorize Class Notice, To Enjoin Other Actions And To Schedule Fairness Hearing (incorporated by reference to Exhibit 10(l) to the Company's Form 8-K dated September 8, 1998). Exhibit 10(m) - Fifth Amendment to the National Western Life Insurance Company Non-Qualified Deferred Compensation Plan effective July 1, 1998 (incorporated by reference to Exhibit 10(l) to the Company's Form 10-Q for the quarter ended September 30, 1998). Exhibit 10(n) - Sixth Amendment to the National Western Life Insurance Company Non-Qualified Deferred Compensation Plan effective August 7, 1998 (filed on page __ of this report). Exhibit 10(o) - Third Amendment to the National Western Life Insurance Company Non-Qualified Defined Benefit Plan effective August 7, 1998 (filed on page __ of this report). Exhibit 10(p) - Exchange Agreement by and among National Western Life Insurance Company, NWL Services, Inc., Alternative Benefit Management, Inc., and American National Insurance Company effective November 23, 1998 (filed on page __ of this report). Exhibit 21 - Subsidiaries of the Registrant (filed on page __ of this report). Exhibit 27 - Financial Data Schedule (filed electronically pursuant to Regulation S-K). (b) Reports on Form 8-K No reports on Form 8-K were filed during the quarter ended December 31, 1998. (c) Exhibits Exhibits required by Regulation S-K are listed as to location in the Listing of Exhibits in Item 14(a)3 above. Exhibits not referred to have been omitted as inapplicable or not required. (d) Financial Statement Schedules The financial statement schedules required by Regulation S-K are listed as to location in Attachment A, Index to Financial Statements and Schedules, on page __ of this report. ATTACHMENT A Index to Financial Statements and Schedules Page Independent Auditors' Report Consolidated Balance Sheets, December 31, 1998 and 1997 Consolidated Statements of Earnings for the years ended December 31, 1998, 1997, and 1996 Consolidated Statements of Comprehensive Income for the years ended December 31, 1998, 1997, and 1996 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1998, 1997, and 1996 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997, and 1996 Notes to Consolidated Financial Statements Schedule I - Summary of Investments Other Than Investments in Related Parties, December 31, 1998 Schedule V - Valuation and Qualifying Accounts for the years ended December 31, 1998, 1997, and 1996 All other schedules are omitted because they are not applicable, not required, or because the information required by the schedule is included elsewhere in the financial statements or notes. INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders National Western Life Insurance Company Austin, Texas We have audited the consolidated financial statements of National Western Life Insurance Company and subsidiaries as listed in the accompanying index. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index. These consolidated financial statements and financial statement schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits. We conducted our audits in accordance with generally accepted auditing standards. 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 National Western Life Insurance Company and subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1998, in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. KPMG LLP Austin, Texas March 5, 1999 NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1998 and 1997 (In thousands)
ASSETS 1998 1997 Cash and investments: Securities held to maturity, at amortized cost (fair value: $2,124,715 and $1,949,876) $ 2,029,728 1,874,643 Securities available for sale, at fair value (cost: $696,333 and $618,274) 735,587 651,736 Mortgage loans, net of allowance for possible losses ($4,640 and $4,640) 174,921 181,878 Policy loans 124,441 133,826 Index options 23,900 420 Other long-term investments 24,999 26,967 Cash and short-term investments 24,508 7,870 Total cash and investments 3,138,084 2,877,340 Accrued investment income 44,777 41,050 Deferred policy acquisition costs 314,493 291,079 Other assets 20,601 15,202 Assets of discontinued operations 48 892 $ 3,518,003 3,225,563 See accompanying notes to consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 1998 and 1997 (In thousands except per share amounts)
LIABILITIES AND STOCKHOLDERS' EQUITY 1998 1997 LIABILITIES: Future policy benefits: Traditional life and annuity products $ 167,248 170,423 Universal life and investment annuity contracts 2,812,230 2,580,867 Other policyholder liabilities 23,955 25,001 Federal income taxes payable: Current 5,221 2,470 Deferred 9,646 13,153 Other liabilities 61,290 31,894 Liabilities of discontinued operations 48 892 Total liabilities 3,079,638 2,824,700 COMMITMENTS AND CONTINGENCIES (Notes 4, 7, 9, and 16) STOCKHOLDERS' EQUITY: Common stock: Class A - $1 par value; 7,500,000 shares authorized; 3,298,128 and 3,291,738 shares issued and outstanding in 1998 and 1997 3,298 3,292 Class B - $1 par value; 200,000 shares authorized, issued and outstanding in 1998 and 1997 200 200 Additional paid-in capital 24,899 24,662 Accumulated other comprehensive income 18,634 16,268 Retained earnings 391,334 356,441 Total stockholders' equity 438,365 400,863 $ 3,518,003 3,225,563 See accompanying notes to consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS For the Years Ended December 31, 1998, 1997, and 1996 (In thousands except per share amounts)
1998 1997 1996 Premiums and other revenue: Life and annuity premiums $ 13,165 15,812 16,611 Universal life and investment annuity contract revenues 83,169 80,250 75,966 Net investment income 233,844 217,446 214,302 Other income 1,052 354 2,718 Realized gains (losses) on investments 2,384 (1,588) 1,612 Total premiums and other revenue 333,614 312,274 311,209 Benefits and expenses: Life and other policy benefits 35,646 37,361 35,354 Decrease in liabilities for future policy benefits (3,205) (2,076) (2,041) Amortization of deferred policy acquisition costs 40,415 39,934 30,361 Universal life and investment annuity contract interest 158,889 145,200 151,475 Other operating expenses 35,504 27,560 25,722 Total benefits and expenses 267,249 247,979 240,871 Earnings before Federal income taxes and discontinued operations 66,365 64,295 70,338 Federal income taxes 17,347 21,723 24,123 Earnings from continuing operations 49,018 42,572 46,215 Losses from discontinued operations (14,125) (1,000) - Net earnings $ 34,893 41,572 46,215 Basic Earnings Per Share: Earnings from continuing operations $ 14.02 12.20 13.24 Losses from discontinued operations (4.04) (0.29) - Net earnings $ 9.98 11.91 13.24 Diluted Earnings Per Share: Earnings from continuing operations $ 13.87 12.09 13.17 Losses from discontinued operations (4.00) (0.28) - Net earnings $ 9.87 11.81 13.17 See accompanying notes to consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME For the Years Ended December 31, 1998, 1997, and 1996 (In thousands)
1998 1997 1996 Net earnings $ 34,893 41,572 46,215 Other comprehensive income, net of effects of deferred policy acquisition costs and taxes: Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during period 3,315 5,675 (4,620) Less: reclassification adjustment for gains included in net earnings (581) (690) (154) Amortization of net unrealized gains related to transferred securities (516) (1,056) (568) Net unrealized gains (losses) on securities 2,218 3,929 (5,342) Foreign currency translation adjustments 148 2,486 - Other comprehensive income 2,366 6,415 (5,342) Comprehensive income $ 37,259 47,987 40,873 See accompanying notes to consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the Years Ended December 31, 1998, 1997, and 1996 (In thousands)
1998 1997 1996 Common stock: Balance at beginning of year $ 3,492 3,491 3,491 Shares exercised under stock option plan 6 1 - Balance at end of year 3,498 3,492 3,491 Additional paid-in capital: Balance at beginning of year 24,662 24,647 24,647 Shares exercised under stock option plan 237 15 - Balance at end of year 24,899 24,662 24,647 Accumulated other comprehensive income: Unrealized gains (losses) on securities: Balance at beginning of year 13,782 9,853 15,195 Change in unrealized gains (losses) during period 2,218 3,929 (5,342) Balance at end of period 16,000 13,782 9,853 Foreign currency translation adjustments: Balance at beginning of year 2,486 - - Change in translation adjustments during period 148 2,486 - Balance at end of period 2,634 2,486 - Accumulated other comprehensive income at end of period 18,634 16,268 9,853 Retained earnings: Balance at beginning of year 356,441 314,869 268,654 Net earnings 34,893 41,572 46,215 Balance at end of year 391,334 356,441 314,869 Total stockholders' equity $ 438,365 400,863 352,860 See accompanying notes to consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1998, 1997, and 1996 (In thousands)
1998 1997 1996 Cash flows from operating activities: Net earnings $ 34,893 41,572 46,215 Adjustments to reconcile net earnings to net cash provided by operating activities: Universal life and investment annuity contract interest 158,889 145,200 151,475 Surrender charges and other policy revenues (40,267) (42,149) (39,562) Realized (gains) losses on investments (2,384) 1,588 (1,612) Accrual and amortization of investment income (7,763) (6,256) (6,880) Depreciation and amortization 997 900 708 Decrease (increase) in other assets 71 (11) (988) Increase in accrued investment income (3,727) (1,547) (3,376) Decrease (increase) in deferred policy acquisition costs (24,438) 989 (11,320) Decrease in liabilities for future policy benefits (3,205) (2,076) (2,041) Increase (decrease) in other policyholder liabilities (1,046) 598 1,570 Increase (decrease) in Federal income taxes payable (2,189) 2,195 10,645 Increase (decrease) in other liabilities 29,396 3,367 (191) Increase in value of index options (7,682) (18) - Other (730) - - Net cash provided by operating activities 130,815 144,352 144,643 Cash flows from investing activities: Proceeds from sales of: Securities held to maturity 2,978 1,993 - Securities available for sale - 50,706 41,276 Other investments 5,043 2,109 3,126 Proceeds from maturities and redemptions of: Securities held to maturity 99,495 105,162 72,138 Securities available for sale 59,035 38,529 44,662 Purchases of: Securities held to maturity (266,580) (115,095) (301,239) Securities available for sale (124,142) (191,168) (27,838) Other investments (20,071) (5,950) (4,014) Principal payments on mortgage loans 37,805 40,987 32,995 Cost of mortgage loans acquired (29,572) (31,654) (26,220) Decrease in policy loans 9,385 8,251 5,846 Decrease in assets of discontinued operations 844 365 4,920 Decrease in liabilities of discontinued operations (844) (365) (4,920) Other (892) (234) (337) Net cash used in investing activities (227,516) (96,364) (159,605) (Continued on next page)
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS, CONTINUED For the Years Ended December 31, 1998, 1997, and 1996 (In thousands)
1998 1997 1996 Cash flows from financing activities: Deposits to account balances for universal life and investment annuity contracts $ 455,709 267,515 304,236 Return of account balances on universal life and investment annuity contracts (342,613) (319,007) (287,940) Issuance of common stock under stock option plan 243 16 - Net cash provided by (used in) financing activities 113,339 (51,476) 16,296 Net increase (decrease) in cash and short-term investments 16,638 (3,488) 1,334 Cash and short-term investments at beginning of year 7,870 11,358 10,024 Cash and short-term investments at end of year $ 24,508 7,870 11,358 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 340 326 251 Income taxes 19,085 19,203 13,466 Noncash investing activities: Foreclosed mortgage loan s $ - 2,320 - Mortgage loans originated to facilitate the sale of real estate 1,032 1,556 4,145 See accompanying notes to consolidated financial statements.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (A) Principles of Consolidation - The accompanying consolidated financial statements include the accounts of National Western Life Insurance Company and its wholly owned subsidiaries (the Company), The Westcap Corporation, NWL Investments, Inc., NWL Properties, Inc., NWL 806 Main, Inc., NWL Services, Inc., and NWL Financial, Inc. The Westcap Corporation ceased brokerage operations during 1995 and filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code in 1996. As a result, The Westcap Corporation is reflected as discontinued operations in the accompanying financial statements. The bankruptcy reorganization was completed in January, 1999, National Western retained 100% continuing ownership of the reorganized Westcap, and the subsidiary is now operating as a real estate management company. All significant intercorporate transactions and accounts have been eliminated in consolidation. (B) Basis of Presentation - The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Significant estimates included in the accompanying financial statements include (1) contingent liabilities related to litigation, (2) recoverability of deferred policy acquisition costs, (3) estimated losses related to discontinued operations, and (4) valuation allowances for mortgage loans. National Western Life Insurance Company also files financial statements with insurance regulatory authorities which are prepared on the basis of statutory accounting practices which are significantly different from financial statements prepared in accordance with generally accepted accounting principles. These differences are described in detail in the statutory information section of this note. (C) Investments - Investments in debt securities the Company purchases with the intent to hold to maturity are classified as securities held to maturity. The Company has the ability to hold the securities, as it would be unlikely that forced sales of securities would be required prior to maturity to cover payments of liabilities. As a result, securities held to maturity are carried at amortized cost less declines in value that are other than temporary. Investments in debt and equity securities that are not classified as securities held to maturity are reported as securities available for sale. Securities available for sale are reported in the accompanying financial statements at individual fair value. Any valuation changes resulting from changes in the fair value of the securities are reflected as a component of stockholders' equity. These unrealized gains or losses in stockholders' equity are reported net of taxes and adjustments to deferred policy acquisition costs. Transfers of securities between categories are recorded at fair value at the date of transfer. The unrealized holding gains or losses for securities transferred from available for sale to held to maturity are included in accumulated other comprehensive income and amortized into earnings over the remaining life of the security as an adjustment to yield in a manner consistent with the amortization or accretion of premium or discount on the associated security. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. Realized gains and losses for securities available for sale and securities held to maturity are included in earnings and are derived using the specific identification method for determining the cost of securities sold. A decline in the fair value below cost that is deemed other than temporary is charged to earnings, resulting in the establishment of a new cost basis for the security. Mortgage loans and other long-term investments are stated at cost, less unamortized discounts and allowances for possible losses. Policy loans are stated at their aggregate unpaid balances. Real estate is stated at the lower of cost or fair value less estimated costs to sell. (D) Cash Equivalents - For purposes of the statements of cash flows, the Company considers all short-term investments with a maturity at date of purchase of three months or less to be cash equivalents. (E) Derivative Financial Instruments - The Company purchases over-the-counter index options, which are derivative financial instruments, to hedge the equity return component of its equity-indexed annuity products. The index options act as hedges to match closely the returns on the S&P 500 Composite Stock Price Index which may be paid to policyholders. As a result, changes to policyholders' liabilities are substantially offset by changes in the value of the options. Cash is exchanged upon purchase of the index options, and no principal or interest payments are made by either party during the option periods. Upon maturity or expiration of the options, cash is paid to the Company based on the S&P 500 performance and terms of the contract. The index options are reported at fair value in the accompanying financial statements. The changes in the values of the index options and the changes in the policyholder liabilities are both reflected in the statement of earnings. Any gains or losses from the sale or expiration of the options, as well as period-to-period changes in values, are reflected as net investment income in the statement of earnings. Although there is credit risk in the event of nonperformance by counterparties to the index options, the Company does not expect any counterparties to fail to meet their obligations, given their high credit ratings. In addition, credit support agreements are in place with certain counterparties, which further reduces the Company's credit exposure. At December 31, 1998 and 1997, the fair values of index options owned by the Company totaled $23,900,000 and $420,000, respectively. (F) Insurance Revenues and Expenses - Premiums on traditional life insurance products are recognized as revenues as they become due or, for short duration contracts, over the contract periods. Benefits and expenses are matched with premiums in arriving at profits by providing for policy benefits over the lives of the policies and by amortizing acquisition costs over the premium-paying periods of the policies. For universal life and investment annuity contracts, revenues consist of policy charges for the cost of insurance, policy administration, and surrender charges assessed during the period. Expenses for these policies include interest credited to policy account balances and benefit claims incurred in excess of policy account balances. The related deferred policy acquisition costs are amortized in relation to the present value of expected gross profits on the policies. (G) Federal Income Taxes - Federal income taxes are accounted for under the asset and liability method. 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. 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. 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. A valuation allowance for deferred tax assets is provided if all or some portion of the deferred tax asset may not be realized. An increase or decrease in a valuation allowance that results from a change in circumstances that affects the realizability of the related deferred tax asset is included in income. (H) Depreciation of Property, Equipment, and Leasehold Improvements - Depreciation is based on the estimated useful lives of the assets and is calculated on the straight-line and accelerated methods. Leasehold improvements are amortized over the lesser of the economic useful life of the improvement or the term of the lease. (I) Classification - Certain reclassifications have been made to the prior years to conform to the reporting categories used in 1998. (J) Statutory Information - National Western Life Insurance Company, domiciled in Colorado, prepares its statutory financial statements in accordance with accounting practices prescribed or permitted by the Colorado Division of Insurance. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. Such practices may differ from state to state and may even differ from company to company within a state. However, the NAIC has recently completed a comprehensive process of codifying statutory accounting practices and procedures. Other than specific individual state laws, the codification results will be the only source of prescribed statutory accounting practices. Insurance companies must adopt these new statutory accounting practices in 2001, which may result in significant changes to existing practices used in the preparation of statutory financial statements. Based on a preliminary review, National Western does not currently anticipate a material impact to its capital and surplus position as a result of implementation of the new prescribed statutory accounting procedures. The following are major differences between generally accepted accounting principles and current prescribed or permitted statutory accounting practices. 1. The Company accounts for universal life and investment annuity contracts based on the provisions of Statement of Financial Accounting Standards (SFAS) No. 97, "Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments." The basic effect of the statement with respect to certain long-duration contracts is that deposits for universal life and investment annuity contracts are not reflected as revenues, and surrenders and certain other benefit payments are not reflected as expenses. However, statutory accounting practices do reflect such items as revenues and expenses. A summary of direct premiums and deposits collected is provided below:
Years Ended December 31, 1998 1997 1996 (In thousands) Direct premiums and deposits collected: Investment annuity deposits $ 431,003 240,987 273,202 Universal life insurance deposits 69,647 65,862 67,438 Traditional life and other premiums 20,237 21,506 23,135 Totals $ 520,887 328,355 363,775
2. Any gains or losses from the sale or expiration of index options, as well as period-to-period changes in values, are reflected as net investment income in the statement of earnings under generally accepted accounting principles. For statutory accounting purposes, period-to-period changes in values of index options are recorded directly to capital and surplus, and gains or losses from sales or expirations are reported in income as realized gains or losses on investments. 3. For statutory accounting purposes, litigation settlements are often recorded as direct reductions of capital and surplus. However, litigation settlements are recorded in the statement of earnings for generally accepted accounting principles. 4. Under generally accepted accounting principles, commissions and certain expenses related to policy issuance and underwriting, all of which generally vary with and are related to the production of new business, are deferred. For traditional products, these costs are amortized over the premium-paying period of the related policies in proportion to the ratio of the premium earned to the total premium revenue anticipated, using the same assumptions as to interest, mortality, and withdrawals as were used in calculating the liability for future policy benefits. For universal life and investment annuity contracts, these costs are amortized in relation to the present value of expected gross profits on these policies. The Company evaluates the recoverability of deferred policy acquisition costs on an annual basis. In this evaluation, the Company considers estimated future gross profits or future premiums, as applicable for the type of contract. The Company also considers expected mortality, interest earned and credited rates, persistency, and expenses. Statutory accounting practices require commissions and related costs to be expensed as incurred. A summary of information relative to deferred policy acquisition costs is provided in the table below:
Years Ended December 31, 1998 1997 1996 (In thousands) Deferred policy acquisition costs, beginning of year $ 291,079 295,666 270,167 Policy acquisition costs deferred: Agents' commissions 62,717 37,069 39,218 Other 2,136 1,876 2,463 Total costs deferred 64,853 38,945 41,681 Amortization of deferred policy acquisition costs (40,415) (39,934) (30,361) Adjustments for unrealized gains and losses on investment securities (1,024) (3,598) 14,179 Deferred policy acquisition costs, end of year $ 314,493 291,079 295,666
5. Under generally accepted accounting principles, the liability for future policy benefits on traditional products has been calculated by the net level method using assumptions as to future mortality (based on the 1965-1970 and 1975-1980 Select and Ultimate mortality tables), interest ranging from 4% to 8%, and withdrawals based on Company experience. For universal life and investment annuity contracts, the liability for future policy benefits represents the account balance. For statutory accounting purposes, liabilities for future policy benefits for life insurance policies are calculated by the net level premium method or the commissioners reserve valuation method. Future policy benefit liabilities for annuities are calculated based on the continuous commissioners annuity reserve valuation method and provisions of Actuarial Guideline 33. 6. Deferred Federal income taxes are provided for temporary differences which are recognized in the financial statements in a different period than for Federal income tax purposes. Deferred taxes are not recognized in statutory accounting practices. Also, for statutory accounting purposes, the Company has recorded Federal income tax receivables as permitted by the Colorado Division of Insurance. The Federal income tax receivables related to subsidiary losses have been recorded directly to surplus and were not recorded in results of operations. 7. For statutory accounting purposes, debt securities are recorded at amortized cost, except for securities in or near default which are reported at market value. 8. Investments in subsidiaries are recorded at admitted asset value for statutory purposes, whereas the financial statements of the subsidiaries have been consolidated with those of the Company under generally accepted accounting principles. 9. The asset valuation reserve and interest maintenance reserve, which are investment valuation reserves prescribed by statutory accounting practices, have been eliminated, as they are not required under generally accepted accounting principles. 10. The recorded value of the life interest in the Libbie Shearn Moody Trust (the Trust) is reported at its initial valuation, net of accumulated amortization, under generally accepted accounting principles. The initial valuation was based on the assumption that the Trust would provide certain income to the Company at an assumed interest rate and is being amortized over 53 years, the life expectancy of Mr. Robert L. Moody at the date he contributed the life interest to the Company. For statutory accounting purposes, the life interest has been valued at $26,400,000, which was computed as the present value of the estimated future income to be received from the Trust. However, this amount is being amortized to a valuation of $12,774,000 over a seven-year period in accordance with Colorado Division of Insurance permitted accounting requirements. Prescribed statutory accounting practices provide no accounting guidance for such asset. The statutory admitted value of this life interest at December 31, 1998, is $14,721,000 in comparison to a carrying value of $4,347,000 in the accompanying consolidated financial statements. 11. Reconciliations of statutory stockholders' equity, as included in the annual statements filed with the Colorado Division of Insurance, to the respective amounts as reported in the accompanying consolidated financial statements prepared under generally accepted accounting principles are as follows:
Stockholders' Equity as of December 31, 1998 1997 1996 (In thousands) Statutory equity $ 310,991 300,589 265,289 Adjustments: Difference in valuation of investment in the Libbie Shearn Moody Trust (10,374) (12,032) (13,692) Deferral of policy acquisition costs 314,493 291,079 295,666 Adjustment of future policy benefits (232,919) (217,040) (220,510) Deferred Federal income taxes payable (9,646) (13,153) (11,910) Adjustment of securities available for sale to fair value 38,840 34,957 26,116 Reversal of asset valuation reserve 19,756 11,654 10,403 Reversal of interest maintenance reserve 10,140 9,630 7,837 Reinstatement of nonadmitted assets 3,257 2,535 3,088 Valuation allowances on investments (5,458) (6,571) (10,052) Other, net (715) (785) 625 Generally accepted accounting principles equity $ 438,365 400,863 352,860
12. Reconciliations of statutory net earnings, as included in the annual statements filed with the Colorado Division of Insurance, to the respective amounts as reported in the accompanying consolidated financial statements prepared under generally accepted accounting principles are as follows:
Net Earnings for the Years Ended December 31, 1998 1997 1996 (In thousands) Statutory net earnings $ 23,973 33,771 35,644 Adjustments: Subsidiary earnings (losses) before deferred Federal income taxes (11,346) 2,372 (656) Deferral of policy acquisition costs 24,438 (989) 11,320 Adjustment of future policy benefits (15,879) 3,470 (2,158) Amortization of investment in the Libbie Shearn Moody Trust (289) (286) (284) Benefit (provision) for deferred Federal income taxes 4,781 2,211 (2,499) Valuation allowances and permanent impairment writedowns on investments 1,253 1,816 954 Unrealized gains (losses) on index options recorded in statutory surplus 7,682 18 - Lawsuit settlements recorded in statutory surplus (4,756) (90) 850 Tax benefit (expense) recorded in surplus 5,320 (1,685) 1,637 Increase in interest maintenance reserve 510 1,793 1,846 Other, net (794) (829) (439) Generally accepted accounting principles net earnings $ 34,893 41,572 46,215
(2) DEPOSITS WITH REGULATORY AUTHORITIES The following assets were on deposit with state and other regulatory authorities as required by law at the end of each year:
December 31, 1998 1997 (In thousands) Debt securities $ 17,912 18,127 Certificates of deposit 260 260 Totals $ 18,172 18,387
(3) INVESTMENTS (A) Investment Income The major components of net investment income are as follows:
Years Ended December 31, 1998 1997 1996 (In thousands) Investment income: Debt securities $ 195,425 184,870 176,825 Mortgage loans 16,943 18,659 19,851 Policy loans 9,252 9,764 10,645 Index options 8,057 18 - Other investment income 7,783 6,742 10,082 Total investment income 237,460 220,053 217,403 Investment expenses 3,616 2,607 3,101 Net investment income $ 233,844 217,446 214,302
Investments of the following amounts were not income producing for the preceding twelve months:
December 31, 1998 1997 (In thousands) Equity securities $ 3,127 2,706 Real estate 319 488 Totals $ 3,446 3,194
The Company had no investments in debt securities or mortgage loans that were on nonaccrual status during 1998 or 1997. As of December 31, 1996, $2,981,000 of securities and mortgage loans were on nonaccrual status. Reductions in interest income associated with nonperforming investments in debt securities and mortgage loans were not significant during 1998, 1997, and 1996. (B) Mortgage Loans and Real Estate Concentrations of credit risk arising from mortgage loans exist in relation to certain groups of customers. A group concentration arises when a number of counterparties have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The Company does not have a significant exposure to any individual customer or counterparty. The major concentrations of mortgage loan credit risk for the Company arise by geographic location in the United States and by property type as detailed below.
December 31, 1998 1997 West South Central 57.1% 54.9% Mountain 19.4 11.3 Pacific 7.7 8.0 South Atlantic 4.8 11.4 All other 11.0 14.4 Totals 100.0% 100.0%
December 31, 1998 1997 Retail 56.7% 62.2% Office 21.0 16.6 Hotel/Motel 7.9 7.9 Apartment 4.2 4.1 All other 10.2 9.2 Totals 100.0% 100.0%
As of December 31, 1998 and 1997, no mortgage loans were considered impaired. For the years ended December 31, 1997, and 1996 average investments in impaired mortgage loans were $676,000, and $232,000, respectively. There were no investments in impaired mortgage loans for the year ended December 31, 1998. Interest income recognized on impaired loans during the years ended December 31, 1997 and 1996, was not significant. Impaired loans are typically placed on nonaccrual status and no interest income is recognized. However, if cash is received on the impaired loan, it is applied to principal and interest on past due payments, beginning with the most delinquent payment. Detailed below are changes in the allowance for mortgage loan losses for 1998, 1997, and 1996:
Years Ended December 31, 1998 1997 1996 (In thousands) Balance at beginning of year $ 4,640 5,988 5,668 Net additions charged to realized investment gains and losses - 1,133 500 Releases due primarily to foreclosures and loan payoffs - (2,481) (180) Balance at end of year $ 4,640 4,640 5,988
At December 31, 1998 and 1997, the Company owned investment real estate totaling $13,553,000 and $15,027,000 which is reflected in other long-term investments in the accompanying financial statements. The Company records real estate at the lower of cost or fair value less estimated costs to sell. Real estate values are monitored and evaluated at least annually by the use of independent appraisals or internal valuations. Decreases in market values affecting carrying values are recorded in a valuation allowance which is reflected in realized gains or losses on investments. For the year ended December 31, 1998, there were no impairment losses on real estate due to decreases in market value. For the years ended December 31, 1997 and 1996, impairment losses on real estate due to decreases in market values totaled $46,000 and $526,000, respectively. (C) Investment Gains and Losses The table below presents realized gains and losses and changes in unrealized gains and losses on investments for 1998, 1997, and 1996:
Changes in Realized Unrealized Investment Investment Gains Gains (Losses) (Losses) From Prior Year (In thousands) Year Ended December 31, 1998: Securities held to maturity $ 797 19,754 Securities available for sale 893 2,218 Other 694 - Totals $ 2,384 21,972 Year Ended December 31, 1997: Securities held to maturity $ 1,791 51,947 Securities available for sale 1,061 3,929 Other (4,440) - Totals $ (1,588) 55,876 Year Ended December 31, 1996: Securities held to maturity $ 936 (59,972) Securities available for sale 237 (5,342) Other 439 - Totals $ 1,612 (65,314)
(D) Debt and Equity Securities The tables below present amortized cost and fair values of securities held to maturity and securities available for sale at December 31, 1998:
Securities Held to Maturity Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value (In thousands) Debt securities: U.S. Treasury and other U.S. government corporations and agencies $ 3,706 359 - 4,065 States and political subdivisions 27,001 2,322 - 29,323 Foreign governments 51,389 4,254 - 55,643 Public utilities 302,484 20,197 3,346 319,335 Corporate 1,159,758 61,252 6,364 1,214,646 Mortgage-backed 410,818 16,287 28 427,077 Asset-backed 74,572 392 338 74,626 Totals $2,029,728 105,063 10,076 2,124,715
Securities Available for Sale Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value (In thousands) Debt securities: U.S. Treasury and other U.S. government corporations and agencies $ 3,231 233 - 3,464 States and political subdivisions 3,000 11 - 3,011 Public utilities 59,699 4,771 72 64,398 Corporate 303,196 18,341 2,904 318,633 Mortgage-backed 199,985 11,322 1,019 210,288 Asset-backed 115,204 5,480 603 120,081 Equity securities 12,018 3,799 105 15,712 Totals $ 696,333 43,957 4,703 735,587
The tables below present amortized cost and fair values of securities held to maturity and securities available for sale at December 31, 1997:
Securities Held to Maturity Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value (In thousands) Debt securities: U.S. Treasury and other U.S. government corporations and agencies $ 23,867 331 - 24,198 States and political subdivisions 26,996 2,549 - 29,545 Foreign governments 51,331 2,357 - 53,688 Public utilities 271,478 10,902 1,322 281,058 Corporate 1,024,104 43,525 1,074 1,066,555 Mortgage-backed 451,515 17,995 108 469,402 Asset-backed 25,352 274 196 25,430 Totals $ 1,874,643 77,933 2,700 1,949,876
Securities Available for Sale Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value (In thousands) Debt securities: U.S. Treasury and other U.S. government corporations and agencies $ 3,219 223 - 3,442 Public utilities 58,567 3,224 283 61,508 Corporate 220,458 13,313 1,479 232,292 Mortgage-backed 240,479 14,138 960 253,657 Asset-backed 85,440 2,130 19 87,551 Equity securities 10,111 3,269 94 13,286 Totals $ 618,274 36,297 2,835 651,736
The amortized cost and fair values of investments in debt securities at December 31, 1998, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Securities Securities Available for Sale Held to Maturity Amortized Fair Amortized Fair Cost Value Cost Value (In thousands) Due in 1 year or less $ - - 7,005 6,995 Due after 1 year through 5 years 33,122 33,289 353,640 362,208 Due after 5 years through 10 years 275,511 286,672 976,306 1,032,098 Due after 10 years 60,493 69,545 207,387 221,711 369,126 389,506 1,544,338 1,623,012 Mortgage and asset-backed securities 315,189 330,369 485,390 501,703 Totals $ 684,315 719,875 2,029,728 2,124,715
The Company uses the specific identification method in computing realized gains and losses. There were no sales of securities available for sale during 1998. Proceeds from sales of securities available for sale during 1997 and 1996 totaled $50,706,000 and $41,276,000, respectively. Gross gains and gross losses realized on those sales are detailed below:
Years Ended December 31, 1998 1997 1996 (In thousands) Gross realized gains $ - 1,029 575 Gross realized losses - - (402) Net realized gains (losses) $ - 1,029 173
In 1998, the Company sold one held to maturity bond due to significant credit deterioration of the issuing company. Amortized cost of the security totaled $2,981,000, and a realized loss of $3,000 was recognized on the sale. In 1997, the Company sold one held to maturity bond due to significant credit deterioration of the issuing company. Amortized cost of the security totaled $1,987,000, and a realized gain of $6,000 was recognized on the sale. The Company did not sell any held to maturity securities during 1996. The Company held in its investment portfolio below investment grade debt securities totaling $44,974,000, $41,149,000, and $38,696,000 at December 31, 1998, 1997, and 1996, respectively. These amounts represent approximately 1.4% of total invested assets in 1998, 1997, and 1996. Below investment grade securities generally have greater default risk than higher rated corporate debt. The issuers of these securities are usually more sensitive to adverse industry or economic conditions than are investment grade issuers. The Company had investments totaling $58,765,000 in Citigroup, Inc. or its affiliates at December 31, 1998. Except for U.S. government agency mortgage- backed securities, the Company had no other investments in any entity in excess of 10% of stockholders' equity at December 31, 1998. (E) Transfers of Securities At July 31, 1994, the Company transferred debt securities with fair values totaling $805 million from securities available for sale to securities held to maturity. On December 29, 1995, the Company made additional transfers totaling $156 million to the held to maturity category from securities available for sale. Lower holdings of securities available for sale significantly reduce the Company's exposure to equity volatility while still providing securities for liquidity and asset/liability management purposes. The transfers of securities were recorded at fair values in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This statement requires that the unrealized holding gain or loss at the date of the transfer continue to be reported in a separate component of stockholders' equity but shall be amortized over the remaining life of the security as an adjustment of yield in a manner consistent with the amortization of any premium or discount. The amortization of an unrealized holding gain or loss reported in equity will offset or mitigate the effect on interest income of the amortization of the premium or discount for the held to maturity securities. The transfer of securities from available for sale to held to maturity had no effect on net earnings of the Company. However, stockholders' equity was adjusted as follows:
Net Unrealized Gains (Losses) as of December 31, 1998 1997 1996 (In thousands) Beginning unamortized gains from transfers $ 1,545 2,601 3,169 Amortization of net unrealized gains related to transferred securities, net of effects of deferred policy acquisition costs and taxes (516) (1,056) (568) Ending unamortized gains from transfers $ 1,029 1,545 2,601
Net unrealized gains and losses on investment securities included in stockholders' equity at December 31, 1998 and 1997, are as follows:
December 31, 1998 1997 (In thousands) Gross unrealized gains $ 43,957 36,297 Gross unrealized losses (4,703) (2,835) Adjustments for: Deferred policy acquisition costs (16,222) (14,637) Deferred Federal income taxes (8,061) (6,588) 14,971 12,237 Net unrealized gains related to securities transferred to held to maturity 1,029 1,545 Net unrealized gains on investment securities $ 16,000 13,782
(F) Change in Accounting Principles In June, 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS No. 133 defines several designations of derivatives based on the instrument's intended use and specifies the appropriate accounting treatment for changes in the fair value of the derivative based on its resulting designation. The statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. The Company currently sells equity-indexed annuities that contain an equity return component for policyholders which is an embedded derivative instrument. The Company purchases index options, which are also derivative instruments, to hedge this equity return component. The index options are reported at fair value in the Company's financial statements, which is in accordance with SFAS No. 133 requirements. The Company also uses a fair value approach in recording policy liabilities for the equity-indexed annuities. However, there is currently no specific, authoritative interpretation of SFAS No. 133 with respect to accounting for equity-indexed annuity liabilities. Additional guidance in 1999 regarding this issue may result in a definitive method significantly different from that currently used by the Company. As a result, the ultimate implementation of SFAS No. 133 could have a significant effect on the Company's results of operations. The Company expects to implement the new statement in the first quarter of 2000. (4) REINSURANCE (A) Summary of Significant Reinsurance Information The Company is party to several reinsurance agreements. The Company's general policy is to reinsure that portion of any risk in excess of $200,000 on the life of any one individual. Prior to 1996, the Company's policy was to reinsure amounts in excess of $150,000. Total life insurance in force was $9.40 billion and $8.56 billion at December 31, 1998 and 1997, respectively. Of these amounts, life insurance in force totaling $1.47 billion and $1.24 billion was ceded to reinsurance companies, primarily on a yearly renewable term basis, at December 31, 1998 and 1997, respectively. In accordance with the reinsurance contracts, reinsurance receivables including amounts related to claims incurred but not reported and liabilities for future policy benefits totaled $4,269,000 and $5,396,000 at December 31, 1998 and 1997, respectively. Premium revenues were reduced by $7,245,000, $5,719,000, and $6,442,000 for reinsurance premiums incurred during 1998, 1997, and 1996, respectively. Benefit expenses were reduced by $3,013,000, $5,396,000, and $19,070,000 for reinsurance recoveries during 1998, 1997, and 1996, respectively. A liability exists with respect to reinsurance, as the Company remains liable if the reinsurance companies are unable to meet their obligations under the existing agreements. (B) Change in Accounting Principles In October, 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-7, "Deposit Accounting: Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk." The SOP specifies classifications for insurance and reinsurance contracts for which deposit accounting is appropriate and specifies accounting methods for each. For each insurance and reinsurance contract accounted for under deposit accounting, a deposit asset or liability should be recognized at inception and should be measured based on consideration paid or received, less any premiums or fees to be retained by the insurer or reinsurer, irrespective of the experience of the contract. The Company anticipates that this SOP will not have a significant effect on its financial statements, as the Company's current insurance and reinsurance contracts all transfer insurance risk. SOP 98-7 is effective for all fiscal years beginning after June 15, 1999. The Company currently plans to implement the SOP in the first quarter of 2000. (5) FEDERAL INCOME TAXES Total Federal income taxes for 1998, 1997, and 1996 were allocated as follows:
Years Ended December 31, 1998 1997 1996 (In thousands) Taxes on earnings from continuing operations: Current $ 22,128 23,934 21,624 Deferred (4,781) (2,211) 2,499 Taxes on earnings from continuing operations 17,347 21,723 24,123 Taxes on components of stockholders' equity: Net unrealized gains and losses on securities available for sale 1,196 2,115 (2,876) Foreign currency translation adjustments 80 1,338 - Total Federal income taxes $ 18,623 25,176 21,247
The provisions for Federal income taxes attributable to earnings from continuing operations vary from amounts computed by applying the statutory income tax rate to earnings before Federal income taxes. The reasons for the differences and the corresponding tax effects are as follows:
Years Ended December 31, 1998 1997 1996 (In thousands) Income tax expense at statutory rate $ 23,228 22,503 24,618 Tax-exempt income (931) (822) (298) Amortization of life interest in the Libbie Shearn Moody Trust 101 100 99 Non-deductible travel and entertainment 108 101 116 Tax benefits from discontinued operations (4,944) (350) (182) Other (215) 191 (230) Taxes on earnings from continuing operations $ 17,347 21,723 24,123
There were no deferred taxes attributable to enacted tax rate changes for the years ended December 31, 1998, 1997, and 1996. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997, are presented below:
December 31, 1998 1997 (In thousands) Deferred tax assets: Future policy benefits, excess of financial accounting liabilities over tax liabilities $ 100,023 90,314 Mortgage loans, principally due to valuation allowances for financial accounting purposes 1,506 1,657 Real estate, principally due to writedowns for financial accounting purposes 1,615 1,678 Accrued and unearned investment income recognized for tax purposes and deferred for financial accounting purposes 634 2,333 Accrued operating expenses recorded for financial accounting purposes not currently tax deductible 5,440 2,357 Net operating loss carryforward 1,509 73 Other 36 886 Total gross deferred tax assets 110,763 99,298 Less valuation allowance - - Net deferred tax assets 110,763 99,298 Deferred tax liabilities: Deferred policy acquisition costs, principally expensed for tax purposes (104,383) (97,173) Securities, principally due to deferred market discount for tax (5,132) (5,687) Real estate, principally due to differences in tax and financial accounting for depreciation (851) (823) Net unrealized gains on securities available for sale (8,616) (7,420) Foreign currency translation adjustment (1,418) (1,338) Other (9) (10) Total gross deferred tax liabilities (120,409) (112,451) Net deferred tax liabilities $ (9,646) (13,153)
There was no valuation allowance for deferred tax assets at December 31, 1998 and 1997. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences. Prior to the Tax Reform Act of 1984 (1984 Act), a portion of a life insurance company's income was not subject to tax until it was distributed to stockholders, at which time it was taxed at the regular corporate tax rate. In accordance with the 1984 Act, this income, referred to as policyholders' surplus, would not increase, yet any amounts distributed would be taxable at the regular corporate rate. The balance of this account as of December 31, 1998, is approximately $2,446,000. No provision for income taxes has been made on this untaxed income, as management is of the opinion that no distribution to stockholders will be made from policyholders' surplus in the foreseeable future. Should the balance in the policyholders' surplus account at December 31, 1998, become taxable, the Federal income taxes computed at present rates would be approximately $856,000. The Company files a consolidated Federal income tax return with its subsidiaries. Allocation of the consolidated tax liability is based on separate return calculations pursuant to the "wait-and-see" method as described in sections 1.1552-1(a)(2) and 1.1502-33(d)(2)(i) of the current Treasury Regulations. Under this method, consolidated group members are not given current credit for net losses until future net taxable income is generated to realize such credits. In accordance with this consolidated tax sharing agreement, tax benefits resulting from discontinued brokerage operation losses totaling $4,944,000, $350,000, and $182,000 for 1998, 1997, and 1996 were included in earnings from continuing operations. (6) TRANSACTIONS WITH CONTROLLING STOCKHOLDER AND AFFILIATES (A) Life Interest in Libbie Shearn Moody Trust The Company's wholly owned subidiary, NWL Services, Inc., is the beneficial owner of a life interest (1/8 share) in the trust estate of Libbie Shearn Moody (the Trust) which was previously owned by Mr. Robert L. Moody, Chairman of the Board of Directors of the Company. The Company has issued term insurance policies on the life of Mr. Robert L. Moody which are reinsured through agreements with unaffiliated insurance companies. NWL Services, Inc. is the beneficiary of these policies for an amount equal to the statutory admitted value of the Trust, which was $14,721,000 at December 31, 1998. The excess of $27,000,000 face amount of the reinsured policies over the statutory admitted value of the Trust has been assigned to Mr. Robert L. Moody. The recorded net asset values in the accompanying consolidated financial statements for the life interest in the Trust are as follows:
December 31, 1998 1997 (In thousands) Original valuation of life interest at February 26, 1960 $ 13,793 13,793 Less accumulated amortization (9,446) (9,157) Net asset value of life interest in the Trust $ 4,347 4,636
Income from the Trust and related expenses reflected in the accompanying consolidated statements of earnings are summarized as follows:
Years Ended December 31, 1998 1997 1996 (In thousands) Income distributions $ 3,451 3,335 3,252 Deduct: Amortization (289) (286) (284) Reinsurance premiums (300) (266) (238) Net income from life interest in the Trust $ 2,862 2,783 2,730
(B) Common Stock Mr. Robert L. Moody, Chairman of the Board of Directors, owns 198,074 of the total outstanding shares of the Company's Class B common stock and 1,160,896 of the Class A common stock. Holders of the Company's Class A common stock elect one-third of the Board of Directors of the Company, and holders of the Class B common stock elect the remainder. Any cash or in-kind dividends paid on each share of Class B common stock shall be only one-half of the cash or in-kind dividends paid on each share of Class A common stock. Also, in the event of liquidation of the Company, the Class A stockholders shall first receive the par value of their shares; then the Class B stockholders shall receive the par value of their shares; and the remaining net assets of the Company shall be divided between the stockholders of both Class A and Class B common stock, based on the number of shares held. (7) PENSION PLANS (A) Defined Benefit Plans The Company has a qualified defined benefit pension plan covering substantially all full-time employees. The plan provides benefits based on the participants' years of service and compensation. The Company makes annual contributions to the plan that comply with the minimum funding provisions of the Employee Retirement Income Security Act. During 1998 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 132, "Employers' Disclosures About Pensions and Other Postretirement Benefits." This statement revises employers' disclosures about pension and other postretirement benefit plans, but it does not change the measurement or recognition of those plans. A detail of plan disclosures in accordance with SFAS No. 132 is provided below: The following summarizes the changes in benefit obligations for the years ended:
December 31, 1998 1997 1996 (In thousands) Benefit obligations at beginning of year $ 9,408 8,332 8,199 Service cost 363 286 287 Interest cost 647 620 571 Actuarial (gain) loss 386 661 (266) Benefits paid (513) (491) (459) Benefit obligations at end of year $ 10,291 9,408 8,332
The following summarizes the changes in the fair value of plan assets, primarily consisting of equity and fixed income securities, for the years ended:
December 31, 1998 1997 1996 (In thousands) Fair value of plan assets at beginning of year $ 9,265 7,899 6,557 Actual return on plan assets 1,549 1,437 643 Employer contribution - 420 1,158 Benefits paid (513) (491) (459) Fair value of plan assets at end of year $ 10,301 9,265 7,899
The following sets forth the plan's funded status and the related amounts recognized in the Company's financial statements as of:
December 31, 1998 1997 1996 (In thousands) Funded status $ 10 (143) (433) Unrecognized net actuarial loss 964 1,503 1,766 Unrecognized transition assets (154) (209) (264) Minimum liability - - (1,039) Unrecognized prior service cost (146) (176) (206) Prepaid (accrued) benefit cost $ 674 975 (176)
The following are the weighted-average assumptions as of:
December 31, 1998 1997 1996 Discount rate 6.75% 7.00% 7.50% Expected return on plan assets 7.50 7.50 8.50 Rate of compensation increase 4.50 4.50 4.50
Net periodic benefit costs include the following components for the years ended:
December 31, 1998 1997 1996 (In thousands) Service cost $ 363 286 287 Interest cost 647 620 571 Expected return on plan assets (674) (594) (614) Amortization of unrecognized transition assets (55) (55) (55) Amortization of prior service cost (30) (30) (30) Recognized net actuarial loss 50 81 113 Net periodic benefit cost $ 301 308 272
The Company also sponsors a nonqualified defined benefit plan primarily for senior officers. The plan provides benefits based on the participants' years of service and compensation. During 1998 the Company transferred the pension obligations and administrative responsibilities of the plan to a pension administration firm. Upon transfer, the Company paid $4,880,000 to cover current and future liabilities and administration of the plan. Pension expense for 1998, up to the time of transfer, was $324,000. The financial effects of the transaction resulted in additional pension expense during 1998 totaling $2,543,000, as the amount paid upon transfer exceeded the pension liabilities recorded for financial statement purposes in accordance with SFAS No. 87 and SFAS No. 132. The obligations under the plan are now the responsibility of the new pension administration firm, which is a subsidiary of American National Insurance Company (ANICO). ANICO has also guaranteed the payment of pension obligations under the plan. However, National Western has a contingent liability with respect to the pension plan should these entities be unable to meet their obligations under the existing agreements. Also, National Western has a contingent liability with respect to the plan in the event that a plan participant continues employment with National Western beyond age seventy, the aggregate average annual participant salary increases exceed 10% per year, or any additional employees become eligible to participate in the plan. If any of these conditions are met, National Western would be responsible for any additional pension obligations resulting from these items. (B) Defined Contribution Plans In addition to the defined benefit plans, the Company has a qualified 401(k) plan for substantially all full-time employees and a nonqualified deferred compensation plan primarily for senior officers. The Company makes annual contributions to the 401(k) plan of two percent of each employee's compensation. Additional Company matching contributions of up to two percent of each employee's compensation are also made each year based on the employee's personal level of salary deferrals to the plan. All Company contributions are subject to a vesting schedule based on the employee's years of service. For the years ended December 31, 1998, 1997, and 1996, Company contributions totaled $270,000, $250,000, and $217,000, respectively. The nonqualified deferred compensation plan was established to allow eligible employees to defer the payment of a percentage of their compensation and to provide for additional Company contributions. Company contributions are subject to a vesting schedule based on the employee's years of service. For the years ended December 31, 1998, 1997, and 1996, Company contributions totaled $60,000, $36,000, and $62,000, respectively. (8) SHORT-TERM BORROWINGS The Company has available a $60 million bank line of credit primarily for cash management purposes relating to investment transactions. The Company is required to maintain a collateral security deposit in trust with the bank equal to 120% of any outstanding liability. The Company had no outstanding liabilities or collateral security deposits with the bank at December 31, 1998 and 1997. The Company had no borrowings on the line of credit during 1998. The weighted average interest rates on borrowings for the years ended December 31, 1997 and 1996 were 6.42% and 6.91%, respectively. Actual borrowings and interest expense for 1997 and 1996 were minimal. (9) COMMITMENTS AND CONTINGENCIES (A) Legal Proceedings The Westcap Corporation Bankruptcy Proceedings By order dated August 28, 1998, the United States Bankruptcy Court, Southern District of Texas, Houston Division, confirmed and approved the Third Amended Joint Consensual Plan of Reorganization (the Plan) of The Westcap Corporation and its wholly owned subsidiary, Westcap Enterprises, Inc. (jointly Westcap). Westcap is a wholly owned subsidiary of National Western Life Insurance Company (National Western). Pursuant to the Plan, National Western received credit for $1,000,000 previously contributed to Westcap in bankruptcy in March, 1997, and paid an additional $14,125,000 to compromise and settle (i) all claims of Westcap against National Western, and (ii) all claims and litigation of certain settling creditors of Westcap who have alleged federal or state securities law "control person" violations by National Western relating to Westcap's brokerage business, in exchange for full and complete releases from all of such claims, litigation, and alleged violations. Of the $14,125,000, amounts totaling $7,284,000 were paid and transmitted to a Disbursing Trust Committee on behalf of Westcap for payment to holders of allowed claims against the Westcap debtors, and National Western paid $6,841,000 to settling Westcap creditors with allowed claims against the Westcap debtors who also settled and released National Western from alleged federal or state securities law "control person" violations relating to Westcap. The settling creditors were: City of Tracy, California; Michigan South Central Power Agency; Covafer, S.A. and Sergio Covarrubias; Sheriff of Palm Beach County, Florida; San Antonio River Authority; Tom Green County, Texas; Eduardo and Antonietta Saad; City of La Mesa; Darlington County, South Carolina; Greenwood County, South Carolina; Bernice and Sarah Finger; Winston-Salem State University Foundation; Mary Robin Christison; Mason Tenders; Clerk of the Circuit Court of St. Lucie County, Florida. Pursuant to the Plan, National Western retained 100% continuing ownership of the reorganized Westcap. Westcap will no longer engage in brokerage operations, but will operate as a real estate management company. Community College District No. 508, County of Cook and State of Illinois (The City Colleges), was excluded from the compromise and settlement by National Western with the settling creditors, but participated with all creditors in the distribution from Westcap. In addition to the amounts described above, included in the distribution to the Disbursing Trust were $48,000 of Westcap assets. The City Colleges had previously obtained a bankruptcy court judgment for approximately $56 million against the Westcap debtors (which was subsequently reduced to approximately $52 million). Under the Plan, The City Colleges participated in the $7,332,000 creditor distribution relating to an allowed $30 million claim, with any distribution relating to the remaining $26 million claim in dispute pending an appeal by Westcap of the bankruptcy judgment. Should Westcap prevail in the appeal, National Western will be entitled to recover 23.1% of the reduced amount of The City Colleges judgment, but not to exceed $600,000. Should Westcap lose the appeal, The City Colleges will receive a higher prorata percentage of the $7,332,000 creditor distribution. However, pursuant to the Plan, National Western will have no additional liability for settlement payments in excess of the $14,125,000 as described above. Under the Plan, National Western will pay all of the attorneys' fees and court costs incurred by Westcap in the appeal of The City Colleges' judgment. The $14,125,000 was paid by National Western on January 13, 1999. However, the settlement payment has been accrued in other liabilities as of December 31, 1998, and reflected as a 1998 loss from discontinued operations in the accompanying financial statements. The $1,000,000 previously contributed to Westcap in bankruptcy was also reflected as a loss from discontinued operations in 1997. Any additional losses will depend on the results of The City Colleges lawsuit filed against National Western on March 28, 1994, for alleged federal or state securities law "control person" violations relating to Westcap, and which is pending in the United States District Court, Western District of Texas. National Western believes it has reasonable and adequate defenses to this suit, and, accordingly, no amounts have been accrued in National Western's financial statements for potential losses relating to such suit. Westcap Related Litigation On March 28, 1994, the Community College District No. 508, County of Cook and State of Illinois (The City Colleges), filed a complaint in the United States District Court for the Northern District of Illinois, Eastern Division, against National Western Life Insurance Company (the Company or National Western) and subsidiaries of The Westcap Corporation (Westcap), a wholly owned subsidiary of the Company. The suit sought rescission of securities purchase transactions by The City Colleges from Westcap between September 9, 1993, and November 3, 1993, alleged compensatory damages, punitive damages, injunctive relief, declaratory relief, fees, and costs. National Western was named as a "controlling person" of the Westcap defendants. Westcap filed Chapter 11 bankruptcy, and The City Colleges filed a claim in the bankruptcy court against Westcap. The claim was tried before the bankruptcy court, and in September, 1997, a $56,173,000 judgment was entered against Westcap favorable to The City Colleges. Westcap appealed this decision to the United States District Court for the Southern District of Texas (Houston Division). On July 24, 1998, the United States District Court affirmed the orders of the bankruptcy court with respect to their underlying conclusion that Westcap is liable to The City Colleges under the Texas Securities Act, but the Court vacated the orders and remanded them to the bankruptcy court to determine the correct amount of damages in a manner consistent with the Court's opinion and the Texas Securities Act. The bankruptcy court on November 16, 1998, entered an order allowing a claim of The City Colleges against the Westcap estate of $51,738,868. Westcap will appeal the bankruptcy court's and District Court's judgment to the Fifth Circuit Court of Appeals. While Westcap is a wholly owned subsidiary of the Company, the Company is not a party to the bankruptcy or the judgment against Westcap by the bankruptcy court or the United States District Court. The lawsuit against the Company was stayed in September, 1994, pending resolution of The City Colleges' claim against Westcap. Following the judgment against Westcap in the bankruptcy court, on December 2, 1997, the stay was lifted by the United States District Court in Illinois, and The City Colleges filed an amended complaint seeking to hold the Company liable for the claim allowed in the bankruptcy court against Westcap under the "control person" provision of the Texas Securities Act. The suit seeks approximately $56 million plus fees and costs. The Company filed jurisdictional and venue motions to have the case transferred to the United States District Court for the Western District of Texas, which motions were agreed to by the Plaintiff, and the case is now pending in the United States District Court for the Western District of Texas, where the parties are engaged in discovery activities. The Company believes it has reasonable and adequate defenses to the suit. Although the alleged damages, if sustained, would be material to the Company's financial statements, a reasonable estimate of any actual losses which may result from the suit cannot be made at this time. Accordingly, no provision for any liability that may result from this suit has been recognized in the accompanying financial statements. On July 5, 1995, San Patricio County, Texas, filed suit in the District Court of San Patricio County, Texas, against National Western Life Insurance Company (the Company) and its chief executive officer, Robert L. Moody. The suit arose from derivative investments purchased by San Patricio County from Westcap Securities, L.P. or Westcap Government Securities, Inc., affiliates of The Westcap Corporation. The suit alleged that the Westcap affiliates were controlled by the Company and Mr. Moody and that they were responsible for the alleged wrongful acts of the Westcap affiliates in selling the securities to the Plaintiff. Plaintiff alleged that the Westcap affiliates violated duties and responsibilities owed to the Plaintiff related to the investment recommendations and decisions made by Plaintiff, and alleged that the Plaintiff was financially damaged by such actions of Westcap. The suit was settled effective March 9, 1998, with a payment of $200,000 by National Western to San Patricio County and with no admission of liability. In exchange for the payment, National Western and Robert L. Moody received a general release of all claims asserted, including all claims that have been asserted against Westcap Securities, L.P., or could have been asserted in another court against Westcap Securities, L.P., and the lawsuit was dismissed. The $200,000 settlement payment was recorded as other operating expenses in 1998. Class Action Litigation National Western Life Insurance Company (the Company or National Western) and National Annuity Programs, Inc. (NAP), have been sued in the District Court of Travis County, Texas, by a former agent of the Company, eight plaintiffs, and fourteen intervenors, being present and past annuity policyholders of the Company, and on behalf of an asserted class of annuity policyholders of the Company, and alleged that, in the sale of certain Company annuities to the plaintiffs and intervenors, the Company and NAP (i) had violated the Texas Deceptive Trade Practices-Consumer Protection Act, statutes in the Texas Insurance Code, and certain rules and regulations of the Texas Department of Insurance; (ii) committed common law fraud; (iii) were negligent; (iv) had breached a duty of good faith and fair dealing; (v) made negligent misrepresentations; (vi) committed a civil conspiracy to commit fraud; and (vii) breached policy contracts. The plaintiffs seek (i) certification of one or more classes; and (ii) recovery of unspecified actual damages, monies paid by plaintiffs, attorneys' fees, prejudgment and postjudgment interests and costs, increased or treble damages, punitive damages, and general relief as awarded by the Court. NAP was an independent marketing general agency under contract with the Company that hired and supervised the agents marketing the annuity products on behalf of the Company. On September 8, 1998, National Western, NAP, and the policyholder plaintiffs, intervenors, and class-representatives in this class action litigation filed with the Court a joint motion for preliminary approval of a Settlement Agreement among the parties. The parties requested the Court to review the Settlement Agreement and make a preliminary determination that it is fair, adequate, and reasonable to the members of the proposed classes and that the proposed classes are capable of being certified for settlement purposes, to approve the form of the notices of the settlement to the classes, and to set a class certification and fairness hearing on the settlement. In exchange for a final order and judgment dismissing with prejudice the claims asserted against National Western, and NAP by all members of the settlement classes, National Western will contribute approximately $5 million to the proposed settlement, and NAP will pay $750,000 to the settlement. Approximately $3,850,000 will be made available for the members of the various classes that qualify for payments, and $1,900,000 will be paid for attorneys' fees and expenses. There is a possibility that National Western's total payment to members of the classes could increase, but it is believed that the amount would not be material. In the settlement, National Western guarantees that at least $900,000 will be paid out to approved claims by members of the classes, and any unclaimed amounts are to be returned to National Western. Additionally, National Western has agreed to pay the costs of notice to the class and administration of the settlement claims process, estimated to be approximately $250,000. National Western has also agreed to guarantee minimum interest rates of 3% and 5% in the future on certain settlement options under specified annuity policies which are the subject matter of the litigation and to provide additional incidental settlement benefits, all as detailed in the motion and Settlement Agreement. The plaintiffs estimate that the aggregate value of all of the settlement benefits, including the $5,750,000 settlement payments and potential future benefits to be derived by policyholders under certain policy settlement elections, is approximately $10 million. On September 9, 1998, the District Court entered an order temporarily certifying a settlement class, preliminarily approved the Settlement Agreement between the parties, determined that it is appropriate to send notice to the proposed class members of the Settlement Agreement, approved the form and content of the notices to the members of the class, authorized National Western to retain an administrator to supervise the Settlement Agreement offer to members of the class, set a "fairness hearing" on the Settlement Agreement for January 20, 1999, and enjoined other actions. National Western proceeded with notification of class members and preliminary administration of the claims process during late 1998 and January, 1999. Estimated costs for this process totaling $250,000 were accrued as other operating expenses as of December 31, 1998, in the accompanying financial statements. On January 20, 1999, the Court held a "fairness hearing" and approved the Settlement Agreement. As a result, National Western also accrued the estimated $5,000,000 settlement as other operating expenses as of December 31, 1998. The actual settlement payments are expected to be paid during 1999. Other Pending Litigation On December 31, 1997, National Western Life Insurance Company (National Western) filed a declaratory judgment action against National Annuity Programs, Inc. (NAP), and Robert L. Myer (Myer) for construction of a General Agent Manager Contract and amendments thereto between National Western and NAP, a declaration that the contract is enforceable, and for an award for damages. The contract was entered into in 1983 and amended in 1994, by which NAP was to market insurance and annuity products issued by National Western. The suit alleges that during the course of the contract NAP violated its terms and conditions, violated the insurance laws and regulations of the State of Texas, misrepresented the terms and conditions of National Western's insurance and annuity products, induced National Western's policyholders to relinquish or terminate its policies of insurance or annuities, and failed to use reasonable efforts to conserve its insurance and annuity products. National Western seeks (i) to withhold, deduct, and/or terminate the payment of agency commissions under the contract to NAP, which are based on future premiums received and policies maintained in force; (ii) damages from breach of the contract; (iii) recovery of damages from Robert L. Myer for tortious interference with National Western's contractual relations with its policyholders; (iv) recovery of damages from Robert L. Myer for conspiracy to cause NAP to breach its contract with National Western and to induce its policyholders to terminate their policies with National Western; and (v) reasonable attorneys' fees, costs, and expenses. The parties have started discovery proceedings. National Western Life Insurance Company is also currently a defendant in several other lawsuits, substantially all of which are in the normal course of business. In the opinion of management, the liability, if any, which may arise from these lawsuits would not have a material adverse effect on the Company's financial position. (B) Financial Instruments In order to meet the financing needs of its customers in the normal course of business, the Company is a party to financial instruments with off-balance sheet risk. These financial instruments are commitments to extend credit which involve elements of credit and interest rate risk in excess of the amounts recognized in the balance sheet. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amounts, assuming that the amounts are fully advanced and that collateral or other security is of no value. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company controls the credit risk of these transactions through credit approvals, limits, and monitoring procedures. The Company had commitments to extend credit relating to mortgage loans totaling $6,946,000 at December 31, 1998. Commitments to extend credit are legally binding agreements to lend to a customer that generally have fixed expiration dates or other termination clauses and may require payment of a fee. Commitments do not necessarily represent future liquidity requirements, as some could expire without being drawn upon. The Company evaluates each customer's creditworthiness on a case-by-case basis. The Company also had commitments to purchase investment securities totaling $10,000,000 at December 31, 1998. (C) Guaranty Association Assessments National Western Life Insurance Company is subject to state guaranty association assessments in all states in which it is licensed to do business. These associations generally guarantee certain levels of benefits payable to resident policyholders of insolvent insurance companies. Many states allow premium tax credits for all or a portion of such assessments, thereby allowing potential recovery of these payments over a period of years. However, several states do not allow such credits. The Company estimates its liabilities for guaranty association assessments by using the latest information available from the National Organization of Life and Health Insurance Guaranty Associations. The Company monitors and revises its estimates for assessments as additional information becomes available which could result in changes to the estimated liabilities. Guaranty association assessments reflected significant decreases in 1998, as these expenses declined $1,317,000 from the prior year. The reduction is due to changes in estimated liabilities, changes in estimated recoverable capitalized assessments, and assessment refunds received from states during 1998. These changes and refunds resulted in a net credit in other operating expenses for guaranty association assessments totaling $365,000 for 1998. Other operating expenses related to state guaranty association assessments totaled $952,000, and $1,146,000 for the years ended December 31, 1997 and 1996, respectively. (D) Changes in Accounting Principles In December, 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) 97-3, which provides guidance on accounting by insurance and other enterprises for assessments related to insurance activities. The SOP provides: (1) guidance for determining when an entity should recognize a liability for guaranty fund and other insurance related assessments, (2) guidance on how to measure the liability including discounting of the liability if the amount and timing of the cash payments are fixed or reliably determinable, (3) guidance on when an asset may be recognized for a portion or all of the assessment liability or paid assessment that can be recovered through premium tax offsets or policy surcharges, and (4) requirements for disclosure of certain information. The Company anticipates that this SOP will not have a significant effect on its reporting of liabilities for guaranty fund assessments, as the Company is currently applying accounting procedures similar to those in the new statement. SOP 97- 3 is effective for financial statements for fiscal years beginning after December 15, 1998. The Company will implement the SOP in the first quarter of 1999. (10) STOCKHOLDERS' EQUITY (A) Changes in Common Stock Shares Outstanding Details of changes in shares of common stock outstanding are provided below:
Years Ended December 31, 1998 1997 1996 (In thousands) Common stock shares outstanding: Shares outstanding at beginning of year 3,492 3,491 3,491 Shares exercised under stock option plan 6 1 - Shares outstanding at end of year 3,498 3,492 3,491
(B) Dividend Restrictions The Company is restricted by state insurance laws as to dividend amounts which may be paid to stockholders without prior approval from the Colorado Division of Insurance. The restrictions are based on statutory earnings and surplus levels of the Company. The maximum dividend payment which may be made without prior approval in 1999 is $30,749,000. The Company has never paid cash dividends on its common stock, as it follows a policy of retaining any earnings in order to finance the development of business and to meet regulatory requirements for capital. (C) Regulatory Capital Requirements The Colorado Division of Insurance imposes minimum risk-based capital requirements on insurance companies that were developed by the National Association of Insurance Commissioners (NAIC). The formulas for determining the amount of risk-based capital (RBC) specify various weighting factors that are applied to statutory financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of the Company's regulatory total adjusted capital to its authorized control level RBC, as defined by the NAIC. Companies below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. The Company's current statutory capital and surplus is significantly in excess of the threshold RBC requirements. (D) Stock and Incentive Plan The Company has a stock and incentive plan which provides for the grant of any or all of the following types of awards to eligible employees: (1) stock options, including incentive stock options and nonqualified stock options; (2) stock appreciation rights, in tandem with stock options or freestanding; (3) restricted stock; (4) incentive awards; and (5) performance awards. The plan began on April 21, 1995, and will terminate on April 20, 2005, unless terminated earlier by the Board of Directors. The number of shares of Class A, $1.00 par value, common stock which may be issued under the plan, or as to which stock appreciation rights or other awards may be granted, may not exceed 300,000. These shares may be authorized and unissued shares or treasury shares. All of the employees of the Company and its subsidiaries are eligible to participate in the plan. In addition, directors of the Company, other than Compensation and Stock Option Committee members, are eligible for restricted stock awards, incentive awards, and performance awards. Company directors, including members of the Compensation and Stock Option Committee, are eligible for nondiscretionary stock options. The Committee approved the issuance of nonqualified stock options to selected officers of the Company during 1998, 1997, and 1996 totaling 48,500, 21,900, and 33,000, respectively. Additionally, during 1998 the Committee granted 10,000 nonqualified, nondiscretionary stock options to Company directors. The directors' stock options vest 20% annually following one full year of service to the Company from the date of grant. The officers' stock options vest 20% annually following three full years of service to the Company from the date of grant. The exercise prices of the stock options were set at the fair market values of the common stock on the dates of grant. A summary of shares available for grant and stock option activity is detailed below:
Options Outstanding Shares Weighted- Available Average For Grant Shares Exercise Price Balance at January 1, 1996 240,500 59,500 $ 38.13 Stock Options: Granted (33,000) 33,000 65.00 Balance at December 31, 1996 207,500 92,500 47.71 Stock Options: Granted (21,900) 21,900 85.13 Exercised - (400) 38.13 Forfeited 100 (100) 75.06 Balance at December 31, 1997 185,700 113,900 54.92 Stock Options: Granted (58,500) 58,500 111.16 Exercised - (6,390) 38.13 Forfeited 250 (250) 105.25 Balance at December 31, 1998 127,450 165,760 $ 73.68
Vested and exercisable options at December 31, 1998, 1997, and 1996 totaled 7,910, 2,400, and 1,400, respectively. The weighted-average exercise price for these options was $38.13. The following table summarizes information about stock options outstanding at December 31, 1998.
Options Outstanding Weighted- Number Average Options Outstanding Remaining Life Exercisable Exercise prices: $ 38.13 52,710 6.4 years 7,910 65.00 32,950 7.3 years - 85.13 21,850 8.3 years - 105.25 48,250 9.3 years - 112.38 10,000 9.5 years - Totals 165,760 7,910
In October, 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 123, "Accounting for Stock-Based Compensation." This statement establishes financial accounting and reporting standards for stock-based employee compensation plans. It defines a fair value based method of accounting for employee stock options or similar equity instruments. However, it also allows an entity to continue to measure compensation cost for plans using the intrinsic value based method of accounting prescribed by Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees." Under the fair value based method, compensation cost is measured at the grant date based on the fair value of the award and is recognized over the service period, which is usually the vesting period. For stock options, fair value is determined using an option pricing model that takes into account various information and assumptions regarding the Company's stock and options. Under the intrinsic value based method, compensation cost is the excess, if any, of the quoted market price of the stock at grant date or other measurement date over the amount an employee must pay to acquire the stock. The Company has elected to continue to apply the accounting methods prescribed by APB Opinion No. 25 for its existing stock and incentive plan. No compensation costs have been recorded for the Company's existing plan using the intrinsic value based method. However, if compensation expense for the stock options had been determined using the fair value based method under SFAS No. 123, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts as follows:
Years Ended December 31, 1998 1997 1996 (In thousands except per share amounts) Net earnings: As reported $ 34,893 41,572 46,215 Pro forma $ 34,241 41,211 45,975 Basic earnings per share: As reported $ 9.98 11.91 13.24 Pro forma $ 9.80 11.80 13.17 Diluted earnings per share: As reported $ 9.87 11.81 13.17 Pro forma $ 9.69 11.70 13.10
The fair value of the options used in estimating the pro forma amounts above were estimated on the date of grant using an option pricing model with the weighted-average assumptions as detailed below:
Options Granted in Years Ended December 31, 1998 1997 1996 Risk-free interest rates 5.1% 5.4% 6.5% Dividend yields - - - Volatility factors 29.0% 32.1% 32.6% Weighted-average expected life 7 years 7 years 7 years Weighted-average fair value per share $44.29 $39.08 $31.63
(11) EARNINGS PER SHARE In February, 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share." This statement changes the computation, presentation, and disclosure requirements for earnings per share (EPS). SFAS No. 128 replaces the presentation of primary and fully diluted EPS with basic and diluted EPS, respectively. Basic EPS excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. The Company adopted SFAS No. 128 effective December 31, 1997. In accordance with the new statement, prior period earnings per share data was restated. The following table sets forth the computation of basic and diluted earnings per share:
Years Ended December 31, 1998 1997 1996 (In thousands except per share amounts) Numerator for basic and diluted earnings per share: Earnings from continuing operations available to common stockholders before and after assumed conversions $ 49,018 42,572 46,215 Denominator: Basic earnings per share - weighted-average shares 3,495 3,491 3,491 Effect of dilutive stock options 40 30 19 Diluted earnings per share - adjusted weighted-average shares for assumed conversions 3,535 3,521 3,510 Basic earnings per share $ 14.02 12.20 13.24 Diluted earnings per share $ 13.87 12.09 13.17
(12) COMPREHENSIVE INCOME The Company adopted Statement of Financial Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income," in the first quarter of 1998. SFAS No. 130 establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains, and losses) in a full set of general-purpose financial statements. This statement requires that all items that are required to be recognized under accounting standards as components of comprehensive income be reported in a financial statement that is displayed with the same prominence as other financial statements. This statement requires that an enterprise (a) classify items of other comprehensive income by their nature in a financial statement and (b) display the accumulated balance of other comprehensive income separately from retained earnings and additional paid-in capital in the equity section of a statement of financial position. SFAS No. 130 affects the Company's reporting presentation of certain items such as foreign currency translation adjustments and unrealized gains and losses on investment securities. These items are now a component of other comprehensive income, as reported in the accompanying financial statements. Prior period financial statements have been reclassified for comparative purposes in accordance with SFAS No. 130. Components of other comprehensive income and related taxes are provided below for 1998, 1997, and 1996.
Amounts Amounts Before (Taxes) Net of Taxes Benefits Taxes (In thousands) 1998: Unrealized gains (losses) on securities, net of effects of deferred policy acquisition costs of $1,024: Unrealized holding gains (losses) arising during period $ 5,100 (1,785) 3,315 Less: reclassification adjustment for (gains) losses included in net earnings (893) 312 (581) Amortization of net unrealized gains related to transferred securities (793) 277 (516) Net unrealized gains (losses) on securities 3,414 (1,196) 2,218 Foreign currency translation adjustments 228 (80) 148 Other comprehensive income $ 3,642 (1,276) 2,366 1997: Unrealized gains (losses) on securities, net of effects of deferred policy acquisition costs of $3,598: Unrealized holding gains (losses)arising during period $ 8,730 (3,055) 5,675 Less: reclassification adjustment for (gains) losses included in net earnings (1,061) 371 (690) Amortization of net unrealized gains related to transferred securities (1,625) 569 (1,056) Net unrealized gains (losses) on securities 6,044 (2,115) 3,929 Foreign currency translation adjustments 3,824 (1,338) 2,486 Other comprehensive income $ 9,868 (3,453) 6,415
Amounts Amounts Before (Taxes) Net of Taxes Benefits Taxes (In thousands) 1996: Unrealized gains (losses) on securities, net of effects of deferred policy acquisition costs of $14,179: Unrealized holding gains (losses) arising during period $ (7,109) 2,489 (4,620) Less: reclassification adjustment for (gains) losses included in net earnings (237) 83 (154) Amortization of net unrealized gains related to transferred securities (872) 304 (568) Other comprehensive income $ (8,218) 2,876 (5,342)
(13) UNAUDITED QUARTERLY FINANCIAL DATA Quarterly results of operations for 1998 are summarized as follows:
First Second Third Fourth Quarter Quarter Quarter Quarter (In thousands except per share data) 1998: Revenues $ 80,145 82,131 76,575 94,763 Earnings from continuing operations $ 10,370 12,270 15,896 10,482 Losses from discontinued operations - - (14,125) - Net earnings $ 10,370 12,270 1,771 10,482 Basic earnings per share: Earnings from continuing operations $ 2.97 3.51 4.55 3.00 Losses from discontinued operations - - (4.04) - Net earnings $ 2.97 3.51 0.51 3.00 Diluted earnings per share: Earnings from continuing operations $ 2.94 3.48 4.48 2.96 Losses from discontinued operations - - (3.98) - Net earnings $ 2.94 3.48 0.50 2.96
The fourth quarter net earnings in 1998 reflect the following significant items: Net earnings for the quarter ended December 31, 1998, were $10,482,000 compared to $14,493,000 for the fourth quarter of 1997. Included in results for the quarter are two nonrecurring charges which significantly lowered the Company's earnings. As more fully described in Note 9, Commitments and Contingencies, the Diffie, et al vs. National Western Life Insurance Company and National Annuity Programs, Inc., class action litigation was settled in January, 1999, with the Company agreeing to pay $5,000,000 in the settlement. This amount was accrued in the accompanying financial statements in the fourth quarter of 1998, thereby reducing earnings $3,250,000, after taxes. Also during the fourth quarter of 1998, the Company transferred pension obligations and administrative responsibilities of its nonqualified defined benefit plan to a pension administration firm. The financial effects of the transaction resulted in additional pension expense in the fourth quarter totaling $1,653,000, net of taxes, as described in detail in Note 7, Pension Plans. Quarterly results of operations for 1997 are summarized as follows:
First Second Third Fourth Quarter Quarter Quarter Quarter (In thousands except per share data) 1997: Revenues $ 72,916 80,924 76,094 82,340 Earnings from continuing operations $ 6,752 11,798 9,529 14,493 Losses from discontinued operations (1,000) - - - Net earnings $ 5,752 11,798 9,529 14,493 Basic earnings per share: Earnings from continuing operations $ 1.94 3.38 2.73 4.15 Losses from discontinued operations (0.29) - - - Net earnings $ 1.65 3.38 2.73 4.15 Diluted earnings per share: Earnings from continuing operations $ 1.92 3.35 2.71 4.11 Losses from discontinued operations (0.28) - - - Net earnings $ 1.64 3.35 2.71 4.11
The fourth quarter net earnings in 1997 reflect the following significant items: Net earnings for the quarter ended December 31, 1997, were $14,493,000 compared to $13,071,000 for the fourth quarter of 1996. This reflects an increase of $1,422,000, or 10.9%, over 1996 fourth quarter earnings. Increases in universal life and annuity contract revenues of 12.8% and net investment income of 4.0% contributed to the higher earnings. Life insurance benefit claims were also down 7.7%, which had a positive effect on 1997 fourth quarter earnings. Realized gains, net of taxes, included in net earnings totaled $509,000 and $219,000 for the fourth quarters of 1997 and 1996, respectively. (14) SEGMENT AND OTHER OPERATING INFORMATION (A) Operating Segment Information In previous years the Company reported two industry segments, life insurance operations and brokerage operations. For the year ended December 31, 1998, the Company implemented Statement of Financial Accounting Standards (SFAS) No. 131, "Disclosures About Segments of an Enterprise and Related Information," and redefined its reportable operating segments as domestic life insurance, international life insurance, and annuities. The Company's segments are organized based on product types and geographic marketing areas. A summary of segment information, prepared in accordance with SFAS No. 131, is provided below: Selected Segment Information:
Domestic International Life Life All Insurance Insurance Annuities Others Totals (In thousands) 1998: Premiums and contract revenues $ 24,296 40,606 31,432 - 96,334 Net investment income 26,211 21,940 182,347 3,346 233,844 Other income 750 32 270 - 1,052 Universal life and investment annuity contract interest 9,963 13,432 135,494 - 158,889 Amortization of deferred policy acquisition costs 2,954 15,836 21,625 - 40,415 Federal income taxes 3,227 3,228 13,880 1,122 21,457 Segment earnings 6,395 6,397 27,508 2,224 42,524 Segment assets 412,538 373,201 2,692,330 19,285 3,497,354 1997: Premiums and contract revenues $ 23,639 40,429 31,994 - 96,062 Net investment income 26,873 21,451 166,348 2,774 217,446 Other income 43 34 277 - 354 Universal life and investment annuity contract interest 9,687 12,575 122,938 - 145,200 Amortization of deferred policy acquisition costs 5,058 13,608 21,268 - 39,934 Federal income taxes 3,089 3,739 14,848 953 22,629 Segment earnings 5,901 7,143 28,389 1,821 43,254 Segment assets 405,427 359,986 2,429,998 14,058 3,209,469 1996: Premiums and contract revenues $ 24,507 36,653 31,417 - 92,577 Net investment income 27,766 21,243 165,943 (650) 214,302 Other income 375 256 2,087 - 2,718 Universal life and investment annuity contract interest 9,694 11,853 129,928 - 151,475 Amortization of deferred policy acquisition costs 5,467 10,264 14,630 - 30,361 Federal income taxes 4,597 3,773 15,595 (224) 23,741 Segment earnings 8,710 7,150 29,550 (425) 44,985 Segment assets 400,747 345,834 2,353,445 6,074 3,106,100
Reconciliations of segment information to the Company's consolidated financial statements are provided below:
Years Ended December 31, 1998 1997 1996 (In thousands) Premiums and Other Revenue: Premiums and contract revenues $ 96,334 96,062 92,577 Net investment income 233,844 217,446 214,302 Other income 1,052 354 2,718 Realized gains (losses) on investments 2,384 (1,588) 1,612 Total consolidated premiums and other revenue $ 333,614 312,274 311,209
Years Ended December 31, 1998 1997 1996 (In thousands) Federal Income Taxes: Total segment Federal income taxes $ 21,457 22,629 23,741 Taxes on realized gains (losses) on investments 834 (556) 564 Tax benefits from discontinued operations (4,944) (350) (182) Total taxes on earnings from continuing operations $ 17,347 21,723 24,123
Years Ended December 31, 1998 1997 1996 (In thousands) Net Earnings: Total segment earnings $ 42,524 43,254 44,985 Realized gains (losses) on investments, net of taxes 1,550 (1,032) 1,048 Losses from discontinued operations (14,125) (1,000) - Tax benefits from discontinued operations 4,944 350 182 Total consolidated net earnings $ 34,893 41,572 46,215
December 31, 1998 1997 1996 (In thousands) Assets: Total segment assets $ 3,497,354 3,209,469 3,106,100 Assets of discontinued operations 48 892 1,257 Other unallocated assets 20,601 15,202 13,472 Total consolidated assets $ 3,518,003 3,225,563 3,120,829
(B) Geographic Information A significant portion of the Company's premiums and contract revenues are from countries other than the United States. Premium and contract revenues detailed by country are provided below:
Years Ended December 31, 1998 1997 1996 (In thousands) United States $ 56,341 56,122 56,503 Argentina 9,052 9,706 10,474 Peru 8,293 8,227 7,541 Chile 6,227 5,451 4,649 Haiti 4,941 4,430 3,796 Columbia 3,612 3,781 3,555 Other foreign countries 15,113 14,064 12,501 Revenues, excluding reinsurance premiums 103,579 101,781 99,019 Reinsurance premiums (7,245) (5,719) (6,442) Total premiums and contract revenues $ 96,334 96,062 92,577
Premiums and contract revenues are attributed to countries based on the location of the policyholder. (C) Major Agency Relationships A significant portion of the Company's premiums and deposits were sold through three marketing agencies in recent years. Combined business from these agencies accounted for approximately 30% of total direct premium revenues and universal life and investment annuity contract deposits for 1998. These same three marketing agencies accounted for 22% and 16% of total direct premiums and deposits for 1997 and 1996, respectively. (15) FAIR VALUES OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Investment securities: Fair values for investments in debt and equity securities are based on quoted market prices, where available. For securities not actively traded, fair values are estimated using values obtained from various independent pricing services and the Securities Valuation Office of the National Association of Insurance Commissioners. In the cases where prices are unavailable from these sources, prices are estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality, and maturity of the investments. Cash and short-term investments: The carrying amounts reported in the balance sheet for these instruments approximate their fair values. Mortgage loans: The fair value of performing mortgage loans is estimated by discounting scheduled cash flows through the scheduled maturities of the loans, using interest rates currently being offered for similar loans to borrowers with similar credit ratings. Fair value for significant nonperforming loans is based on recent internal or external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information. Policy loans: The fair value for policy loans is calculated by discounting estimated cash flows using U.S. Treasury bill rates as of December 31, 1998 and 1997. The estimated cash flows include assumptions as to whether such loans will be repaid by the policyholders or settled upon payment of death or surrender benefits on the underlying insurance contracts. As a result, these assumptions incorporate both Company experience and mortality assumptions associated with such contracts. Index options: Fair values for index options are based on quoted market prices. Life interest in Libbie Shearn Moody Trust: The fair value of the life interest is estimated based on assumptions as to future dividends from the Trust over the life expectancy of Mr. Robert L. Moody. These estimated cash flows were discounted at a rate consistent with uncertainties relating to the amount and timing of future cash distributions. However, the Company has limited the fair value to the statutory admitted value of the Trust, as this is the maximum amount to be received by the Company in the event of Mr. Moody's premature death. Investment annuity and supplemental contracts: Fair value of the Company's liabilities for deferred investment annuity contracts is estimated to be the cash surrender value of each contract. The cash surrender value represents the policyholder's account balance less applicable surrender charges. The fair value of liabilities for immediate investment annuity contracts and supplemental contracts with and without life contingencies is estimated by discounting estimated cash flows using U.S. Treasury bill rates as of December 31, 1998 and 1997. Fair value for the Company's insurance contracts other than investment contracts is not required to be disclosed. This includes the Company's traditional and universal life products. However, the fair values of liabilities under all insurance contracts are taken into consideration in the Company's overall management of interest rate risk, which minimizes exposure to changing interest rates through the matching of investment maturities with amounts due under insurance and investment contracts. The carrying amounts and fair values of the Company's financial instruments are as follows:
December 31, 1998 December 31, 1997 Carrying Fair Carrying Fair Value Value Value Value (In thousands) ASSETS Investments in debt and equity securities: Securities held to maturity $ 2,029,728 2,124,715 1,874,643 1,949,876 Securities available for sale 735,587 735,587 651,736 651,736 Cash and short-term investments 24,508 24,508 7,870 7,870 Mortgage loans 174,921 186,161 181,878 192,640 Policy loans 124,441 150,583 133,826 152,809 Index options 23,900 23,900 420 420 Life interest in Libbie Shearn Moody Trust 4,347 14,721 4,636 16,668 Assets of discontinued operations - cash 41 41 269 269 LIABILITIES Deferred investment annuity contracts $ 2,127,007 1,863,552 1,934,019 1,703,599 Immediate investment annuity and supplemental contracts 219,406 229,738 196,827 205,042
Fair value estimates are made at a specific point in time based on relevant market information and information about the financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. (16) DISCONTINUED BROKERAGE OPERATIONS Effective July 17, 1995, The Westcap Corporation (Westcap), a wholly owned brokerage subsidiary of National Western Life Insurance Company, discontinued all sales and trading activities in its Houston, Texas, office. In September, 1995, Westcap approved a plan to close its remaining sales office in New Jersey and to cease all brokerage operations. Subsequently, on April 12, 1996, The Westcap Corporation and its wholly owned subsidiary, Westcap Enterprises, Inc., separately filed voluntary petitions for reorganization under Chapter 11 of the U.S. Bankruptcy Code in the United States Bankruptcy Court, Southern District of Texas, Houston Division. In accordance with generally accepted accounting principles, the assets and liabilities of Westcap have been reclassified in the accompanying consolidated balance sheets to separately identify them as assets and liabilities of discontinued operations. Losses from discontinued brokerage operations have also been reflected separately from continuing operations of the Company. The 1995 losses from discontinued operations resulted in the complete write-off of National Western Life Insurance Company's investment in Westcap on a consolidated basis. However, a $1,000,000 cash infusion was made to Westcap on March 18, 1997, for operational expenses incurred during its bankruptcy. This contribution was reflected as a loss from discontinued operations in 1997. As more fully described in Note 9, Commitments and Contingencies, by order dated August 28, 1998, the United States Bankruptcy Court, Southern District of Texas, Houston Division, confirmed and approved the Third Amended Joint Consensual Plan of Reorganization (the Plan) of The Westcap Corporation and Westcap Enterprises, Inc. Pursuant to the Plan, National Western received credit for the $1,000,000 previously contributed to Westcap in bankruptcy in March, 1997, and paid an additional $14,125,000 to compromise and settle various claims and litigation. The $14,125,000 was paid by National Western on January 13, 1999. However, the settlement payment has been accrued in other liabilities as of December 31, 1998, and reflected as a 1998 loss from discontinued operations in the accompanying financial statements. As part of the bankruptcy reorganization, National Western retained 100% continuing ownership of the reorganized Westcap, and the subsidiary is now operating as a real estate management company. NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES SCHEDULE I SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN RELATED PARTIES December 31, 1998 (In thousands)
Balance (1) Market Sheet Type of Investment Cost Value Amount Fixed maturity bonds: Securities held to maturity: United States government and government agencies and authorities $ 3,706 4,065 3,706 States, municipalities, and political subdivisions 27,001 29,323 27,001 Foreign governments 51,389 55,643 51,389 Public utilities 302,484 319,335 302,484 Corporate 1,159,758 1,214,646 1,159,758 Mortgage-backed 410,818 427,077 410,818 Asset-backed 74,572 74,626 74,572 Total securities held to maturity 2,029,728 2,124,715 2,029,728 Securities available for sale: United States government and government agencies and authorities 3,231 3,464 3,464 States, municipalities, and political subdivisions 3,000 3,011 3,011 Public utilities 59,699 64,398 64,398 Corporate 303,196 318,633 318,633 Mortgage-backed 199,985 210,288 210,288 Asset-backed 115,204 120,081 120,081 Total securities available for sale 684,315 719,875 719,875 Total fixed maturity bonds 2,714,043 2,844,590 2,749,603 Equity securities: Securities available for sale: Common stocks: Public utilities 192 390 390 Banks, trust and insurance companies 195 3,091 3,091 Industrial and other 86 81 81 Preferred stocks 11,545 12,150 12,150 Total equity securities 12,018 15,712 15,712 Index options 16,201 23,900 23,900 Mortgage loans (2) 167,354 162,714 Policy loans 124,441 124,441 Other long-term investments (3) 27,067 24,999 Cash and short-term investments 24,508 24,508 Total investments other than investments in related parties $ 3,085,632 3,125,877 Notes: (1) Bonds are shown at amortized cost, mortgage loans are shown at unpaid principal balances before allowances for possible losses of $4,640,000, and real estate is stated at cost before allowances for possible losses of $2,068,000. (2) Mortgage loans with related parties totaling $12,207,000 have been excluded. (3) Real estate acquired by foreclosure included in other long-term investments is as follows: cost $2,369,000; balance sheet amount $1,705,000.
NATIONAL WESTERN LIFE INSURANCE COMPANY AND SUBSIDIARIES SCHEDULE V VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1998, 1997, and 1996 (In thousands)
(1) Balance Charged Balance at to Costs at Beginning and (2) (3) End of Description of Period Expenses Reductions Transfers Period Valuation accounts deducted from applicable assets: Allowance for possible losses on mortgage loans: December 31, 1998 $ 4,640 - - - 4,640 December 31, 1997 $ 5,988 1,133 (2,408) (73) 4,640 December 31, 1996 $ 5,668 500 (180) - 5,988 Allowance for possible losses on real estate: December 31, 1998 $ 2,222 - (154) - 2,068 December 31, 1997 $ 2,288 46 (185) 73 2,222 December 31, 1996 $ 2,152 526 (390) - 2,288 Notes: (1) These amounts were charged to realized gains and losses on investments. (2) These amounts were related to charge-off of assets against the allowances. (3) These amounts were transferred to real estate.
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. NATIONAL WESTERN LIFE INSURANCE COMPANY Date: March 29, 1999 /S/ Robert L. Moody By: Robert L. Moody, Chairman of the Board, Chief Executive Officer, and Director 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. Signature Title (Capacity) Date /S/ Robert L. Moody Chairman of the Board, March 29, 1999 Robert L. Moody Chief Executive Officer, and Director (Principal Executive Officer) /S/ Ross R. Moody President, Chief Operating March 29, 1999 Ross R. Moody Officer, and Director /S/ Robert L. Busby, III Senior Vice President - March 29, 1999 Robert L. Busby, III Chief Administrative Officer, Chief Financial Officer and Treasurer (Principal Financial Officer) /S/ Vincent L. Kasch Vice President - Controller March 29, 1999 Vincent L. Kasch and Assistant Treasurer (Principal Accounting Officer) /S/ Arthur O. Dummer Director March 29, 1999 Arthur O. Dummer Director March 29, 1999 Harry L. Edwards /S/ E. Douglas McLeod Director March 29, 1999 E. Douglas McLeod /S/ Charles D. Milos, Jr. Director March 29, 1999 Charles D. Milos, Jr. Director March 29, 1999 Frances A. Moody Director March 29, 1999 Russell S. Moody /S/ Louis E. Pauls, Jr. Director March 29, 1999 Louis E. Pauls, Jr. /S/ E.J. Pederson Director March 29, 1999 E.J. Pederson EX-10.N 2 EXHIBIT 10(n) - MATERIAL CONTRACTS SIXTH AMENDMENT TO THE NATIONAL WESTERN LIFE INSURANCE COMPANY NON-QUALIFIED DEFERRED COMPENSATION PLAN This Sixth Amendment to the National Western Life Insurance Company Non- Qualified Deferred Compensation Plan (the Plan) is hereby made effective this 7th day of August, 1998. WITNESSETH: WHEREAS, the Plan was originally established effective April 1, 1995; and WHEREAS, Section 6.2 of the Plan permits the Company to amend the Plan at any time; and WHEREAS, the Company desires to change certain provisions of the Plan; NOW THEREFORE, the Plan is hereby amended as follows: 1. Section 5.4, Form of Payment, is hereby amended to read as follows: "A Participant or Beneficiary entitled to payment may elect to receive a single lump sum payment. Alternatively, a Participant or Beneficiary entitled to payment may elect to have payment made on an annual installment basis, provided that such election is made at least thirteen (13) months prior to the first payment to be made under the annual installment payment option. If a Participant does not choose a method of payment, or fails to elect the installment payment option within the thirteen (13) month time period specified above, payment shall be made on the annual installment basis over an installment period of five (5) years. Under the annual installment payment option, the installment payment period shall not exceed ten (10) years. Each annual installment payment shall equal the Participant's Account Balance divided by the number of annual installment payments remaining to be paid in the annual installment payment period chosen by the Participant." 2. Section 5.3, Timing of Payment, is hereby amended to read as follows: "A Participant, or in the case of a benefit due to the death of a Participant, his Beneficiary, shall be entitled to payment of his vested Account Balance immediately following the termination of his employment status with the Employer, and payment shall be made according to the following paragraphs of this Section 5.3. If the Participant has chosen payment under the lump sum option of Section 5.4, or if the Participant has chosen the installment payment option under Section 5.4 and has not yet begun to receive installment payments, payment shall be made as soon as administratively feasible following the termination of his employment status, based on the Participants Account Balance as of the last day of the calendar quarter next preceding the date of distribution. However, if the Employer determines that such payment would not be in the best interest of remaining participants due to fluctuations in the value of the trust, no distribution shall be made until a subsequent value of the trust is determined as of the last day of the calendar quarter in which the event requiring distribution occurs. In the event of the death of a Participant who has begun to receive annual payments under the installment payment option, such death occurring before all of the installments are paid, the Account Balance shall be paid to the Participant's beneficiary or estate within twelve (12) months of the date of the Participant's death." 3. A new section 2.3, Loss of Eligible Employee Status, is hereby added to read as follows: In the event of the demotion of a participating Eligible Employee, such that the employee is no longer an Eligible Employee within the meaning of section 1.2(h) herein, no further contributions by that employee shall be allowed under the Plan. The provisions of Article V, DETERMINATION OF PAYMENT OF ACCOUNT, shall continue to govern the employee's account. Approved by National Western Board of Directors On December 11, 1998 EX-10.O 3 EXHIBIT 10(o) - MATERIAL CONTRACTS THIRD AMENDMENT TO THE NATIONAL WESTERN LIFE INSURANCE COMPANY NON-QUALIFIED DEFINED BENEFIT PLAN This Third Amendment to the National Western Life Insurance Company Non- Qualified Defined Benefit Plan (the Plan) is hereby effective this 7th day of August, 1998. WITNESSETH: WHEREAS, the Plan was originally established effective January 1, 1991; and WHEREAS, Section 6.2 of the Plan permits the Company to amend the Plan at anytime; and WHEREAS, the Company desires to change certain provisions of the Plan; NOW THEREFORE, the Plan is hereby amended as follows: 1. A new Section 2.2, Loss of Eligible Employee Status, is hereby added to read as follows: "In the event of the demotion of a participating Eligible Employee, such that the employee is no longer an Eligible Employee within the meaning of Section 1.2(i) herein, the employee shall lose his status as Participant, and no further contributions by that employee shall be allowed under the Plan." 2. Section 1.2(e), Compensation, is hereby amended effective October 1, 1998, by the addition of the following "As used throughout this Plan, `Compensation' shall not include income from the exercise of Company stock options." Approved by National Western Board of Directors On December 11, 1998 EX-10.P 4 EXHIBIT 10(p) - MATERIAL CONTRACTS EXCHANGE AGREEMENT THIS EXCHANGE AGREEMENT (this "Agreement") is entered into as of November ___, 1998, by and among National Western Life Insurance Company ("National Western"), a Colorado insurance corporation, NWL Services, Inc. ("NWL Services") a Nevada corporation, Alternative Benefit Management, Inc. ("ABM"), a Nevada corporation, and American National Insurance Company ("American National"), a Texas insurance corporation. RECITALS A. National Western and NWL Services intend to transfer assets to ABM in exchange for stock of ABM and the assumption of certain liabilities of National Western by ABM. American National will guarantee ABM's obligations under this Agreement. American National and ANTAC, Inc. will contemporaneously execute a separate exchange agreement with ABM. All of the above-referenced transfers are intended to qualify under Section 351 of the Internal Revenue Code. AGREEMENT NOW, THEREFORE, in consideration of the foregoing, and the mutual covenants and undertakings contained herein, the parties hereto agree as follows: 1. Definitions. In addition to any other defined terms contained in this Agreement, the following definitions of terms shall govern this Agreement, unless the context thereof specifically indicates a different meaning: (a) National Western Cash Contribution. The sum of $5,130,000. (b) NWL Services Cash Contribution. The sum of $1,850,000. (c) Effective Date. The date, which shall be no later than November 23, 1998, on which: (i) National Western transfers the National Western Cash Contribution and ABM assumes the Liabilities (as hereinafter defined) and issues 2,500 shares of its Class A Preferred Stock (as hereinafter defined) to National Western, and (ii) NWL Services transfers the NWL Services Cash Contribution and ABM issues 18,500 shares of its Class B Preferred Stock (as hereinafter defined) to NWL Services, in accordance with the terms of this Agreement. (d) Class A Preferred Stock. The Class A Preferred Stock of ABM, the terms of which are more particularly described in the Articles of Incorporation of Alternative Benefit Management, Inc. dated September 25, 1998, as amended as of the Effective Date (the "Articles"). (e) Class B Preferred Stock. The Class B Preferred Stock of ABM, the terms of which are more particularly described in the Articles. (f) Employee Benefit Program. The employment-related benefit program of National Western known as the non-qualified defined benefit plan as in effect as of October 1, 1998, as amended from time to time. (g) Liabilities. All current and future obligations associated with the Employee Benefit Program, which amounts, as set forth in Exhibit A, would be of a future nature as if any such obligation were an obligation of National Western. (h) Securities Act. The Securities Act of 1933, as amended. 2. Agreements Regarding Transfers of Assets, Values, Assumption of Liabilities, and Issuance of Class A Preferred Stock and Class B Preferred Stock. (a) Exchanges for Class A Preferred Stock and Class B Preferred Stock. In exchange for stock as hereinafter described, National Western, NWL Services, and ABM shall perform the following exchanges, and American National shall make the following guaranty: (i) National Western shall transfer the National Western Cash Contribution to ABM for 2,500 shares of Class A Preferred Stock and the assumption of the Liabilities by ABM and the performance by ABM of all of the administration of the Employee Benefit Program. This administration shall include, but is not limited to, any and all activities currently being undertaken by National Western, or its Pension Committee, in the administration of the Employee Benefit Program, as well as any additional activities that may become necessary or proper for the proper administration of the Employee Benefit Program; and (ii) NWL Services shall transfer the NWL Services Cash Contribution to ABM for 18,500 shares of Class B Preferred Stock. (b) Guaranty by American National. For valuable consideration, the receipt and adequacy of which are hereby acknowledged, American National hereby irrevocably and unconditionally guarantees to National Western the full and prompt payment and performance of the Liabilities and of ABM's obligations under Section 7(b) hereof (the "Guaranteed Obligations"). 3. Representations and Warranties of National Western. National Western represents and warrants to ABM and American National that, as of the date hereof and the Effective Date: (a) Due Organization. National Western is a Colorado insurance corporation duly organized and validly existing under the laws of Colorado and has full corporate power and authority to execute, deliver, and perform this Agreement. (b) Due Authorization. The execution, delivery, and performance of this Agreement have been and remain duly authorized by all necessary corporate action and do not contravene any provision of National Western's articles of incorporation or bylaws, as amended to date, or any law, regulation, rule, decree, order, judgment, or contractual restriction binding on National Western or its assets. (c) Consents. All consents, licenses, authorizations, and approvals of, and registrations and declarations with, any governmental authority or regulatory body necessary for the due execution, delivery, and performance of this Agreement have been obtained and remain in full force and effect, and all conditions thereof have been duly complied with, and no other action by, and no notice to or filing with, any governmental authority or regulatory body is required in connection with the execution, delivery, or performance of this Agreement. (d) Binding Obligation. This Agreement constitutes the legal, valid, and binding obligation of National Western and is enforceable against National Western in accordance with its terms, subject, as to enforceability, to bankruptcy, insolvency, reorganization, moratorium, conservatorship, receivership, and other laws of general applicability relating to or affecting creditors' rights, and to equitable principles of general application. (e) No Litigation or Claims. There is no litigation pending or, to National Western's knowledge, threatened, either individually or in the aggregate which, if determined adversely to National Western would materially and adversely affect its execution, delivery, or performance of this Agreement. (f) Class A Preferred Stock. (i) National Western understands that the Class A Preferred Stock has not been and will not be registered under the Securities Act or any other securities laws or regulations. Accordingly, the Class A Preferred Stock may not be offered, sold, transferred, pledged, hypothecated, or otherwise disposed of, except in a transaction exempt from the registration requirements of the Securities Act and any other applicable securities laws and regulations. (ii) National Western understands that neither ABM nor any person representing ABM has made any representations with respect to ABM or the offering or sale of the Class A Preferred Stock other than as set forth or specifically referred to herein. (iii) National Western has had access to such financial and other information concerning ABM as National Western has deemed necessary in connection with National Western's decision to purchase the Class A Preferred Stock. National Western has such knowledge and experience in financial and business matters that it is capable of evaluating the merits and risks of the purchase of the Class A Preferred Stock. (iv) National Western is acquiring the Class A Preferred Stock for its own account. National Western will not offer, sell, or transfer, directly or indirectly, any Class A Preferred Stock except in transactions exempt from the Securities Act and any other applicable securities laws and regulations. (v) National Western is not acquiring the Class A Preferred Stock directly or indirectly with the assets of any employee benefit plan. 4. Representations and Warranties of NWL Services. NWL Services represents and warrants to ABM that, as of the date hereof and the Effective Date: (a) Due Organization. NWL Services is a Nevada corporation duly organized and validly existing under the laws of Nevada and has full corporate power and authority to execute, deliver, and perform this Agreement. (b) Due Authorization. The execution, delivery and performance of this Agreement have been and remain duly authorized by all necessary corporate action and do not contravene any provision of NWL Services's articles of incorporation or bylaws, as amended to date, or any law, regulation, rule, decree, order, judgment, or contractual restriction binding on NWL Services or its assets. (c) Consents. All consents, licenses, authorizations, and approvals of, and registrations and declarations with, any governmental authority or regulatory body necessary for the due execution, delivery, and performance of this Agreement have been obtained and remain in full force and effect, and all conditions thereof have been duly complied with, and no other action by, and no notice to or filing with, any governmental authority or regulatory body is required in connection with the execution, delivery, or performance of this Agreement. (d) Binding Obligation. This Agreement constitutes the legal, valid, and binding obligation of NWL Services and is enforceable against NWL Services in accordance with its terms, subject, as to enforceability, to bankruptcy, insolvency, reorganization, moratorium, conservatorship, receivership, and other laws of general applicability relating to or affecting creditors' rights, and to equitable principles of general application. (e) No Litigation or Claims. There is no litigation pending or, to NWL Services's knowledge, threatened, either individually or in the aggregate which, if determined adversely to NWL Services would materially and adversely affect its execution, delivery, or performance of this Agreement. (f) Class B Preferred Stock. (i) NWL Services understands that the Class B Preferred Stock has not been and will not be registered under the Securities Act or any other securities laws or regulations. Accordingly, the Class B Preferred Stock may not be offered, sold, transferred, pledged, hypothecated, or otherwise disposed of, except in a transaction exempt from the registration requirements of the Securities Act and any other applicable securities laws and regulations. (ii) NWL Services understands that neither ABM nor any person representing ABM has made any representations with respect to ABM or the offering or sale of the Class B Preferred Stock other than as set forth or specifically referred to herein. (iii) NWL Services has had access to such financial and other information concerning ABM as NWL Services has deemed necessary in connection with NWL Services's decision to purchase the Class B Preferred Stock. NWL Services has such knowledge and experience in financial and business matters that it is capable of evaluating the merits and risks of the purchase of the Class B Preferred Stock. (iv) NWL Services is acquiring the Class B Preferred Stock for its own account and not with a view to or for sale in connection with a distribution of the Class B Preferred Stock. NWL Services will not offer, sell, or transfer, directly or indirectly, any Class B Preferred Stock except in transactions exempt from the Securities Act and any other applicable securities laws and regulations. (v) NWL Services is not acquiring the Class B Preferred Stock directly or indirectly with the assets of any employee benefit plan. 5. Representations and Warranties of ABM. ABM hereby represents and warrants to National Western and NWL Services that, as of the date hereof and the Effective Date: (a) Due Organization. ABM is a Nevada corporation duly organized and validly existing under the laws of Nevada and has full corporate power and authority to execute, deliver, and perform this Agreement. (b) Due Authorization. The execution, delivery, and performance of this Agreement have been and remain duly authorized by all necessary corporate action and do not contravene any provision of ABM's articles of incorporation or by-laws, as amended to date, or any law, regulation, rule, decree, order, judgment, or contractual restriction binding on ABM or its assets. (c) Consents. All consents, licenses, authorizations, and approvals of, and registrations and declarations with, any governmental authority or regulatory body necessary for the due execution, delivery, and performance of this Agreement have been obtained and remain in full force and effect, and all conditions thereof have been duly complied with, and no other action by, and no notice to or filing with, any governmental authority or regulatory body is required in connection with the execution, delivery, or performance of this Agreement. (d) Binding Obligation. This Agreement constitutes the legal, valid, and binding obligation of ABM and is enforceable against ABM in accordance with its terms, subject, as to enforceability, to bankruptcy, insolvency, reorganization, moratorium, conservatorship, receivership, and other laws of general applicability relating to or affecting creditors' rights, and to equitable principles of general application. (e) No Litigation or Claims. There is no litigation pending or, to ABM's knowledge, threatened, either individually or in the aggregate which, if determined adversely to ABM, would materially and adversely affect the issuance of its Class A Preferred Stock to National Western or Class B Preferred Stock to NWL Services, the value of its Class A Preferred Stock or Class B Preferred Stock, or its execution, delivery, or performance of this Agreement. (f) Right to Accept Transfers, Assume Liabilities, and Issue Class A Preferred Stock and Class B Preferred Stock. ABM has the right, power, and authority to (i) accept the National Western and NWL Services Cash Contributions, (ii) assume and be liable for the Liabilities associated with the Employee Benefit Program and, (iii) upon the receipt and assignment of the Cash Contributions and the assumption of the Liabilities, to issue the Class A Preferred Stock to National Western and Class B Preferred Stock to NWL Services in exchange therefor, in accordance with the terms of this Agreement. (g) Class A Preferred Stock. (i) Assuming the accuracy of National Western's representations and warranties and National Western's compliance with the agreements set forth in Section 3 hereof, the sale of the Class A Preferred Stock is exempt from registration under the Securities Act. (ii) The Class A Preferred Stock has not been and will not be registered under the Securities Act or any other securities laws or regulations. The Class A Preferred Stock will be subject to certain restrictions on the transferability thereof. (h) Class B Preferred Stock. (i) Assuming the accuracy of NWL Services's representations and warranties and NWL Services's compliance with the agreements set forth in Section 4 hereof, the sale of the Class B Preferred Stock is exempt from registration under the Securities Act. (ii) The Class B Preferred Stock has not been and will not be registered under the Securities Act or any other securities laws or regulations. The Class B Preferred Stock will be subject to certain restrictions on the transferability thereof. 6. Representations and Warranties of American National. American National hereby represents and warrants to National Western and NWL Services that, as of the date hereof and the Effective Date: (a) Due Organization. American National is a Texas insurance corporation duly organized and validly existing under the laws of Texas and has full corporate power and authority to execute, deliver, and perform this Agreement. (b) Due Authorization. The execution, delivery, and performance of this Agreement have been and remain duly authorized by all necessary corporate action and do not contravene any provision of American National's articles of incorporation or by-laws, as amended to date, or any law, regulation, rule, decree, order, judgment, or contractual restriction binding on American National or its assets. (c) Consents. All consents, licenses, authorizations, and approval of, and registrations and declarations with, any governmental authority or regulatory body necessary for the due execution, delivery, and performance of this Agreement have been obtained and remain in full force and effect, and all conditions thereof have been duly complied with, and no other action by, and no notice to or filing with, any governmental authority or regulatory body is required in connection with the execution, delivery, or performance of this Agreement. (d) Binding Obligation. This Agreement constitutes the legal, valid, and binding obligation of American National and is enforceable against American National in accordance with its terms, subject, as to enforceability, to bankruptcy, insolvency, reorganization, moratorium, conservatorship, receivership, and other laws of general applicability relating to or affecting creditors' rights, and to equitable principles of general application. (e) No Litigation or Claims. There is no litigation pending or, to American National's knowledge, threatened, either individually or in the aggregate which, if determined adversely to American National, would materially and adversely affect the performance of this Agreement. 7. Covenants Regarding Transaction, Liabilities, and Transfers of Class A Preferred Stock. (a) Decision To Enter into Transaction. (i) National Western is a sophisticated investor. National Western's decision to enter into this Agreement with ABM is based upon its independent evaluation of the Class A Preferred Stock and the financial condition of ABM. In entering into this Agreement, National Western has not relied upon any oral or written information provided by ABM, other than the representations and warranties of ABM contained herein. National Western acknowledges that no officer, director, employee, agent, or representative of ABM has been authorized to make, and that National Western has not relied upon, any statements or representations other than those specifically contained in this Agreement. (ii) ABM is a sophisticated investor. ABM's decision to enter into this Agreement with National Western is based upon its independent evaluation of the transfer by National Western to it as provided hereunder of the National Western Cash Contribution and the Liabilities. In entering into this Agreement, ABM has not relied upon any oral or written information provided by National Western, other than the representations and warranties of National Western contained herein. ABM acknowledges that no officer, director, employee, agent, or representative of National Western has been authorized to make, and that ABM has not relied upon, any statements or representations other than those specifically contained in this Agreement. (b) Liabilities. (i) In General. ABM covenants with National Western and their respective successors and permitted assigns that, from and after the Effective Date, ABM (A) shall be liable for the Liabilities associated with the Employee Benefit Program and (B) shall indemnify, defend, and hold National Western and their respective successors and permitted assigns harmless from same. ABM and American National shall not secure or fund their obligations hereunder or take any other action that would cause the Employee Benefit Program to be considered funded or secured for purposes of the Employee Retirement Income Security Act of 1974, as amended, or the Internal Revenue Code of 1986, as amended. (ii) ABM's Responsibility Regarding Payments of Liabilities When National Western Is Insolvent. Notwithstanding anything to the contrary herein: (A) ABM (and American National if applicable) shall cease payment of benefits to Employee Benefit Program participants and their beneficiaries if National Western is Insolvent. National Western shall be considered "Insolvent" for the purposes of this Agreement if: (1) National Western is unable to pay its debts as they become due; or (2) National Western is placed into receivership by the Colorado Department of Insurance or ancillary receivership by any state in which National Western is licensed. (B) At all times during the continuance of this Agreement: (1) The Board of Directors and Chief Executive Officer of National Western have the duty to inform ABM in writing of National Western's Insolvency. If a person claiming to be a creditor of National Western alleges in writing to ABM that National Western has become Insolvent, ABM shall determine whether National Western is Insolvent and, pending such determination, ABM (and American National if applicable) shall discontinue payment of benefits to Employee Benefit Program participants or their beneficiaries. (2) Unless ABM has actual knowledge of National Western's Insolvency, or has received notice from National Western or a person claiming to be a creditor alleging that National Western is Insolvent, ABM shall have no duty to inquire whether National Western is Insolvent. ABM may in all events rely on such evidence concerning National Western's solvency as may be furnished to ABM and that provides ABM with a reasonable basis for making a determination concerning National Western's solvency. (3) If at any time ABM has determined that National Western is Insolvent or has been notified by the Chief Executive Officer or the Board of Directors of National Western that National Western is Insolvent, ABM (and American National if applicable) shall discontinue payments to Employee Benefit Program participants or their beneficiaries and shall immediately remit the then fair market value of the Liabilities to National Western. Nothing in this Agreement shall in any way diminish any rights of Employee Benefit Program participants or their beneficiaries to pursue their rights as general creditors of National Western with respect to benefits due under the Employee Benefit Program or otherwise. (C) Upon payment to National Western under Section 7(b)(ii)(B)(3) above, all obligations of ABM under this Agreement shall terminate. (c) American National Guarantee. (i) American National's guaranty hereunder shall be an absolute, continuing, irrevocable, and unconditional guaranty of payment and performance, and not a guaranty of collection, and American National shall remain liable on its obligations hereunder until the payment and performance in full of the Guaranteed Obligations. No set-off, counterclaim, recoupment, reduction, or diminution of any obligation, or any defense of any kind or nature which ABM may have against National Western or any other party, or which American National may have against ABM, National Western, or any other party, shall be available to, or shall be asserted by, American National against National Western or its successor or any part thereof or against payment of the Guaranteed Obligations or any part thereof. (ii) If American National becomes liable for the Guaranteed Obligations, other than under this Agreement, such liability shall not be in any manner impaired or affected hereby, and the rights of National Western hereunder shall be cumulative of any and all other rights that it may ever have against American National. The exercise by American National of any right or remedy hereunder or under any other instrument, or at law or in equity, shall not preclude the concurrent or subsequent exercise of any right or remedy. (iii) In the event of default by ABM in payment or performance of the Guaranteed Obligations, or any part thereof, when such Guaranteed Obligations become due, whether by their terms or otherwise, American National agrees to promptly pay the amount due thereon to the applicable beneficiary (subject to Section 7(b)(ii) hereof) under the Employee Benefit Program or to National Western, without notice or demand in lawful currency of the United States of America, and it shall not be necessary for National Western, in order to enforce such payment by American National, first to institute suit or exhaust its remedies against ABM or others liable for such Guaranteed Obligations. Notwithstanding anything to the contrary contained in this Agreement, American National hereby irrevocably subordinates to the prior indefeasible payment in full of the Guaranteed Obligations, any and all rights American National may now or hereafter have under this Agreement or at law or in equity (including, without limitation, the law subrogating American National to the rights of National Western) to assert the claim against or seek contribution, indemnification or any other form of reimbursement from ABM or any other party liable for payment of any or all of the Guaranteed Obligations for the payment made by American National under or in connection with this Agreement or otherwise. (iv) If payment of any amount payable by ABM under the Guaranteed Obligations is stayed upon the insolvency, bankruptcy, or reorganization of ABM, all such amounts otherwise subject to payment under the terms of the Guaranteed Obligations shall nonetheless be payable by American National hereunder forthwith on demand by National Western. (v) American National hereby agrees that its obligations hereunder shall not be released, discharged, diminished, impaired, reduced, or affected for any reason or by the occurrence of any event, including, without limitation, one or more of the following events, whether or not with notice to or the consent of American National: (A) the taking or accepting of collateral as security for any or all of the Guaranteed Obligations or the release, surrender, exchange, or subordination of any such collateral now or hereafter securing any or all of the Guaranteed Obligations; (B) any partial release of the liability of American National hereunder; (C) any disability of ABM, or the dissolution, insolvency, or bankruptcy of ABM, American National, or any other party at any time liable for the payment of any or all of the Guaranteed Obligations; (D) any renewal, extension, modification, waiver, amendment, or rearrangement of any or all of the Guaranteed Obligations or any instrument, document, or agreement evidencing, securing, or otherwise relating to any or all of the Guaranteed Obligations; (E) any adjustment, indulgence, forbearance, waiver, or compromise that may be granted or given by National Western to ABM, American National, or any other party ever liable for any or all of the Guaranteed Obligations; (F) any neglect, delay, omission, failure, or refusal of National Western to take or prosecute any action for the collection of any of the Guaranteed Obligations or to foreclose or take or prosecute any action in connection with any instrument, document, or agreement evidencing, securing, or otherwise relating to any or all of the Guaranteed Obligations; (G) the unenforceability or invalidity of any or all of the Guaranteed Obligations or of any instrument, document, or agreement evidencing, securing, or otherwise relating to any or all of the Guaranteed Obligations; (H) any payment by ABM or any other party to National Western is held to constitute a preference under applicable bankruptcy or insolvency law or if for any other reason National Western is required to refund any payment or pay the amount thereof to someone else; (I) the settlement or compromise of any of the Guaranteed Obligations; (J) any change in the corporate existence, structure, or ownership of ABM; or (K) any other circumstance which might otherwise constitute a defense available to, or discharge of, ABM or American National. (d) Class A Preferred Stock. (i) National Western agrees that if it decides to transfer all or any part of its shares of Class A Preferred Stock to a third party, ABM may in its sole discretion require (A) an investment letter, in form and substance satisfactory to ABM, signed by National Western and such third party, certifying as to the facts surrounding such transaction, and/or (B) a written opinion of counsel (which shall not be at the expense of ABM), in form and substance satisfactory to ABM, to the effect that such transaction will not violate the Securities Act or any applicable state securities laws. (ii) ABM agrees that if National Western decides to transfer all or any part of its shares of Class A Preferred Stock to a third party, ABM shall provide any and all information and documents reasonably requested by National Western and shall otherwise reasonably cooperate with National Western to ensure that any such transfer is made by National Western in compliance with all applicable federal and state securities laws, rules, and regulations. 8. Covenants Regarding Transaction and Transfers of Class B Preferred Stock. (a) Decision To Enter into Transaction. (i) NWL Services is a sophisticated investor. NWL Services's decision to enter into this Agreement with ABM is based upon its independent evaluation of the Class B Preferred Stock and the financial condition of ABM. In entering into this Agreement, NWL Services has not relied upon any oral or written information provided by ABM, other than the representations and warranties of ABM contained herein. NWL Services acknowledges that no officer, director, employee, agent, or representative of ABM has been authorized to make, and that NWL Services has not relied upon, any statements or representations other than those specifically contained in this Agreement. (ii) ABM is a sophisticated investor. ABM's decision to enter into this Agreement with NWL Services is based upon its independent evaluation of the transfer by NWL Services to it as provided hereunder of the NWL Services Cash Contribution. In entering into this Agreement, ABM has not relied upon any oral or written information provided by NWL Services, other than the representations and warranties of NWL Services contained herein. ABM acknowledges that no officer, director, employee, agent, or representative of NWL Services has been authorized to make, and that ABM has not relied upon, any statements or representations other than those specifically contained in this Agreement. (b) Class B Preferred Stock. (i) NWL Services agrees that if it decides to transfer all or any part of its shares of Class B Preferred Stock to a third party, ABM may in its sole discretion require (A) an investment letter, in form and substance satisfactory to ABM, signed by NWL Services and such third party, certifying as to the facts surrounding such transaction, and/or (B) a written opinion of counsel (which shall not be at the expense of ABM), in form and substance satisfactory to ABM, to the effect that such transaction will not violate the Securities Act or any applicable state securities laws. (ii) ABM agrees that if NWL Services decides to transfer all or any part of its shares of Class B Preferred Stock to a third party, ABM shall provide any and all information and documents reasonably requested by NWL Services and shall otherwise reasonably cooperate with NWL Services to ensure that any such transfer is made by NWL Services in compliance with all applicable federal and state securities laws, rules, and regulations. 9. Miscellaneous Provisions. (a) Severability of Provisions. Any provision of this Agreement which is illegal, invalid, prohibited, or unenforceable shall be ineffective to the extent of such illegality, invalidity, prohibition, or unenforceability without invalidating or impairing the remaining provisions hereof. (b) Successors and Assigns. This Agreement shall be binding upon and shall inure to the benefit of National Western, NWL Services, ABM, and American National and their respective successors and permitted assigns. No party may assign its rights or delegate its obligations hereunder without the prior written consent of the other parties; provided, however, that National Western and NWL Services shall have the right to assign their rights and delegate their obligations hereunder to a parent, any affiliate or subsidiary, or to any successor by merger, reorganization, or acquisition of substantially all of its assets, without ABM's consent. (c) Sole Benefit. This Agreement and all of its provisions are for the sole benefit of National Western, NWL Services, ABM, and American National and their respective successors and permitted assigns. No third party shall be a beneficiary of this Agreement, including with respect to any assets transferred to ABM. In particular, this Agreement shall not grant any rights or recourse to the employee participants or the beneficiaries thereof in addition to those granted in the Employee Benefit Program. (d) Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed an original, but all of which, taken together, shall constitute one and the same instrument. (e) Governing Law. This Agreement is made pursuant to, and shall be construed and governed in accordance with, the laws of the State of Texas, without regard to its conflict of laws provisions. (f) Notices. Any notice or other communication hereunder with respect to this Agreement shall be in writing and shall be deemed duly given if delivered in person or sent by certified or registered mail or the equivalent (with return receipt requested), or by overnight delivery service, or by facsimile transmission, addressed as follows: If to National Western: National Western Life Insurance Company 850 East Anderson Lane Austin, Texas 78752 Attention: Ross R. Moody If to NWL Services: NWL Services, Inc. 639 Isbell Road, Suite 390 Reno, Nevada 89509 Attention: Janice George If to ABM: Alternative Benefit Management, Inc. One Moody Plaza Galveston, Texas 77550 Attention: G. Richard Ferdinandtsen If to American National: American National Insurance Company One Moody Plaza Galveston, Texas 77550 Attention: Stephen E. Pavlicek The name, address, and/or facsimile number for any person to whom any notice is to be sent may be changed by written notice given in the manner provided in this Section. (g) Exhibits. Exhibit A to this Agreement is incorporated herein and made a part hereof. (h) Amendment. This Agreement may be amended only by a written instrument signed by National Western, NWL Services, ABM, and American National. No amendment, modification, or release of the provisions of this Agreement shall be established by conduct, custom, or course of dealing. (i) Further Assurances. Subject to the terms and conditions of this Agreement, each of the parties agrees to use its best efforts to do, or cause to be done, all things necessary, proper, or advisable under applicable laws and regulations to effect the transactions contemplated by this Agreement, including, without limitation, the performance of such further acts or the execution and delivery of such additional instruments or documents as any party may reasonably request in order to carry out the purposes of this Agreement and the transactions contemplated hereby. (j) Confidentiality Provision. Each party hereto agrees that, except as otherwise required by law, rule, regulation, or order, it shall keep the contents of this Agreement and any information related to this Agreement confidential and further agrees that it shall not generate or participate in any publicity, publication, or media release, public announcement, or public disclosure, whether oral or written, regarding this Agreement without the prior written consent of the other parties. The provisions of the preceding sentence shall not in any way limit any party's right to discuss any matters relating to this Agreement with its respective regulators, consultants, accountants, and attorneys. (k) Section Headings. Section headings of this Agreement are solely for convenience of reference and shall not be deemed a part of, nor shall they govern the interpretation of any of the provisions in, this Agreement. (l) Entire Agreement. This Agreement, together with any separate agreements specifically referenced herein, contains the entire agreement between and among National Western, NWL Services, ABM, and American National with respect to the subject matter hereof and supersedes all prior and contemporaneous negotiations, arrangements, understandings, and agreements, whether oral or written, express or implied, between and among them with respect to the subject matter hereof. There are no written or oral agreements, understandings, representations, or warranties between or among the parties hereto other than those set forth herein. IN WITNESS WHEREOF, National Western, NWL Services, ABM, and American National have caused their names to be signed hereto as of the day and year first written above. NATIONAL WESTERN LIFE INSURANCE COMPANY, a Colorado insurance corporation By: /S/ Ross R. Moody Ross R. Moody Its: President and Chief Operating Officer NWL SERVICES, INC., a Nevada corporation By: /S/ Arthur O. Dummer Arthur O. Dummer Its: Vice President ALTERNATIVE BENEFIT MANAGEMENT, INC., a Nevada corporation By: /S/ Stephen E. Pavlicek Stephen E. Pavlicek Its: Senior Vice President - Controller AMERICAN NATIONAL INSURANCE COMPANY, a Texas insurance corporation By: /S/ G. Richard Ferdinandsten G. Richard Ferdinandtsen Its: Senior Executive Vice President and Chief Operating Officer Exhibit A Liabilities The Liabilities valued as of October 1, 1998, are as follows: Non-Qualified Defined Benefit Plan $ 4,880,000 The Liabilities transferred under the Non-Qualified Defined Benefit Plan do not include the following: (1) Any amounts attributable to retirement dates beyond age seventy (70) have been retained by National Western; (2) Any amounts attributable to aggregate average annual salary increases exceeding 10% per year have been retained by National Western; and (3) Any amounts attributable to participants in the Employee Benefit Program other than participants includable as of the Effective Date have been retained by National Western. EX-21 5 EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT Name of Subsidiary State of Incorporation The Westcap Corporation Delaware NWL Investments, Inc. Texas NWL Properties, Inc. Texas NWL 806 Main, Inc. Texas NWL Services, Inc. Nevada NWL Financial, Inc. Nevada All of the subsidiaries listed above are wholly owned by National Western Life Insurance Company. The subsidiaries conduct business under the same corporate names as detailed above. EX-27 6
7 This schedule contains summary financial information extracted from the National Western Life Insurance Company and subsidiaries consolidated financial statements and is qualified in its entirety by reference to such financial statements. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 719,875 2,029,728 2,124,715 15,712 174,921 13,553 3,138,084 24,508 224 314,493 3,518,003 2,979,478 0 14,272 9,683 2,571 0 0 3,498 434,867 3,518,003 96,334 233,844 2,384 1,052 191,330 40,415 35,504 66,365 17,347 49,018 (14,125) 0 0 34,893 9.98 9.87 0 0 0 0 0 0 00 Consists of $13,165 revenues from traditional contracts subject to FAS 60 accounting treatment and $83,169 revenues from universal life and investment annuity contracts subject to FAS 97 accounting treatment. Consists of $35,646 benefits paid to policyholders, $(3,205) decrease in reserves on traditional contracts and $158,889 interest on universal life and investment annuity contracts.
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