EX-99.2 5 dex992.htm CONSOLIDATED FINANCIAL STATEMENTS Prepared by R.R. Donnelley Financial -- Consolidated Financial Statements

Exhibit 99.2
 
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES

 
 
Independent Auditors’ Report
 
The Board of Directors
Nationwide Financial Services, Inc.:
 
We have audited the consolidated financial statements of Nationwide Financial Services, Inc. and subsidiaries (collectively the “Company”) 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 statements schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Nationwide Financial Services, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States of America. 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.
As discussed in note 2 to the consolidated financial statements, the Company changed its methods of accounting for derivative instruments and hedging activities, and for purchased or retained interests in securitized financial assets in 2001.
 
LOGO
 
Columbus, Ohio
January 29, 2002,
    except for Note 22, as to which
    the date is May 22, 2002

[F-1]

 
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
   
Years ended December 31,
  
(in millions, except per share amounts)
 
2001
    
2000
    
1999
  
Revenues
                        
Policy charges
  
$
1,019.1
 
  
$
1,092.2
 
  
$
895.6
 
Life insurance premiums
  
 
251.1
 
  
 
240.0
 
  
 
220.8
 
Net investment income
  
 
1,736.8
 
  
 
1,661.9
 
  
 
1,525.6
 
Net realized (losses) gains on investments, hedging instruments and hedged items:
                        
Unrelated parties
  
 
(57.5
)
  
 
(24.9
)
  
 
(11.0
)
Related party
  
 
44.4
 
  
 
—  
 
  
 
—  
 
Other
  
 
76.6
 
  
 
81.7
 
  
 
63.7
 
   
 
3,070.5
 
  
 
3,050.9
 
  
 
2,694.7
 
Benefits and expenses
                        
Interest credited to policyholder account balances
  
 
1,248.8
 
  
 
1,183.9
 
  
 
1,096.4
 
Other benefits and claims
  
 
279.8
 
  
 
241.6
 
  
 
210.4
 
Policyholder dividends on participating policies
  
 
41.7
 
  
 
44.5
 
  
 
42.4
 
Amortization of deferred policy acquisition costs
  
 
348.1
 
  
 
351.6
 
  
 
272.7
 
Interest expense on debt and capital and preferred securities of subsidiary trusts
  
 
54.9
 
  
 
48.5
 
  
 
47.2
 
Other operating expenses
  
 
529.0
 
  
 
558.4
 
  
 
473.0
 
   
 
2,502.3
 
  
 
2,428.5
 
  
 
2,142.1
 
Income from continuing operations before federal income tax expense and cumulative effect of adoption of accounting principles
  
 
568.2
 
  
 
622.4
 
  
 
552.6
 
Federal income tax expense
  
 
143.9
 
  
 
187.3
 
  
 
183.0
 
                         
Income from continuing operations before cumulative effect of adoption of accounting principles
  
 
424.3
 
  
 
435.1
 
  
 
369.6
 
Discounted operations, net of tax
  
 
(4.4
)
  
 
(0.2
)
  
 
11.7
 
Cumulative effect of adoption of accounting principles, net of tax
  
 
(7.1
)
  
 
—  
 
  
 
—  
 
Net income
  
$
412.8
 
  
$
434.9
 
  
$
381.3
 
Income from continuing operations before cumulative effect of adoption of accounting principles per common share
                        
Basic
  
$
3.29
 
  
$
3.38
 
  
$
2.88
 
Diluted
  
$
3.28
 
  
$
3.38
 
  
$
2.88
 
Net income per common share
                        
Basic
  
$
3.20
 
  
$
3.38
 
  
$
2.96
 
Diluted
  
$
3.20
 
  
$
3.38
 
  
$
2.96
 
                         
Weighted average common shares outstanding
  
 
128.9
 
  
 
128.7
 
  
 
128.5
 
Weighted average diluted common shares outstanding
  
 
129.2
 
  
 
128.9
 
  
 
128.6
 
 
See accompanying notes to consolidated financial statements, including note 16 which describes related party transactions.

[F-2]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
   
December 31,
  
(in millions, except per share amounts)
 
2001
    
2000
  
Assets
                
Investments:
                
Securities available-for-sale, at fair value:
                
Fixed maturity securities (cost $18,135.8 in 2001; $15,297.9 in 2000)
  
$
18,548.3
 
  
$
15,497.2
 
Equity securities (cost $143.2 in 2001; $149.1 in 2000)
  
 
150.5
 
  
 
150.2
 
Mortgage loans on real estate, net
  
 
7,113.1
 
  
 
6,168.3
 
Real estate, net
  
 
172.0
 
  
 
310.7
 
Policy loans
  
 
592.7
 
  
 
562.6
 
Other long-term investments
  
 
125.0
 
  
 
111.8
 
Short-term investments, including amounts managed by a related party
  
 
1,112.8
 
  
 
558.4
 
   
 
27,814.4
 
  
 
23,359.2
 
Cash
  
 
65.0
 
  
 
62.7
 
Accrued investment income
  
 
309.7
 
  
 
252.5
 
Deferred policy acquisition costs
  
 
3,213.7
 
  
 
2,872.7
 
Other assets
  
 
911.4
 
  
 
662.7
 
Assets held in separate accounts
  
 
59,646.7
 
  
 
65,968.8
 
   
$
91,960.9
 
  
$
93,178.6
 
Liabilities and Shareholders’ Equity
                
Future policy benefits and claims
  
$
25,491.6
 
  
$
22,243.3
 
Short-term debt
  
 
100.0
 
  
 
118.7
 
Long-term debt
  
 
597.0
 
  
 
298.4
 
Other liabilities
  
 
2,382.3
 
  
 
1,251.9
 
Liabilities related to separate accounts
  
 
59,646.7
 
  
 
65,968.8
 
   
 
88,217.6
 
  
 
89,881.1
 
Commitments and contingencies (notes 12 and 18)
                
NFS-obligated mandatorily redeemable capital and preferred securities of subsidiary trusts holding solely junior subordinated debentures of NFS
  
 
300.0
 
  
 
300.0
 
Shareholders’ equity:
                
Preferred stock, $0.01 par value. Authorized 50.0 million shares; no shares issued and outstanding
  
 
—  
 
  
 
—  
 
Class A common stock, $0.01 par value. Authorized 750.0 million shares; 24.1 million and 24.0 million shares issued and outstanding, respectively
  
 
0.2
 
  
 
0.2
 
Class B common stock, $0.01 par value. Authorized 750.0 million shares; 104.7 million shares issued and outstanding
  
 
1.0
 
  
 
1.0
 
Additional paid-in capital
  
 
646.5
 
  
 
640.8
 
Retained earnings
  
 
2,598.8
 
  
 
2,245.5
 
Accumulated other comprehensive income
  
 
202.5
 
  
 
114.5
 
Other
  
 
(5.7
)
  
 
(4.5
)
   
 
3,443.3
 
  
 
2,997.5
 
   
$
91,960.9
 
  
$
93,178.6
 
 
See accompanying notes to consolidated financial statements, including note 16 which describes related party transactions.

[F-3]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders’ Equity
(in millions)
   
Class A common stock
   
Class B common stock
  
Additional paid-in capital
  
Retained earnings
     
Accumulated other comprehensive income (loss)
    
Other
     
Total shareholders’ equity
  
Balance as of December 31, 1998
   
$
0.2
   
$
1.0
  
$
629.5
  
$
1,541.5
 
   
$
275.9
 
  
$
(0.6
)
   
$
2,447.5
 
Comprehensive income:
                                                      
Net income
   
 
—  
   
 
—  
  
 
—  
  
 
381.3
 
   
 
—  
 
  
 
—  
 
   
 
381.3
 
Net unrealized losses on securities available-for-sale arising during the year, net of tax
   
 
—  
   
 
—  
  
 
—  
  
 
—  
 
   
 
(314.9
)
  
 
—  
 
   
 
(314.9
)
                         
Total comprehensive income
                                                
 
66.4
 
                         
Cash dividends declared
   
 
—  
   
 
—  
  
 
—  
  
 
(48.9
)
   
 
—  
 
  
 
—  
 
   
 
(48.9
)
Other, net
   
 
—  
   
 
—  
  
 
5.4
  
 
(6.5
)
   
 
23.5
 
  
 
(0.3
)
   
 
22.1
 
Balance as of December 31, 1999
   
 
0.2
   
 
1.0
  
 
634.9
  
 
1,867.4
 
   
 
(15.5
)
  
 
(0.9
)
   
 
2,487.1
 
Comprehensive income:
                                                      
Net income
   
 
—  
   
 
—  
  
 
—  
  
 
434.9
 
   
 
—  
 
  
 
—  
 
   
 
434.9
 
Net unrealized gains on securities available-for-sale arising during the year, net of tax
   
 
—  
   
 
—  
  
 
—  
  
 
—  
 
   
 
130.0
 
  
 
—  
 
   
 
130.0
 
                         
Total comprehensive income
                                                
 
564.9
 
                         
Cash dividends declared
   
 
—  
   
 
—  
  
 
—  
  
 
(59.2
)
   
 
—  
 
  
 
—  
 
   
 
(59.2
)
Other, net
   
 
—  
   
 
—  
  
 
5.9
  
 
2.4
 
   
 
—  
 
  
 
(3.6
)
   
 
4.7
 
Balance as of December 31, 2000
   
 
0.2
   
 
1.0
  
 
640.8
  
 
2,245.5
 
   
 
114.5
 
  
 
(4.5
)
   
 
2,997.5
 
Comprehensive income:
                                                      
Net income
   
 
—  
   
 
—  
  
 
—  
  
 
412.8
 
   
 
—  
 
  
 
—  
 
   
 
412.8
 
Net unrealized gains on securities available-for-sale arising during the year, net of tax
   
 
—  
   
 
—  
  
 
—  
  
 
—  
 
   
 
98.2
 
  
 
—  
 
   
 
98.2
 
Cumulative effect of adoption of accounting principles, net of tax
   
 
—  
   
 
—  
  
 
—  
  
 
—  
 
   
 
(1.4
)
  
 
—  
 
   
 
(1.4
)
Accumulated net losses on cash flow hedges, net of tax
   
 
—  
   
 
—  
  
 
—  
  
 
—  
 
   
 
(8.8
)
  
 
—  
 
   
 
(8.8
)
                         
Total comprehensive income
                                                
 
500.8
 
                         
Cash dividends declared
   
 
—  
   
 
—  
  
 
—  
  
 
(61.9
)
   
 
—  
 
  
 
—  
 
   
 
(61.9
)
Other, net
   
 
—  
   
 
—  
  
 
5.7
  
 
2.4
 
   
 
—  
 
  
 
(1.2
)
   
 
6.9
 
Balance as of December 31, 2001
   
$
0.2
   
$
1.0
  
$
646.5
  
$
2,598.8
 
   
$
202.5
 
  
$
(5.7
)
   
$
3,443.3
 
 
See accompanying notes to consolidated financial statements, including note 16 which describes related party transactions.

[F-4]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
   
Years ended December 31,
  
(in millions)
  
2001
    
2000
     
1999
  
Cash flows from operating activities
                         
Net income
  
$
412.8
 
  
$
434.9
 
   
$
381.3
 
Adjustments to reconcile net income to net cash provided by operating activities:
                         
Loss (income) from discontinued operations
  
 
4.4
 
  
 
0.2
 
   
 
(11.7
)
Interest credited to policyholder account balances
  
 
1,248.8
 
  
 
1,183.9
 
   
 
1,096.4
 
Capitalization of deferred policy acquisition costs
  
 
(762.6
)
  
 
(784.9
)
   
 
(638.7
)
Amortization of deferred policy acquisition costs
  
 
348.1
 
  
 
351.6
 
   
 
272.7
 
Amortization and depreciation
  
 
(17.3
)
  
 
(1.3
)
   
 
8.0
 
Realized losses (gains) on investments, hedging instruments and hedged items:
                         
Unrelated parties
  
 
57.5
 
  
 
24.9
 
   
 
11.0
 
Related party
  
 
(44.4
)
  
 
—  
 
   
 
—  
 
Cumulative effect of adoption of accounting principles
  
 
10.9
 
  
 
—  
 
   
 
—  
 
Increase in accrued investment income
  
 
(57.2
)
  
 
(13.8
)
   
 
(8.0
)
(Increase) decrease in other assets
  
 
(284.7
)
  
 
(90.7
)
   
 
79.4
 
Increase (decrease) in policy liabilities
  
 
33.0
 
  
 
(0.3
)
   
 
(20.9
)
Increase in other liabilities
  
 
297.2
 
  
 
228.0
 
   
 
139.1
 
Other, net
  
 
8.3
 
  
 
22.1
 
   
 
(3.2
)
Net cash provided by continuing operations
  
 
1,254.8
 
  
 
1,354.6
 
   
 
1,305.4
 
Net cash provided by (used in) discontinued operations
  
 
1.4
 
  
 
(7.6
)
   
 
33.2
 
Net cash provided by operating activities
  
 
1,256.2
 
  
 
1,347.0
 
   
 
1,338.6
 
Cash flows from investing activities
                         
Proceeds from maturity of securities available-for-sale
  
 
3,933.9
 
  
 
2,988.7
 
   
 
2,307.9
 
Proceeds from sale of securities available-for-sale
  
 
498.2
 
  
 
604.4
 
   
 
513.1
 
Proceeds from repayments of mortgage loans on real estate
  
 
1,204.4
 
  
 
911.7
 
   
 
696.7
 
Proceeds from sale of real estate
  
 
29.1
 
  
 
18.7
 
   
 
5.7
 
Proceeds from sale of limited partnership to related party
  
 
158.9
 
  
 
—  
 
   
 
—  
 
Proceeds from repayments of policy loans and sale of other invested assets
  
 
68.9
 
  
 
79.3
 
   
 
40.9
 
Cost of securities available-for-sale acquired
  
 
(7,246.7
)
  
 
(3,547.7
)
   
 
(3,710.3
)
Cost of mortgage loans on real estate acquired
  
 
(2,123.1
)
  
 
(1,318.0
)
   
 
(971.4
)
Cost of real estate acquired
  
 
(0.4
)
  
 
(7.1
)
   
 
(14.2
)
Short-term investments, net
  
 
(574.6
)
  
 
(64.2
)
   
 
112.9
 
Net cash paid for purchase of subsidiaries
  
 
—  
 
  
 
—  
 
   
 
(125.2
)
Collateral received—securities lending, net
  
 
791.6
 
  
 
—  
 
   
 
—  
 
Other, net
  
 
(192.9
)
  
 
(272.3
)
   
 
(133.3
)
Net cash used in continuing operations
  
 
(3,452.7
)
  
 
(606.5
)
   
 
(1,277.2
)
Net cash provided by (used in) discontinued operations
  
 
10.5
 
  
 
44.0
 
   
 
(106.0
)
Net cash used in investing activities
  
 
(3,442.2
)
  
 
(562.5
)
   
 
(1,383.2
)
Cash flows from financing activities
                         
Net proceeds from issuance of long-term debt
  
 
298.6
 
  
 
—  
 
   
 
—  
 
Net change in short-term debt
  
 
(18.7
)
  
 
118.7
 
   
 
—  
 
Cash dividends paid
  
 
(61.9
)
  
 
(56.7
)
   
 
(46.4
)
Increase in investment and universal life insurance product account balances
  
 
6,186.6
 
  
 
4,517.0
 
   
 
3,799.4
 
Decrease in investment and universal life insurance product account balances
  
 
(4,220.1
)
  
 
(5,325.6
)
   
 
(3,709.6
)
Other, net
  
 
3.8
 
  
 
2.3
 
   
 
(0.8
)
Net cash provided by (used in) financing activities
  
 
2,188.3
 
  
 
(744.3
)
   
 
42.6
 
Net increase (decrease) in cash
  
 
2.3
 
  
 
40.2
 
   
 
(2.0
)
Cash, beginning of year
  
 
62.7
 
  
 
22.5
 
   
 
24.5
 
Cash, end of year
  
$
65.0
 
  
$
62.7
 
   
$
22.5
 
See accompanying notes to consolidated financial statements, including note 16 which describes related party transactions.

[F-5]

 
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2001, 2000 and 1999

(1)  Organization and Description of Business
 
Nationwide Financial Services, Inc. (NFS) is the holding company for Nationwide Life Insurance Company (NLIC) and other companies that comprise the domestic life insurance and retirement savings operations of Nationwide. NFS and its subsidiaries are collectively referred to as the Company. The Company is a leading provider of long-term savings and retirement products in the United States of America. The Company develops and sells a diverse range of products including individual annuities, private and public sector pension plans and other investment products sold to institutions, life insurance, mutual funds and other asset management services. As described more fully in note 22, on May 22, 2002, NFS entered into transactions to exchange its equity interests in its domestic asset management operations for shares of its common stock. The accompanying consolidated financial statements and related notes reflect this business as discontinued operations. The Company sells its products through a diverse network of distribution channels, including independent broker/dealers, brokerage firms, financial institutions, pension plan administrators, life insurance specialists, Nationwide Retirement Solutions, The 401(k) Company and Nationwide agents.
The 24.1 million shares of Class A common stock outstanding as of December 31, 2001 are publicly held and were primarily issued through NFS’ initial public offering completed in March 1997. The Class A shares represent 18.7% of the equity ownership in NFS and 2.3% of the combined voting power of NFS’ Class A and Class B common stock. Nationwide Corporation (Nationwide Corp.) owns all of the outstanding shares of Class B common stock, which represents the remaining 81.3% equity ownership and 97.7% of the combined voting power of the shareholders of NFS.
 
(2)  Summary of Significant Accounting Policies
 
The significant accounting policies followed by the Company that materially affect financial reporting are summarized below. The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) which differ from statutory accounting practices. The statutory financial statements of the Company’s insurance subsidiaries are presented on the basis of accounting practices prescribed or permitted by the Ohio Department of Insurance. The State of Ohio has adopted the National Association of Insurance Commissioners (NAIC) statutory accounting practices (NAIC SAP) as the basis of its statutory accounting practices. The Company’s insurance subsidiaries have no statutory accounting practices that differ from NAIC SAP. See also note 15.
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses for the reporting period. Actual results could differ significantly from those estimates.
The most significant estimates include those used in determining deferred policy acquisition costs for investment products and universal life insurance products, valuation allowances for mortgage loans on real estate, impairment losses on other investments and federal income taxes. Although some variability is inherent in these estimates, management believes the amounts provided are appropriate.
 
(a)  Consolidation Policy
The consolidated financial statements include the accounts of NFS and companies in which NFS directly or indirectly has a controlling interest. All significant intercompany balances and transactions have been eliminated.

[F-6]

 
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

 
(b)  Valuation of Investments, Investment Income and Related Gains and Losses
The Company is required to classify its fixed maturity securities and equity securities as either held-to-maturity, available-for-sale or trading. The Company classifies fixed maturity and equity securities as available-for-sale. Available-for-sale securities are stated at fair value, with the unrealized gains and losses, net of adjustments to deferred policy acquisition costs and deferred federal income tax, reported as a separate component of accumulated other comprehensive income (AOCI) in shareholders’ equity. The adjustment to deferred policy acquisition costs represents the change in amortization of deferred policy acquisition costs that would have been required as a charge or credit to operations had such unrealized amounts been realized. Management regularly reviews its fixed maturity and equity securities portfolio to evaluate the necessity of recording impairment losses for other-than-temporary declines in the fair value of investments. A number of criteria are considered during this process including, but not limited to, the current fair value as compared to amortized cost or cost, as appropriate, of the security, the length of time the security’s fair value has been below amortized cost/cost, and by how much, and specific credit issues related to the issuer. Impairment losses result in a reduction of the cost basis of the underlying investment.
For mortgage-backed securities, the Company recognizes income using a constant effective yield method based on prepayment assumptions and the estimated economic life of the securities. When estimated prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated future payments, and any resulting adjustment is included in net investment income. All other investment income is recorded on the accrual basis.
Mortgage loans on real estate are carried at the unpaid principal balance less valuation allowances. The Company provides valuation allowances for impairments of mortgage loans on real estate based on a review by portfolio managers. Mortgage loans on real estate are considered impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When the Company determines that a loan is impaired, a provision for loss is established equal to the difference between the carrying value and the estimated value of the mortgage loan. Estimated value is based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral, if the loan is collateral dependent. Loans in foreclosure and loans considered impaired are placed on non-accrual status. Interest received on non-accrual status mortgage loans on real estate is included in net investment income in the period received.
The valuation allowance account for mortgage loans on real estate is maintained at a level believed adequate by the Company to absorb estimated probable credit losses. The Company’s periodic evaluation of the adequacy of the allowance for losses is based on past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of the underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors.
Real estate is carried at cost less accumulated depreciation. Real estate designated as held for disposal is carried at the lower of the carrying value at the time of such designation or fair value less cost to sell. Other long-term investments are carried on the equity method of accounting. Impairment losses are recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to

[F-7]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

be generated by those assets are less than the assets’ carrying amount.
Realized gains and losses on the sale of investments are determined on the basis of specific security identification. Changes in valuation allowances and impairment losses for other-than-temporary declines in fair values are included in realized gains and losses on investments, hedging instruments and hedged items.
 
(c)  Derivative Instruments
Derivatives are carried at fair value. On the date the derivative contract is entered into, the Company designates the derivative as either a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (fair value hedge), a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge), or a foreign currency fair value or cash flow hedge (foreign currency hedge) or a non-hedge transaction. The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for entering into various hedge transactions. This process includes linking all derivatives that are designated as fair value, cash flow or foreign currency hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used for hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively.
The Company enters into interest rate swaps, cross-currency swaps or Eurodollar Futures to hedge the fair value of existing fixed rate assets and liabilities. In addition, the Company uses short treasury future positions to hedge the fair value of bond and mortgage loan commitments. Typically, the Company is hedging the risk of changes in fair value attributable to changes in benchmark interest rates. Derivative instruments classified as fair value hedges are carried at fair value, with changes in fair value recorded in realized gains and losses on investments, hedging instruments and hedged items. Changes in the fair value of the hedged item, attributable to the risk being hedged, are also recorded in realized gains and losses on investments, hedging instruments and hedged items. The adjustment of the carrying amount of hedged assets using Eurodollar Futures and firm commitments using Treasury Futures are accounted for in the same manner as other components of the carrying amount of that asset. The adjustment of the carrying amount is amortized to investment income over the life of the asset.
The Company may enter into receive fixed/pay variable interest rate swaps to hedge existing floating rate assets or to hedge cash flows from the anticipated purchase of investments. These derivative instruments are classified as cash flow hedges and are carried at fair value, with the offset recorded in AOCI to the extent the hedging relationship is effective. The ineffective portion of the hedging relationship is recorded in realized gains and losses on investments, hedging instruments and hedged items. Gains and losses on cash flow derivative instruments are reclassified out of AOCI and recognized in earnings over the same period(s) that the hedged item affects earnings.
Amounts receivable or payable under interest rate and foreign currency swaps are recognized as an adjustment to net investment income or interest credited to policyholder account balances consistent with the nature of the hedged item.
From time to time, the Company may enter into a

[F-8]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
 

derivative transaction that will not qualify for hedge accounting. These include basis swaps (receive one variable rate, pay another variable rate) to hedge variable rate assets or foreign-denominated liabilities. These instruments are carried at fair value, with changes in fair value recorded in realized gains and losses on investments, hedging instruments and hedged items.
The Company discontinues hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative expires, or is sold, terminated or exercised, the derivative is dedesignated as a hedging instrument, because it is unlikely that a forecasted transaction will occur, a hedged firm commitment no longer meets the definition of a firm commitment, or management determines that designation of the derivative as a hedging instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair value hedge, the Company continues to carry the derivative on the consolidated balance sheet at its fair value, and no longer adjusts the hedged item for changes in fair value. The adjustment of the carrying amount of the hedged item is accounted for in the same manner as other components of the carrying amount of that item. When hedge accounting is discontinued because the hedged item no longer meets the definition of a firm commitment, the Company continues to carry the derivative on the consolidated balance sheet at its fair value, removes any asset or liability that was recorded pursuant to recognition of the firm commitment from the consolidated balance sheet and recognizes any gain or loss in net realized gains and losses on investments, hedging instruments and hedged items. When hedge accounting is discontinued because it is probable that a forecasted transaction will not occur, the Company continues to carry the derivative on the consolidated balance sheet at fair value and gains and losses that were accumulated in AOCI are recognized immediately in realized gains and losses on investments, hedging instruments and hedged items. In all other situations in which hedge accounting is discontinued, the Company continues to carry the derivative at its fair value on the consolidated balance sheet, and recognizes any changes in fair value in net realized gains and losses on investments, hedging instruments and hedged items.
Prior to the adoption of SFAS 133, defined in note 2(k), provided they met specific criteria, interest rate and foreign currency swaps and futures were considered hedges and accounted for under the accrual and deferral method, respectively. Amounts receivable or payable under interest rate and foreign currency swaps were recognized as an adjustment to net investment income or interest credited to policyholder account balances consistent with the nature of the hedged item. Changes in the fair value of interest rate swaps were not recognized on the consolidated balance sheet, except for interest rate swaps designated as hedges of fixed maturity securities available-for-sale, for which changes in fair values were reported in AOCI. Gains and losses on foreign currency swaps were recorded in earnings based on the related spot foreign exchange rate at the end of the reporting period. Gains and losses on these contracts offset those recorded as a result of translating the hedged foreign currency denominated liabilities and investments to U.S. dollars.
 
(d)  Revenues and Benefits
Investment Products and Universal Life Insurance Products:    Investment products consist primarily of individual and group variable and fixed deferred annuities. Universal life insurance products include universal life insurance, variable universal life insurance, corporate-owned life insurance and other interest-sensitive life insurance policies. Revenues for investment products and universal life insurance products consist of net investment income, asset fees, cost of insurance, policy

[F-9]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
 

administration and surrender charges that have been earned and assessed against policy account balances during the period. The timing of revenue recognition as it relates to fees assessed on investment contracts and universal life contracts is determined based on the nature of such fees. Asset fees, cost of insurance and policy administration charges are assessed on a daily or monthly basis and recognized as revenue when assessed and earned. Certain amounts assessed that represent compensation for services to be provided in future periods are reported as unearned revenue and recognized in income over the periods benefited. Surrender charges are recognized upon surrender of a contract in accordance with contractual terms. Policy benefits and claims that are charged to expense include interest credited to policy account balances and benefits and claims incurred in the period in excess of related policy account balances.
Traditional Life Insurance Products:    Traditional life insurance products include those products with fixed and guaranteed premiums and benefits and consist primarily of whole life insurance, limited-payment life insurance, term life insurance and certain annuities with life contingencies. Premiums for traditional life insurance products are recognized as revenue when due. Benefits and expenses are associated with earned premiums so as to result in recognition of profits over the life of the contract. This association is accomplished by the provision for future policy benefits and the deferral and amortization of policy acquisition costs.
 
(e)  Deferred Policy Acquisition Costs
The costs of acquiring new business, principally commissions, certain expenses of the policy issue and underwriting department and certain variable sales expenses that relate to and vary with the production of new or renewal business have been deferred. Deferred policy acquisition costs are subject to recoverability testing at the time of policy issuance and loss recognition testing at the end of each accounting period.
For investment products and universal life insurance products, deferred policy acquisition costs are being amortized with interest over the lives of the policies in relation to the present value of estimated future gross profits from projected interest margins, asset fees, cost of insurance, policy administration and surrender charges. For years in which gross profits are negative, deferred policy acquisition costs are amortized based on the present value of gross revenues. The Company regularly reviews the estimated future gross profits and revises such estimates when appropriate. The cumulative change in amortization as a result of changes in estimates to reflect current best estimates is recorded as a charge or credit to amortization expense. The most significant assumptions that are involved in the estimation of future gross profits include future market performance and surrender/lapse rates. In the event actual expense differs significantly from assumptions or assumptions are significantly revised, the Company may be required to record a significant charge or credit to amortization expense. Deferred policy acquisition costs are adjusted to reflect the impact of unrealized gains and losses on fixed maturity securities available-for-sale as described in note 2(b).
For traditional life insurance products, these deferred policy acquisition costs are predominantly being amortized with interest over the premium paying period of the related policies in proportion to the ratio of actual annual premium revenue to the anticipated total premium revenue. Such anticipated premium revenue was estimated using the same assumptions as were used for computing liabilities for future policy benefits.
 
(f)  Separate Accounts
Separate account assets and liabilities represent contractholders’ funds which have been segregated into

[F-10]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

accounts with specific investment objectives. Separate account assets are recorded at market value except for separate account contracts with guaranteed investment returns. For all but $1.39 billion and $1.12 billion of separate account assets as of December 31, 2001 and 2000, respectively, the investment income and gains or losses of these accounts accrue directly to the contractholders. The activity of the separate accounts is not reflected in the consolidated statements of income and cash flows except for the fees the Company receives. Such fees are assessed on a daily or monthly basis and recognized as revenue when assessed and earned.
 
(g)  Future Policy Benefits
Future policy benefits for investment products in the accumulation phase, universal life insurance and variable universal life insurance policies have been calculated based on participants’ contributions plus interest credited less applicable contract charges.
Future policy benefits for traditional life insurance policies have been calculated by the net level premium method using interest rates varying from 6.0% to 10.5% and estimates of mortality, morbidity, investment yields and withdrawals which were used or which were being experienced at the time the policies were issued.
 
(h)  Participating Business
Participating business represented approximately 17% in 2001 (21% in 2000 and 29% in 1999) of the Company’s life insurance in force, 63% in 2001 (66% in 2000 and 69% in 1999) of the number of life insurance policies in force, and 9% in 2001 (8% in 2000 and 13% in 1999) of life insurance statutory premiums. The provision for policyholder dividends was based on then current dividend scales and has been included in “Future policy benefits and claims” in the accompanying consolidated balance sheets.
 
(i)  Federal Income Tax
The Company files a consolidated federal income tax return with Nationwide Mutual Insurance Company (NMIC), the majority shareholder of Nationwide Corp. The members of the consolidated tax return group have a tax sharing arrangement, which provides, in effect, for each member to bear essentially the same federal income tax liability as if separate tax returns were filed.
The Company provides for federal income taxes based on amounts the Company believes it will ultimately owe. Inherent in the provision for federal income taxes are estimates regarding the deductibility of certain expenses and the realization of certain tax credits. In the event the ultimate deductibility of certain expenses or the realization of certain tax credits differ from estimates, the Company may be required to significantly change the provision for federal income taxes recorded in the consolidated financial statements.
The Company utilizes the asset and liability method of accounting for income tax. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under this method, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts expected to be realized.
 

[F-11]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

(j)  Reinsurance Ceded
Reinsurance premiums ceded and reinsurance recoveries on benefits and claims incurred are deducted from the respective income and expense accounts. Assets and liabilities related to reinsurance ceded are reported on a gross basis.
 
(k)  Recently Issued Accounting Pronouncements
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 (SFAS 133). SFAS 133, as amended by SFAS 137, Accounting for Derivative Instruments and Hedging Activities—Deferral of the Effective Date of FASB Statement No. 133, and SFAS 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, was adopted by the Company effective January 1, 2001. Upon adoption, the provisions of SFAS 133 were applied prospectively.
SFAS 133 establishes accounting and reporting standards for derivative instruments and hedging activities. It requires an entity to recognize all derivatives as either assets or liabilities on the balance sheet and measure those instruments at fair value.
As of January 1, 2001, the Company had $755.4 million notional amount of freestanding derivatives with a market value of ($7.0) million. All other derivatives qualified for hedge accounting under SFAS 133. The adoption of SFAS 133 resulted in the Company recording a net transition adjustment loss of $4.8 million (net of related income tax of $2.6 million) in net income. In addition, a net transition adjustment loss of $3.6 million (net of related income tax of $2.0 million) was recorded in AOCI as of January 1, 2001. The adoption of SFAS 133 resulted in the Company derecognizing $17.0 million of deferred assets related to hedges, recognizing $10.9 million of additional derivative instrument liabilities and $1.3 million of additional firm commitment assets, while also decreasing hedged future policy benefits by $3.0 million and increasing the carrying amount of hedged investments by $10.6 million. Further, the adoption of SFAS 133 resulted in the Company reporting total derivative instrument assets and liabilities of $44.8 million and $107.1 million, respectively, as of January 1, 2001.
The adoption of SFAS 133 may increase the volatility of reported earnings and other comprehensive income. The amount of volatility will vary with the level of derivative and hedging activities and fluctuations in market interest rates and foreign currency exchange rates during any period.
In November 1999, the Emerging Issues Task Force (EITF) issued EITF Issue No. 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets (EITF 99-20). The Company adopted EITF 99-20 on April 1, 2001. EITF 99-20 establishes the method of recognizing interest income and impairment on asset-backed investment securities. EITF 99-20 requires the Company to update the estimate of cash flows over the life of certain retained beneficial interests in securitization transactions and purchased beneficial interests in securitized financial assets. Pursuant to EITF 99-20, based on current information and events, if the Company estimates that the fair value of its beneficial interests is not greater than or equal to its carrying value and if there has been a decrease in the estimated cash flows since the last revised estimate, considering both timing and amount, then an other-than-temporary impairment should be recognized. The cumulative effect, net of tax, upon adoption of EITF 99-20 on April 1, 2001 decreased net income by $2.3 million with a corresponding increase to AOCI.
In July 2001, the FASB issued Statement of Financial Accounting Standards No. 141, Business Combinations (SFAS 141) and Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142).

[F-12]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 and the use of the pooling-of-interests method has been eliminated.
SFAS 142 applies to all acquired intangible assets whether acquired singularly, as part of a group, or in a business combination. SFAS 142 supersedes APB Opinion No. 17, Intangible Assets, and will carry forward provisions in Opinion 17 related to internally developed intangible assets. SFAS 142 changes the accounting for goodwill and intangible assets with indefinite lives from an amortization method to an impairment-only approach. The amortization of goodwill from past business combinations ceased upon adoption of this statement, which was January 1, 2002 for the Company. Companies are required to evaluate all existing goodwill and intangible assets with indefinite lives for impairment within six months of adoption. Any transitional impairment losses will be recognized in the first interim period in the year of adoption and will be recognized as the cumulative effect of a change in accounting principle.
The Company is evaluating the potential impact of adopting SFAS 141 and SFAS 142 on the results of operations and financial position. For 2001, the amortization of excess of cost over fair value of net assets acquired was $11.6 million and unamortized goodwill amounted to $130.0 million as of December 31, 2001.
In October 2001, the FASB issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (SFAS 144). SFAS 144 supersedes SFAS 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of, and APB Opinion No. 30, Reporting the Results of Operations—Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. SFAS 144 is effective for fiscal years beginning after December 15, 2001 (January 1, 2002 for the Company) and will carry forward many of the provisions of SFAS 121 and Opinion 30 for recognition and measurement of the impairment of long-lived assets to be held and used, and measurement of long-lived assets to be disposed of by sale. Under SFAS 144, if a long-lived asset is part of a group that includes other assets and liabilities, then the provisions of SFAS 144 apply to the entire group. In addition, SFAS 144 does not apply to goodwill and other intangible assets that are not amortized. Management does not expect the adoption of SFAS 144 to have a material impact on the results of operations or financial position of the Company.
In 2001, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 01-5, Amendments to Specific AICPA Pronouncements for Changes Related to the NAIC Codification (SOP 01-5). In doing so, AICPA SOP 94-5, Disclosures of Certain Matters in the Financial Statements of Insurance Enterprises, was amended to reflect the results of the completion of the NAIC codification of statutory accounting practices for certain insurance enterprises (Codification). The adoption of SOP 01-5 did not have an impact on the results of operations or financial position of the Company.
 
(l)  Reclassification
 
Certain items in the 2000 and 1999 consolidated financial statements and related footnotes have been reclassified to conform to the 2001 presentation.
 

[F-13]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
 

(3)  Investments
 
The amortized cost, gross unrealized gains and losses and estimated fair value of securities available-for-sale as of December 31, 2001 and 2000 were:
(in millions)
  
Amortized cost
   
Gross unrealized gains
   
Gross unrealized losses
  
Estimated fair value
December 31, 2001
                          
Fixed maturity securities:
                          
U.S. Treasury securities and obligations of U.S. Government corporations and agencies
  
$
266.7
   
$
23.4
   
$
0.5
  
$
289.6
Obligations of states and political subdivisions
  
 
7.6
   
 
0.3
   
 
—  
  
 
7.9
Debt securities issued by foreign governments
  
 
41.8
   
 
2.6
   
 
—  
  
 
44.4
Corporate securities
  
 
11,925.0
   
 
475.3
   
 
178.3
  
 
12,222.0
Mortgage-backed securities—U.S. Government backed
  
 
2,017.9
   
 
67.9
   
 
3.7
  
 
2,082.1
Asset-backed securities
  
 
3,876.8
   
 
76.7
   
 
51.2
  
 
3,902.3
Total fixed maturity securities
  
 
18,135.8
   
 
646.2
   
 
233.7
  
 
18,548.3
Equity securities
  
 
143.2
   
 
11.9
   
 
4.6
  
 
150.5
   
$
18,279.0
   
$
658.1
   
$
238.3
  
$
18,698.8
December 31, 2000
                          
Fixed maturity securities:
                          
U.S. Treasury securities and obligations of U.S. Government corporations and agencies
  
$
281.1
   
$
33.5
   
$
0.1
  
$
314.5
Obligations of states and political subdivisions
  
 
8.6
   
 
0.2
   
 
—  
  
 
8.8
Debt securities issued by foreign governments
  
 
94.1
   
 
1.6
   
 
0.1
  
 
95.6
Corporate securities
  
 
9,801.2
   
 
237.0
   
 
135.1
  
 
9,903.1
Mortgage-backed securities—U.S. Government backed
  
 
2,724.7
   
 
46.1
   
 
3.9
  
 
2,766.9
Asset-backed securities
  
 
2,388.2
   
 
36.3
   
 
16.2
  
 
2,408.3
Total fixed maturity securities
  
 
15,297.9
   
 
354.7
   
 
155.4
  
 
15,497.2
Equity securities
  
 
149.1
   
 
10.4
   
 
9.3
  
 
150.2
   
$
15,447.0
   
$
365.1
   
$
164.7
  
$
15,647.4

[F-14]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

 
The amortized cost and estimated fair value of fixed maturity securities available-for-sale as of December 31, 2001, by expected maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(in millions)
  
Amortized cost
  
Estimated fair value
Fixed maturity securities available-for-sale:
        
Due in one year or less
  
$  1,125.6
  
$  1,141.9
Due after one year through five years
  
5,216.7
  
5,359.8
Due after five years through ten years
  
4,149.9
  
4,266.1
Due after ten years
  
1,748.9
  
1,796.1
   
12,241.1
  
12,563.9
Mortgage-backed securities—U.S. Government backed
  
2,017.9
  
2,082.1
Asset-backed securities
  
3,876.8
  
3,902.3
   
$18,135.8
  
$18,548.3
 
The components of unrealized gains on securities available-for-sale, net, were as follows as of December 31:
(in millions)
  
2001
    
2000
  
Gross unrealized gains
  
$  419.8
 
  
$200.4
 
Adjustment to deferred policy
acquisition costs
  
(97.9
)
  
(24.4
)
Deferred federal income tax
  
(112.7
)
  
(61.5
)
   
$  209.2
 
  
$114.5
 
 
An analysis of the change in gross unrealized gains (losses) on securities available-for-sale follows for the years ended December 31:
(in millions)
  
2001
  
2000
    
1999
  
Securities available-for-sale:
                
Fixed maturity securities
  
$213.2
  
$282.6
 
  
$(607.1
)
Equity securities
  
6.2
  
(7.5
)
  
(8.5
)
   
$219.4
  
$275.1
 
  
$(615.6
)
 
Proceeds from the sale of securities available-for-sale during 2001, 2000 and 1999 were $498.8 million, $624.3 million and $513.1 million, respectively. During 2001, gross gains of $32.5 million ($12.1 million and $11.0 million in 2000 and 1999, respectively) and gross losses of $10.0 million ($15.4 million and $35.5 million in 2000 and 1999, respectively) were realized on those sales.
NFS had $25.2 million and $13.0 million of real estate investments as of December 31, 2001 and 2000, respectively, that were non-income producing the preceding twelve months.
Real estate is presented at cost less accumulated depreciation of $22.0 million as of December 31, 2001 ($25.7 million as of December 31, 2000). The carrying value of real estate held for disposal totaled $33.4 million and $8.5 million as of December 31, 2001 and 2000, respectively.
        The recorded investment of mortgage loans on real estate considered to be impaired was $29.9 million as of December 31, 2001 ($9.8 million as of December 31, 2000), which includes $5.3 million ($5.3 million as of December 31, 2000) of impaired mortgage loans on real estate for which the related valuation allowance was $1.0 million ($1.6 million as of December 31, 2000) and $24.6 million ($4.5 million as of December 31, 2000) of impaired mortgage loans on real estate for which there was no valuation allowance. Impaired mortgage loans with no valuation allowance are a result of collateral dependent loans where the fair value of the collateral is greater than the recorded investment of the loan. During 2001, the average recorded investment in impaired mortgage loans on real estate was $7.9 million ($7.7 million in 2000) and interest income recognized on those loans totaled $0.4 million in 2001 ($0.4 million in 2000) which is equal to interest income recognized using a cash-basis method of income recognition.

[F-15]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

Activity in the valuation allowance account for mortgage loans on real estate for the years ended December 31 was as follows:
(in millions)
  
2001
    
2000
    
1999
Allowance, beginning of year
  
$
45.3
 
  
$
44.4
 
  
$
42.4
Additions (reductions) charged (credited) to operations
  
 
(1.2
)
  
 
4.1
 
  
 
0.7
Direct write-downs charged against the allowance
  
 
(1.2
)
  
 
(3.2
)
  
 
—  
Allowance on acquired mortgage loans
  
 
—  
 
  
 
—  
 
  
 
1.3
Allowance, end of year
  
$
42.9
 
  
$
45.3
 
  
$
44.4
 
An analysis of investment income (loss) from continuing operations by investment type follows for the years ended December 31:
(in millions)
  
2001
    
2000
  
1999
  
Gross investment income:
                      
Securities available-for-sale:
                      
Fixed maturity securities
  
$
1,187.5
 
  
$
1,095.5
  
$
1,031.5
 
Equity securities
  
 
1.8
 
  
 
2.6
  
 
2.5
 
Mortgage loans on real estate
  
 
527.9
 
  
 
494.5
  
 
460.4
 
Real estate
  
 
33.1
 
  
 
32.2
  
 
28.8
 
Short-term investments
  
 
30.4
 
  
 
34.9
  
 
23.9
 
Derivatives
  
 
(19.7
)
  
 
3.9
  
 
(1.0
)
Other
  
 
24.2
 
  
 
48.4
  
 
26.8
 
Total investment income
  
 
1,785.2
 
  
 
1,712.0
  
 
1,572.9
 
Less investment expenses
  
 
48.4
 
  
 
50.1
  
 
47.3
 
    Net investment income
  
$
1,736.8
 
  
$
1,661.9
  
$
1,525.6
 
 
An analysis of net realized (losses) gains on investments, hedging instruments and hedged items from continuing operations, by investment type follows for the years ended December 31:
(in millions)
  
2001
    
2000
    
1999
  
Unrelated parties:
                        
Realized gains (losses) on sale of securities available-for-sale:
                        
Fixed maturity securities
  
$
20.8
 
  
$
(8.0
)
  
$
(32.5
)
Equity securities
  
 
1.7
 
  
 
4.7
 
  
 
8.0
 
Other-than-temporary impairments of securities available-for-sale:
                        
Fixed maturity securities
  
 
(66.1
)
  
 
(10.5
)
  
 
7.5
 
Equity securities
  
 
(13.9
)
  
 
—  
 
  
 
—  
 
Real estate
  
 
1.9
 
  
 
(0.5
)
  
 
0.9
 
Mortgage loans on real estate1
  
 
0.6
 
  
 
(4.2
)
  
 
(0.6
)
Derivatives
  
 
—  
 
  
 
(2.7
)
  
 
(1.6
)
Other
  
 
(2.5
)
  
 
(3.7
)
  
 
7.3
 
Total—unrelated parties
  
 
(57.5
)
  
 
(24.9
)
  
 
(11.0
)
Related party—gain on sale of limited partnership
  
 
44.4
 
  
 
—  
 
  
 
—  
 
Net realized losses on investments, hedging instruments and hedged items
  
$
(13.1
)
  
$
(24.9
)
  
$
(11.0
)
1     The 2001 amount is comprised of $9.9 million of net realized gains on the sale of mortgage loans on real estate, including those related to a securitization
       transaction, and $9.3 million of realized losses on derivatives hedging the sale of mortgage loans on real estate.
 
The 2001 loss from discontinued operations includes $12.8 million of realized losses on other-than-temporary impairments of equity securities available-for-sale.

[F-16]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

 
Fixed maturity securities with an amortized cost of $6.6 million as of December 31, 2001 and $6.5 million as of December 31, 2000 were on deposit with various regulatory agencies as required by law. In addition, fixed maturity securities with an amortized cost of $6.3 million as of December 31, 2000 were placed in escrow under a contractual obligation and none as of December 31, 2001.
As of December 31, 2001 the Company had pledged fixed maturity securities with a fair value of $112.3 million as collateral to various derivative counterparties.
As of December 31, 2001 the Company held collateral of $18.0 million on derivative transactions. This amount is included in short-term investments with a corresponding liability recorded in other liabilities.
As of December 31, 2001, the Company had loaned securities with a fair value of $775.5 million. As of December 31, 2001 the Company held collateral of $791.6 million. This amount is included in short-term investments with a corresponding liability recorded in other liabilities.
 
(4)  Short-term Debt
 
NLIC has established a $300 million commercial paper program under which, borrowings are unsecured and are issued for terms of 364 days or less. As of December 31, 2001 and 2000 the Company had $100.0 million and $118.7 million, respectively, of commercial paper outstanding at an average effective rate of 1.90% and 6.53%, respectively. See also note 17.
 
(5)  Long-term Debt
 
Long-term debt as of December 31, 2001 and 2000 consists of the following:
(in millions)
  
2001
  
2000
8.00% senior notes, due March 1, 2027
  
$298.4
  
$298.4
6.25% senior notes, due November 15, 2011
  
  298.6
  
—
   
$597.0
  
$298.4
 
The senior notes are not subject to any sinking fund payments. The terms of the senior notes contain various restrictive covenants including limitations on the disposition of subsidiaries. As of December 31, 2001, NFS was in compliance with all such covenants. The 8.00% senior notes are redeemable in whole or in part, at the option of NFS, at any time on or after March 1, 2007 at scheduled redemption premiums through March 1, 2016, and, thereafter, at 100% of the principal amount thereof plus, in each case, accrued and unpaid interest. The 6.25% senior notes are not redeemable prior to their maturity date. The Company made interest payments of $24.0 million in 2001, 2000 and 1999 on the senior notes.
 
(6)  Mandatorily Redeemable  Capital and Preferred Securities of Subsidiary Trusts
 
Nationwide Financial Services Capital Trust (Trust I) and Nationwide Financial Services Capital Trust II (Trust II, or collectively, the Trusts), wholly owned subsidiaries of NFS, were formed under the laws of the state of Delaware. The Trusts exist for the exclusive purposes of (i) issuing Capital and Preferred Securities representing undivided beneficial interests in the assets of the Trusts; (ii) investing the gross proceeds from the sale of the Capital and Preferred Securities in Junior Subordinated Debentures of NFS; and (iii) engaging in only those activities necessary or incidental thereto. These Junior Subordinated Debentures and the related income effects are eliminated in the consolidated financial statements.
On March 11, 1997, Trust I sold, in a public offering, $100.0 million of 7.899% Capital Securities, representing preferred undivided beneficial interests in the assets of Trust I generating net proceeds of $98.3 million. Concurrent with the sale of the Capital Securities, NFS sold to Trust I $103.1 million in principal amount of its 7.899% Junior Subordinated Debentures due March 1, 2037. The

[F-17]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

Junior Subordinated Debentures are the sole assets of Trust I and are redeemable by NFS in whole at any time or in part from time to time at par plus an applicable make-whole premium. The Capital Securities will mature or be called simultaneously with the Junior Subordinated Debentures and have a liquidation value of $1,000 per Capital Security.
The Capital Securities, through obligations of NFS under the Junior Subordinated Debentures, the Capital Securities Guarantee Agreement and the related Declaration of Trust and Indenture, are fully and unconditionally guaranteed by NFS. Distributions on the Capital Securities are cumulative and payable semi-annually in arrears.
On October 19, 1998, Trust II sold, in a public offering, 8 million shares representing $200 million of 7.10% Trust Preferred Securities representing preferred undivided beneficial interests in the assets of Trust II generating net proceeds of $193.7 million. Concurrent with the sale of the Preferred Securities, NFS sold to Trust II $206.2 million of Junior Subordinated Debentures due October 31, 2028. The Junior Subordinated Debentures are the sole assets of Trust II and are redeemable, in whole or in part, on or after October 19, 2003 at a redemption price equal to the principal amount to be redeemed plus any accrued and unpaid interest. The Preferred Securities have a liquidation amount of $25 per security and must be redeemed by Trust II when the Junior Subordinated Debentures mature or are redeemed by NFS.
The Preferred Securities, through obligations of NFS under the Junior Subordinated Debentures, the Preferred Securities Guarantee Agreement and the related Amended and Restated Declaration of Trust, are fully and unconditionally guaranteed by NFS. Distributions on the Preferred Securities are cumulative and payable quarterly beginning January 31, 1999. Including amortization of issue costs and amortization of a deferred loss on hedging transactions the effective interest rate on the Preferred Securities is 7.41%.
Distributions on the Capital and Preferred Securities have been classified as interest expense in the consolidated statements of income. The Company made distributions of $22.8 million on the Capital and Preferred Securities in 2001, 2000 and 1999.
 
(7)  Derivative Financial Instruments
 
Qualitative Disclosure
 
Interest Rate Risk Management
The Company is exposed to changes in the fair value of fixed rate investments (commercial mortgage loans and corporate bonds) due to changes in interest rates. To manage this risk, the Company enters into various types of derivative instruments to minimize fluctuations in fair values resulting from changes in interest rates. The Company principally uses interest rate swaps and short Eurodollar futures to manage this risk.
Under interest rate swaps, the Company receives variable interest rate payments and makes fixed rate payments, thereby creating floating rate investments.
Short Eurodollar futures change the fixed rate cash flow exposure to variable rate cash flows. With short Eurodollar futures, if interest rates rise (fall), the gains (losses) on the futures adjust the fixed rate income on the investments, thereby creating floating rate investments.
As a result of entering into commercial mortgage loan and private placement commitments, the Company is exposed to changes in the fair value of the commitment due to changes in interest rates during the commitment period. To manage this risk, the Company enters into short Treasury futures.
With short Treasury futures, if interest rates rise (fall), the gains (losses) on the futures will offset the change in fair value of the commitment.

[F-18]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

Floating rate investments (commercial mortgage loans and corporate bonds) expose the Company to fluctuations in cash flow and investment income due to changes in interest rates. To manage this risk, the Company enters into receive fixed, pay variable over-the-counter interest rate swaps or long Eurodollar futures strips to convert the variable rate investments to a fixed rate.
In using interest rate swaps, the Company receives fixed interest rate payments and makes variable rate payments; thereby creating fixed rate assets.
The long Eurodollar futures change the variable rate cash flow exposure to fixed rate cash flows. With long Eurodollar futures, if interest rates rise (fall), the losses (gains) on the futures are used to reduce the variable rate income on the investments, thereby creating fixed rate investments.
 
Foreign Currency Risk Management
In conjunction with the Company’s medium-term note program, from time to time, the Company issues both fixed and variable rate liabilities denominated in foreign currencies. As a result, the Company is exposed to changes in fair value of the liabilities due to changes in foreign currency exchange rates and interest rates. To manage these risks, the Company enters into cross-currency interest rate swaps to convert these liabilities to a variable U.S. dollar rate.
For a fixed rate liability, the cross-currency interest rate swap is structured to receive a fixed rate, in the foreign currency, and pay a variable U.S. dollar rate, generally 3-month libor. For a variable rate foreign liability, the cross-currency interest rate swap is structured to receive a variable rate, in the foreign currency, and pay a variable U.S. dollar rate, generally 3-month libor.
The Company is exposed to changes in fair value of fixed rate investments denominated in a foreign currency due to changes in foreign currency exchange rates and interest rates. To manage this risk, the Company uses cross-currency interest rate swaps to convert these assets to variable U.S. dollar rate instruments.
Cross-currency interest rate swaps on assets are structured to pay a fixed rate, in the foreign currency, and receive a variable U.S. dollar rate, generally 3-month libor.
 
Non-Hedging Derivatives
From time-to-time, the Company enters into over-the-counter basis swaps (receive one variable rate, pay another variable rate) to change the rate characteristics of a specific investment to better match the variable rate paid on a liability. While the pay-side terms of the basis swap will line up with the terms of the asset, the Company is not able to match the receive-side terms of the derivative to a specific liability; therefore, basis swaps do not receive hedge accounting treatment.
 
Quantitative Disclosure
Fair Value Hedges
During the year ended December 31, 2001, gains of $2.1 million were recognized in net realized losses on investments, hedging instruments and hedged items. This represents the ineffective portion of the fair value hedging relationships. There were no gains or losses attributable to the portion of the derivative instruments’ change in fair value excluded from the assessment of hedge effectiveness. There were also no gains or losses recognized in earnings as a result of hedged firm commitments no longer qualifying as fair value hedges.
 
Cash Flow Hedges
For the year ended December 31, 2001, the ineffective portion of cash flow hedges was immaterial. There were no gains or losses attributable to the portion of the derivative instruments’ change in fair value excluded from the assessment of hedge effectiveness.

[F-19]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

The Company anticipates reclassifying less than $0.1 million in losses out of AOCI over the next 12-month period.
As of December 31, 2001, the maximum length of time over which the Company is hedging its exposure to the variability in future cash flows associated with forecasted transactions is twelve months. The Company did not discontinue any cash flow hedges because the original forecasted transaction was no longer probable.
 
Other Derivative Instruments, Including Embedded Derivatives
Net realized gains and losses on investments, hedging instruments and hedged items for the year ended December 31, 2001 include a loss of $1.6 million related to other derivative instruments, including embedded derivatives. For the year ended December 31, 2001 a $27.7 million loss was recorded in net realized losses on investments, hedging instruments and hedged items reflecting the change in fair value of cross-currency interest rate swaps hedging variable rate medium-term notes denominated in foreign currencies. An offsetting gain of $26.3 million was recorded in net realized losses on investments, hedging instruments and hedged items to reflect the change in spot rates of these foreign currency denominated obligations during the year ended December 31, 2001.
The notional amount of derivative financial instruments outstanding as of December 31, 2001 and 2000 were as follows:
(in millions )
  
2001
  
2000
Interest rate swaps
        
Pay fixed/receive variable rate swaps hedging investments
  
$1,952.3
  
$   934.8
Pay variable/receive fixed rate swaps hedging investments
  
     698.4
  
       98.8
Pay variable/receive variable rate swaps hedging investments
  
     197.8
  
     184.0
Other contracts hedging investments
  
     523.0
  
       20.4
Cross currency interest rate swaps
        
Hedging foreign currency denominated investments
  
       56.1
  
       30.5
Hedging foreign currency denominated liabilities
  
  2,500.4
  
  1,512.2
Interest rate futures contracts
  
  6,019.4
  
  5,659.8

[F-20]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

 
(8)  Federal Income Tax
 
The tax effects of temporary differences that give rise to significant components of the net deferred tax liability as of December 31, 2001 and 2000 were as follows:
(in millions)
  
2001
    
2000
  
Deferred tax assets
            
Equity securities
  
$       6.5
 
  
$    —  
 
Future policy benefits
  
8.2
 
  
34.4
 
Liabilities in separate accounts
  
482.5
 
  
462.0
 
Mortgage loans on real estate and real estate
  
7.5
 
  
18.8
 
Derivatives
  
93.0
 
  
—  
 
Other assets and other liabilities
  
82.1
 
  
41.0
 
Total gross deferred tax assets
  
679.8
 
  
556.2
 
Less valuation allowance
  
(7.0
)
  
(7.0
)
Net deferred tax assets
  
672.8
 
  
549.2
 
Deferred tax liabilities
            
Deferred policy acquisition costs
  
861.3
 
  
783.7
 
Derivatives
  
91.5
 
  
—  
 
Fixed maturity securities
  
173.0
 
  
98.9
 
Deferred tax on realized investment gains
  
26.1
 
  
29.0
 
Equity securities and other long-term investments
  
31.7
 
  
6.4
 
Other
  
47.6
 
  
32.0
 
Total gross deferred tax liabilities
  
1,231.2
 
  
950.0
 
Net deferred tax liability
  
$   558.4
 
  
$400.8
 
 
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion of the total gross deferred tax assets will not be realized. Future taxable amounts or recovery of federal income tax paid within the statutory carryback period can offset nearly all future deductible amounts. The valuation allowance was unchanged for the years ended December 31, 2001, 2000 and 1999.
The Company’s current federal income tax liability was $182.0 million and $105.7 million as of December 31, 2001 and 2000, respectively.
Federal income tax expense attributable to income from continuing operations before cumulative effect of adoption of accounting principles for the years ended December 31 was as follows:
(in millions)
  
2001
  
2000
  
1999
Currently payable
  
$  26.4
  
$  60.2
  
$  34.8
Deferred tax expense
  
  117.5
  
  127.1
  
  148.2
   
$143.9
  
$187.3
  
$183.0

[F-21]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

 
Total federal income tax expense for the years ended December 31, 2001, 2000 and 1999 differs from the amount computed by applying the U.S. federal income tax rate to income from continuing operations before federal income tax expense and cumulative effect of adoption of accounting principles as follows:
   
2001
    
2000
    
1999
  
(in millions)
  
Amount
    
%
    
Amount
    
%
    
Amount
    
%
  
Computed (expected) tax expense
  
$
198.9
 
  
35.0
 
  
$
217.9
 
  
35.0
 
  
$
193.3
 
  
35.0
 
Tax exempt interest and dividends received deduction
  
 
(48.8
)
  
(8.6
)
  
 
(24.7
)
  
(4.0
)
  
 
(7.3
)
  
(1.3
)
Income tax credits
  
 
(11.5
)
  
(2.0
)
  
 
(8.0
)
  
(1.3
)
  
 
(4.3
)
  
(0.8
)
Other, net
  
 
5.3
 
  
0.9
 
  
 
2.1
 
  
0.4
 
  
 
1.3
 
  
0.2
 
Total (effective rate of each year)
  
$
143.9
 
  
25.3
 
  
$
187.3
 
  
30.1
 
  
$
183.0
 
  
33.1
 
Total federal income tax (refunded) paid was $(48.7) million, $64.5 million and $2.3 million during the years ended December 31, 2001, 2000 and 1999, respectively.
 
(9)  Earnings
Per Share
 
Basic earnings per share represent the amount of earnings for the period available to each share of common stock outstanding during the reporting period. Diluted earnings per share represent the amount of earnings for the period available to each share of common stock outstanding during the reporting period adjusted for the potential issuance of common shares for stock options. The calculations of basic and diluted earnings per share for the years ended December 31 follows:
(in millions, except per share amounts)
  
2001
    
2000
     
1999
Basic and diluted income from continuing operations before cumulative effect of adoption of accounting principles
  
$
424.3
 
  
$
435.1
 
   
$
369.6
Discontinued operations, net of tax
  
 
(4.4
)
  
 
(0.2
)
   
 
11.7
Cumulative effect of adoption of accounting principles, net of tax
  
 
(7.1
)
  
 
—  
 
   
 
—  
Basic and diluted net income
  
$
412.8
 
  
$
434.9
 
   
$
381.3
Weighted average common shares outstanding—basic
  
 
128.9
 
  
 
128.7
 
   
 
128.5
Dilutive effect of stock options
  
 
0.3
 
  
 
0.2
 
   
 
0.1
Weighted average common shares outstanding—diluted
  
 
129.2
 
  
 
128.9
 
   
 
128.6
Income from continuing operations before cumulative effect of adoption of accounting principles per common share:
                       
Basic
  
$
3.29
 
  
$
3.38
 
   
$
2.88
Diluted
  
$
3.28
 
  
$
3.38
 
   
$
2.88
Discontinued operations, net of tax, per common share:
                       
Basic
  
$
(0.03
)
  
$
—  
 
   
$
0.08
Diluted
  
$
(0.03
)
  
$
—  
 
   
$
0.08
Cumulative effect of adoption of accounting principles, net of tax, per common share:
                       
Basic
  
$
(0.06
)
  
$
—  
 
   
$
—  
Diluted
  
$
(0.05
)
  
$
—  
 
   
$
—  
Net income per common share:
                       
Basic
  
$
3.20
 
  
$
3.38
 
   
$
2.96
Diluted
  
$
3.20
 
  
$
3.38
 
   
$
2.96

[F-22]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

(10)  Comprehensive Income (Loss)
 
Comprehensive income (loss) includes net income as well as certain items that are reported directly within separate components of shareholders’ equity that bypass net income. Other comprehensive income (loss) is comprised of unrealized gains (losses) on securities available-for-sale and accumulated net losses on cash flow hedges. The related before and after federal income tax amounts for the years ended December 31, 2001, 2000 and 1999 were as follows:
(in millions)
  
2001
    
2000
    
1999
  
Unrealized gains (losses) on securities available-for-sale arising during the period:
                        
Gross
  
$
154.3
 
  
$
261.4
 
  
$
(665.0
)
Adjustment to deferred policy acquisition costs
  
 
(73.5
)
  
 
(75.3
)
  
 
167.5
 
Related federal income tax (expense) benefit
  
 
(28.3
)
  
 
(65.1
)
  
 
171.8
 
Net
  
 
52.5
 
  
 
121.0
 
  
 
(325.7
)
Reclassification adjustment for net losses on securities available-for-sale realized during the period:
                        
Gross
  
 
70.3
 
  
 
13.8
 
  
 
17.0
 
Related federal income tax benefit
  
 
(24.6
)
  
 
(4.8
)
  
 
(6.2
)
Net
  
 
45.7
 
  
 
9.0
 
  
 
10.8
 
Other comprehensive income (loss) on securities available-for-sale
  
 
98.2
 
  
 
130.0
 
  
 
(314.9
)
Accumulated net loss on cash flow hedges:
                        
Gross
  
 
(13.5
)
  
 
—  
 
  
 
—  
 
Related federal income tax benefit
  
 
4.7
 
  
 
—  
 
  
 
—  
 
Other comprehensive loss on cash flow hedges
  
 
(8.8
)
  
 
—  
 
  
 
—  
 
Accumulated net loss on transition adjustments:
                        
Transition adjustment—SFAS 133
  
 
(5.6
)
  
 
—  
 
  
 
—  
 
Transition adjustment—EITF 99-20
  
 
3.5
 
  
 
—  
 
  
 
—  
 
Related federal income tax benefit
  
 
0.7
 
  
 
—  
 
  
 
—  
 
Other comprehensive loss on transition adjustments
  
 
(1.4
)
  
 
—  
 
  
 
—  
 
Total other comprehensive income (loss)
  
$
88.0
 
  
$
130.0
 
  
$
(314.9
)
Reclassification adjustments for net realized gains and losses on the ineffective portion of cash flow hedges were immaterial during 2001 and, therefore, are not reflected in the table above.
 
(11)  Fair Value of Financial Instruments
 
The following disclosures summarize the carrying amount and estimated fair value of the Company’s financial instruments. Certain assets and liabilities are specifically excluded from the disclosure requirements of financial instruments. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The fair value of a financial instrument is defined as the amount at which the financial instrument could be exchanged in a current transaction between willing parties. In cases where quoted market prices are not available, fair value is to be based on estimates using present value or other valuation techniques. Many of the Company’s assets and liabilities subject to the disclosure requirements are not actively traded, requiring fair values to be estimated by management using present value or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Although fair value estimates are calculated using assumptions that management believes are appropriate,

[F-23]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

changes in assumptions could cause these estimates to vary materially. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in the immediate settlement of the instruments.
Although insurance contracts, other than policies such as annuities that are classified as investment contracts, are specifically exempted from the disclosure requirements, estimated fair value of policy reserves on life insurance contracts is provided to make the fair value disclosures more meaningful.
The tax ramifications of the related unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
In estimating its fair value disclosures, the Company used the following methods and assumptions:
Fixed maturity and equity securities:    The fair value for fixed maturity securities is based on quoted market prices, where available. For fixed maturity securities not actively traded, fair value is estimated using values obtained from independent pricing services or, in the case of private placements, is estimated by discounting expected future cash flows using a current market rate applicable to the yield, credit quality and maturity of the investments. The fair value for equity securities is based on quoted market prices. The carrying amount and fair value for fixed maturity and equity securities exclude the fair value of derivative contracts designated as hedges of fixed maturity and equity securities.
Mortgage loans on real estate, net:    The fair value for mortgage loans on real estate is estimated using discounted cash flow analyses, using interest rates currently being offered for similar loans to borrowers with similar credit ratings. Loans with similar characteristics are aggregated for purposes of the calculations. Fair value for impaired mortgage loans is the estimated fair value of the underlying collateral.
Policy loans, short-term investments and cash:    The carrying amount reported in the consolidated balance sheets for these instruments approximates their fair value.
Separate account assets and liabilities:    The fair value of assets held in separate accounts is based on quoted market prices. The fair value of liabilities related to separate accounts is the amount payable on demand, which is net of certain surrender charges.
Investment contracts:    The fair value for the Company’s liabilities under investment type contracts is based on one of two methods. For investment contracts without defined maturities, fair value is the amount payable on demand. For investment contracts with known or determined maturities, fair value is estimated using discounted cash flow analysis. Interest rates used are similar to currently offered contracts with maturities consistent with those remaining for the contracts being valued.
Policy reserves on life insurance contracts:     Included are disclosures for individual and corporate-owned life insurance, universal life insurance and supplementary contracts with life contingencies for which the estimated fair value is the amount payable on demand. Also included are disclosures for the Company’s limited payment policies, which the Company has used discounted cash flow analyses similar to those used for investment contracts with known maturities to estimate fair value.
Collateral received—securities lending and derivatives:    The carrying amount reported in the consolidated balance sheets for these instruments approximates their fair value.
Short-term debt:    The carrying amount reported in the consolidated balance sheets for these instruments approximates their fair value.
Long-term debt:    The fair value for long-term debt is based on quoted market prices.

[F-24]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

Capital and preferred securities of subsidiary trusts:    The fair value for capital and preferred securities of subsidiary trusts is based on quoted market prices.
Commitments to extend credit:    Commitments to extend credit have nominal fair value because of the short-term nature of such commitments. See note 12.
Futures contracts:    The fair value for futures contracts is based on quoted market prices.
Interest rate and foreign currency swaps:    The fair value for interest rate and foreign currency swaps are calculated with pricing models using current rate assumptions.
Carrying amount and estimated fair value of financial instruments subject to disclosure requirements and policy reserves on life insurance contracts were as follows as of December 31:
    
2001
     
2000
  
(in millions)
   
Carrying amount
       
Estimated fair value
     
Carrying amount
       
Estimated fair value
  
Assets
                                        
Investments:
                                        
Securities available-for-sale:
                                        
Fixed maturity securities
   
$
18,548.3
 
     
$
18,548.3
 
   
$
15,505.5
 
     
$
15,505.5
 
Equity securities
   
 
150.5
 
     
 
150.5
 
   
 
150.2
 
     
 
150.2
 
Mortgage loans on real estate, net
   
 
7,113.1
 
     
 
7,293.3
 
   
 
6,168.3
 
     
 
6,327.8
 
Policy loans
   
 
592.7
 
     
 
592.7
 
   
 
562.6
 
     
 
562.6
 
Short-term investments
   
 
1,112.8
 
     
 
1,112.8
 
   
 
558.4
 
     
 
558.4
 
Cash
   
 
65.0
 
     
 
65.0
 
   
 
62.7
 
     
 
62.7
 
Assets held in separate accounts
   
 
59,646.7
 
     
 
59,646.7
 
   
 
65,968.8
 
     
 
65,968.8
 
Liabilities
                                        
Investment contracts
   
 
(19,825.1
)
     
 
(18,679.1
)
   
 
(16,874.9
)
     
 
(16,035.7
)
Policy reserves on life insurance contracts
   
 
(5,666.5
)
     
 
(5,524.4
)
   
 
(5,368.4
)
     
 
(5,128.5
)
Collateral received—securities lending and derivatives
   
 
(809.6
)
     
 
(809.6
)
   
 
—  
 
     
 
—  
 
Short-term debt
   
 
(100.0
)
     
 
(100.0
)
   
 
(118.7
)
     
 
(118.7
)
Long-term debt
   
 
(597.0
)
     
 
(598.6
)
   
 
(298.4
)
     
 
(283.1
)
Liabilities related to separate accounts
   
 
(59,646.7
)
     
 
(58,510.8
)
   
 
(65,968.8
)
     
 
(64,303.8
)
Capital and preferred securities of subsidiary trusts
   
 
(300.0
)
     
 
(294.3
)
   
 
(300.0
)
     
 
(288.1
)
Derivative financial instruments
                                        
Interest rate swaps hedging assets
   
 
(5.6
)
     
 
(5.6
)
   
 
(8.3
)
     
 
(8.3
)
Cross currency interest rate swaps
   
 
(66.0
)
     
 
(66.0
)
   
 
(24.3
)
     
 
(30.9
)
Futures contracts
   
 
(33.0
)
     
 
(33.0
)
   
 
(16.0
)
     
 
(16.0
)
 
(12)
Risk Disclosures
 
The following is a description of the most significant risks facing life insurers and how the Company mitigates those risks:
Credit Risk:    The risk that issuers of securities owned by the Company or mortgagors on mortgage loans on real estate owned by the Company will default or that other parties, including reinsurers, which owe the Company money, will not pay. The Company minimizes this risk by adhering to a conservative investment strategy, by maintaining reinsurance and

[F-25]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

credit and collection policies and by providing for any amounts deemed uncollectible.
Interest Rate Risk:    The risk that interest rates will change and cause a decrease in the value of an insurer’s investments. This change in rates may cause certain interest-sensitive products to become uncompetitive or may cause disintermediation. The Company mitigates this risk by charging fees for non-conformance with certain policy provisions, by offering products that transfer this risk to the purchaser and/or by attempting to match the maturity schedule of its assets with the expected payouts of its liabilities. To the extent that liabilities come due more quickly than assets mature, an insurer could potentially have to borrow funds or sell assets prior to maturity and potentially recognize a gain or loss.
Legal/Regulatory Risk:    The risk that changes in the legal or regulatory environment in which an insurer operates will result in increased competition, reduced demand for a company’s products, or create additional expenses not anticipated by the insurer in pricing its products. The Company mitigates this risk by offering a wide range of products and by operating throughout the U.S., thus reducing its exposure to any single product or jurisdiction, and also by employing underwriting practices which identify and minimize the adverse impact of this risk.
Financial Instruments with Off-Balance-Sheet Risk: The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business through management of its investment portfolio. These financial instruments include commitments to extend credit in the form of loans and derivative financial instruments. These instruments involve, to varying degrees, elements of credit risk in excess of amounts recognized on the consolidated balance sheets.
Commitments to fund fixed rate mortgage loans on real estate are agreements to lend to a borrower and are subject to conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a deposit. Commitments extended by the Company are based on management’s case-by-case credit evaluation of the borrower and the borrower’s loan collateral. The underlying mortgage property represents the collateral if the commitment is funded. The Company’s policy for new mortgage loans on real estate is to generally lend no more than 80% of collateral value. Should the commitment be funded, the Company’s exposure to credit loss in the event of nonperformance by the borrower is represented by the contractual amounts of these commitments less the net realizable value of the collateral. The contractual amounts also represent the cash requirements for all unfunded commitments. Commitments on mortgage loans on real estate of $344.0 million extending into 2002 were outstanding as of December 31, 2001. The Company also had $81.5 million of commitments to purchase fixed maturity securities outstanding as of December 31, 2001.
Notional amounts of derivative financial instruments, primarily interest rate swaps, interest rate futures contracts and foreign currency swaps, significantly exceed the credit risk associated with these instruments and represent contractual balances on which calculations of amounts to be exchanged are based. Credit exposure is limited to the sum of the aggregate fair value of positions that have become favorable to NFS, including accrued interest receivable due from counterparties. Potential credit losses are minimized through careful evaluation of counterparty credit standing, selection of counterparties from a limited group of high quality institutions, collateral agreements and other contract provisions. As of December 31, 2001, NFS’ credit risk from these derivative financial instruments was $1.5 million net of $18.0 million of cash collateral.

[F-26]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

Equity Market Risk:    Asset fees calculated as a percentage of the separate account assets are a significant source of revenue to the Company. As of December 31, 2001, 82% of separate account assets were invested in equity mutual funds. Gains and losses in the equity markets will result in corresponding increases and decreases in the Company’s separate account assets and the reported asset fee revenue. In addition, a decrease in separate account assets may decrease the Company’s expectations of future profit margins, which may require the Company to accelerate the amortization of deferred policy acquisition costs.
Significant Concentrations of Credit Risk:    The Company grants mainly commercial mortgage loans on real estate to customers throughout the U.S. The Company has a diversified portfolio with no more than 20% (22% in 2000) in any geographic area and no more than 2% (1% in 2000) with any one borrower as of December 31, 2001. As of December 31, 2001, 34% (36% in 2000) of the carrying value of the Company’s commercial mortgage loan portfolio financed retail properties.
Significant Business Concentrations:    As of December 31, 2001, the Company did not have a material concentration of financial instruments in a single investee, industry or geographic location. Also, the Company did not have a concentration of business transactions with a particular customer, lender or distribution source, a market or geographic area in which business is conducted that makes it vulnerable to an event which could cause a severe impact to the Company’s financial position.
Reinsurance:    The Company has entered into reinsurance contracts to cede a portion of its general account individual annuity business. Total recoveries due from these contracts were $161.2 million and $143.1 million as of December 31, 2001 and 2000, respectively. The contracts are immaterial to the Company’s results of operations. The ceding of risk does not discharge the original insurer from its primary obligation to the policyholder. Under the terms of the contracts, trusts have been established as collateral for the recoveries. The trust assets are invested in investment grade securities, the fair value of which must at all times be greater than or equal to 100% or 102% of the reinsured reserves, as outlined in the underlying contract.
Collateral—Derivatives:    The Company enters into agreements with various counterparties to execute over-the-counter derivative transactions. The Company’s policy is to include a Credit Support Annex with each agreement to protect the Company for any exposure above the approved credit threshold. This also protects the counterparty against exposure to the Company. The Company generally posts securities as collateral and receives cash as collateral from counterparties. The Company maintains ownership of the securities at all times and is entitled to receive from the borrower any payments for interest or dividends received during the loan term.
Collateral—Securities Lending:    The Company, through its agent, lends certain portfolio holdings and in turn receives cash collateral. The cash collateral is invested in high-quality short-term investments. The Company’s policy requires a minimum of 102% of the fair value of the securities loaned be maintained as collateral. Net returns on the investments, after payment of a rebate to the borrower, are shared between the Company and its agent. Both the borrower and the Company can request or return the loaned securities at any time. The Company maintains ownership of the securities at all times and is entitled to receive from the borrower any payments for interest or dividends received during the loan term.

[F-27]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

 
(13)  Pension
Plan, Postretirement Benefits Other than Pensions and Retirement Savings Plan
 
The Company is a participant, together with other affiliated companies, in a pension plan covering all employees who have completed at least one year of service and who have met certain age requirements. Plan contributions are invested in a group annuity contract of NLIC. Benefits are based upon the highest average annual salary of a specified number of consecutive years of the last ten years of service. The Company funds pension costs accrued for direct employees plus an allocation of pension costs accrued for employees of affiliates whose work efforts benefit the Company.
Pension costs (benefits) charged to operations by the Company during the years ended December 31, 2001, 2000 and 1999 were $5.7 million, $2.7 million and ($0.2) million, respectively. The Company has recorded a prepaid pension asset of $9.4 million and $13.6 million as of December 31, 2001 and 2000, respectively.
In addition to the defined benefit pension plan, the Company, together with other affiliated companies, participates in life and health care defined benefit plans for qualifying retirees. Postretirement life and health care benefits are contributory and generally available to full time employees who have attained age 55 and have accumulated 15 years of service with the Company after reaching age 40. Postretirement health care benefit contributions are adjusted annually and contain cost-sharing features such as deductibles and coinsurance. In addition, there are caps on the Company’s portion of the per-participant cost of the postretirement health care benefits. These caps can increase annually, but not more than three percent. The Company’s policy is to fund the cost of health care benefits in amounts determined at the discretion of management. Plan assets are invested primarily in group annuity contracts of NLIC.
The Company elected to immediately recognize its estimated accumulated postretirement benefit obligation (APBO), however; certain affiliated companies elected to amortize their initial transition obligation over periods ranging from 10 to 20 years.
The Company’s accrued postretirement benefit expense as of December 31, 2001 and 2000 was $53.8 million and $51.0 million, respectively and the net periodic postretirement benefit cost (NPPBC) for 2001, 2000 and 1999 was $3.2 million, $4.1 million and $4.9 million, respectively.

[F-28]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

Information regarding the funded status of the pension plan as a whole and the postretirement life and health care benefit plan as a whole as of December 31, 2001 and 2000 follows:
   
Pension Benefits
    
Postretirement Benefits
  
(in millions)
  
2001
    
2000
    
2001
    
2000
  
Change in benefit obligation
                                
Benefit obligation at beginning of year
  
$
1,981.7
 
  
$
1,811.4
 
  
$
276.4
 
  
$
239.8
 
Service cost
  
 
89.3
 
  
 
81.4
 
  
 
12.6
 
  
 
12.2
 
Interest cost
  
 
129.1
 
  
 
125.3
 
  
 
21.4
 
  
 
18.7
 
Participant contributions
  
 
—  
 
  
 
—  
 
  
 
3.3
 
  
 
2.9
 
Plan amendment
  
 
27.7
 
  
 
—  
 
  
 
0.2
 
  
 
—  
 
Actuarial (gain) loss
  
 
(5.8
)
  
 
34.8
 
  
 
20.2
 
  
 
16.1
 
Benefits paid
  
 
(89.8
)
  
 
(71.2
)
  
 
(20.1
)
  
 
(13.3
)
Benefit obligation at end of year
  
 
2,132.2
 
  
 
1,981.7
 
  
 
314.0
 
  
 
276.4
 
Change in plan assets
                                
Fair value of plan assets at beginning of year
  
 
2,337.1
 
  
 
2,247.6
 
  
 
119.4
 
  
 
91.3
 
Actual return (loss) on plan assets
  
 
(46.6
)
  
 
140.9
 
  
 
(0.2
)
  
 
12.2
 
Employer contribution
  
 
—  
 
  
 
—  
 
  
 
17.3
 
  
 
26.3
 
Participant contributions
  
 
—  
 
  
 
—  
 
  
 
3.3
 
  
 
2.9
 
Plan curtailment
  
 
—  
 
  
 
19.8
 
  
 
—  
 
  
 
—  
 
Benefits paid
  
 
(89.8
)
  
 
(71.2
)
  
 
(20.1
)
  
 
(13.3
)
Fair value of plan assets at end of year
  
 
2,200.7
 
  
 
2,337.1
 
  
 
119.7
 
  
 
119.4
 
Funded status
  
 
68.5
 
  
 
355.4
 
  
 
(194.3
)
  
 
(157.0
)
Unrecognized prior service cost
  
 
49.5
 
  
 
25.0
 
  
 
0.2
 
  
 
—  
 
Unrecognized net gains
  
 
(79.3
)
  
 
(311.7
)
  
 
(4.0
)
  
 
(34.1
)
Unrecognized net (asset) obligation at transition
  
 
(5.1
)
  
 
(6.4
)
  
 
0.8
 
  
 
1.0
 
Prepaid (accrued) benefit cost
  
$
33.6
 
  
$
62.3
 
  
$
(197.3
)
  
$
(190.1
)
Assumptions used in calculating the funded status of the pension plan and postretirement life and health care benefit plan were as follows:
   
Pension Benefits
  
Postretirement Benefits
   
2001
  
2000
  
2001
  
2000
Weighted average discount rate
  
6.50%
  
6.75%
  
7.25%
  
7.50%
Rate of increase in future compensation levels
  
4.75%
  
5.00%
  
—  
  
—  
Assumed health care cost trend rate:
                
Initial rate
  
—  
  
—  
  
11.00%
  
11.00%
Ultimate rate
  
—  
  
—  
  
5.50%
  
5.50%
Declining period
  
—  
  
—  
  
4 Years
  
4 Years

[F-29]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

The components of net periodic pension cost for the pension plan as a whole for the years ended December 31, 2001, 2000 and 1999 were as follows:
(in millions)
  
2001
    
2000
    
1999
  
Service cost (benefits earned during the period)
  
$    89.3
 
  
$    81.4
 
  
$    80.0
 
Interest cost on projected benefit obligation
  
129.1
 
  
125.3
 
  
109.9
 
Expected return on plan assets
  
(183.8
)
  
(184.5
)
  
(160.3
)
Recognized gains
  
(7.8
)
  
(11.8
)
  
(9.1
)
Amortization of prior service cost
  
3.2
 
  
3.2
 
  
3.2
 
Amortization of unrecognized transition asset
  
(1.3
)
  
(1.3
)
  
(1.4
)
   
$    28.7
 
  
$    12.3
 
  
$    22.3
 
Effective December 31, 1998, Wausau Service Corporation (WSC) ended its affiliation with Nationwide and employees of WSC ended participation in the pension plan resulting in a curtailment gain of $67.1 million. During 1999, the pension plan transferred assets to settle its obligation related to WSC employees, resulting in a gain of $32.9 million. The spin-off of liabilities and assets was completed in the year 2000, resulting in an adjustment to the curtailment gain of $19.8 million.
Assumptions used in calculating the net periodic pension cost for the pension plan were as follows:
   
2001
  
2000
  
1999
Weighted average discount rate
  
6.75%
  
7.00%
  
6.08%
Rate of increase in future compensation levels
  
5.00%
  
5.25%
  
4.33%
Expected long-term rate of return on plan assets
  
8.00%
  
8.25%
  
7.33%
The components of NPPBC for the postretirement benefit plan as a whole for the years ended December 31, 2001, 2000 and 1999 were as follows:
(in millions)
  
2001
    
2000
    
1999
  
Service cost (benefits attributed to employee service during the year)
  
$  12.6
 
  
$  12.2
 
  
$  14.2
 
Interest cost on accumulated postretirement benefit obligation
  
21.4
 
  
18.7
 
  
17.6
 
Expected return on plan assets
  
(9.6
)
  
(7.9
)
  
(4.8
)
Amortization of unrecognized transition obligation of affiliates
  
0.6
 
  
0.6
 
  
0.6
 
Net amortization and deferral
  
(0.4
)
  
(1.3
)
  
(0.5
)
   
$  24.6
 
  
$  22.3
 
  
$  27.1
 
Actuarial assumptions used for the measurement of the NPPBC for the postretirement benefit plan for 2001, 2000 and 1999 were as follows:
   
2001
  
2000
  
1999
Discount rate
  
7.50%
  
7.80%
  
6.65%
Long-term rate of return on plan assets, net of tax in 1999
  
8.00%
  
8.30%
  
7.15%
Assumed health care cost trend rate:
            
Initial rate
  
11.00%
  
13.00%
  
15.00%
Ultimate rate
  
5.50%
  
5.50%
  
5.50%
Declining period
  
4 Years
  
5 Years
  
6 Years
Because current plan costs are very close to the employer dollar caps, the health care cost trend has an immaterial effect on plan obligations and expense for the postretirement benefit plan as a whole. For this reason, the effect of a one percentage point increase or decrease in the assumed health care cost trend rate on the APBO as of December 31, 2001 and on the NPPBC for the year ended December 31, 2001 was not calculated.

[F-30]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

The Company, together with other affiliated companies, sponsors a defined contribution retirement savings plan covering substantially all employees of the Company. Employees may make salary deferral contributions of up to 22%. Salary deferrals of up to 6% are subject to a 50% Company match. The Company match is funded on a bi-weekly basis and the expense of such contributions are allocated to the Company based on employee contributions. The Company’s expense for contributions to this plan totaled $7.1 million, $5.8 million and $4.9 million for 2001, 2000 and 1999, respectively, including $0.4 million, $0.4 million and $0.1 million related to discontinued operations for 2001, 2000 and 1999, respectively. Individuals are subject to a dollar limit on salary deferrals per Internal Revenue Service (IRS) Section 402(g) and other limits also apply. The Company has no legal obligation for benefits under this plan.
 
(14)  Stock Compensation
 
The Company sponsors the Nationwide Financial Services, Inc. 1996 Long-Term Equity Compensation Plan (LTEP) covering selected officers, directors and employees of the Company and certain of its affiliates. The LTEP provides for the grant of any or all of the following types of awards: (i) stock options for shares of Class A common stock; (ii) stock appreciation rights (SARs); (iii) restricted stock; and (iv) performance awards. The LTEP was effective December 11, 1996 and no awards may be granted under the LTEP after December 11, 2006. The number of shares of Class A common stock which may be issued under the LTEP, or as to which SARs or other awards may be granted, currently may not exceed 6.1 million.
The Company has elected to continue to follow Accounting Principles Board Opinion No. 25—Accounting for Stock Issued to Employees (APB 25) and related interpretations in accounting for its employee stock options as permitted by SFAS No. 123—Accounting for Stock-Based Compensation (SFAS 123). Under APB 25, because the exercise price of the Company’s employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. Pro forma disclosures as if the Company adopted the expense recognition provisions of SFAS 123, which require the fair value of the options granted to be recorded as expense over the vesting period, are presented below.
Stock options granted under the LTEP in 2001, 2000 and 1999 have ten year terms. Generally, one third of the options vest and become fully exercisable at the end of each of three years of continued employment, or upon retirement. The Company’s stock option activity and related information for the three years ended December 31 is summarized below:
   
2001
  
2000
  
1999
   
Options on Class A common stock
     
Weighted average exercise price
  
Options on Class A common stock
     
Weighted average exercise price
  
Options on Class A common stock
     
Weighted average exercise price
Outstanding, beginning of period
  
2,797,836
 
   
$
34.99
  
1,623,529
 
   
$
40.34
  
562,134
 
   
$
32.68
Granted
  
1,194,517
 
   
$
42.62
  
1,182,542
 
   
$
27.60
  
1,076,475
 
   
$
44.29
Exercised
  
(50,286
)
   
$
27.10
  
(6,935
)
   
$
28.81
  
(5,555
)
   
$
23.50
Cancelled
  
(131,208
)
   
$
39.75
  
(1,300
)
   
$
31.21
  
(9,525
)
   
$
48.08
Outstanding, end of period
  
3,810,859
 
   
$
37.32
  
2,797,836
 
   
$
34.99
  
1,623,529
 
   
$
40.34
Exercisable, end of period
  
1,512,090
 
   
$
36.84
  
868,094
 
   
$
37.39
  
321,897
 
   
$
31.84
Weighted average fair value of options
granted during the year
         
$
17.94
         
$
11.58
         
$
18.44

[F-31]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

The following table summarizes information about employee options outstanding and exercisable as of December 31, 2001.
   
Options outstanding
  
Options currently exercisable
Range of exercise prices
  
Number
   
Weighted average remaining contractual lives
   
Weighted average exercise price
  
Number
   
Weighted average exercise price
$23.50-$31.19
  
1,291,927
   
7.67
   
$
26.59
  
525,594
   
$
25.77
$36.02-$48.13
  
2,518,932
   
8.06
   
$
42.83
  
986,496
   
$
42.74
The fair values of the stock options are estimated on the dates of grant using a Black-Scholes option pricing model with the following weighted average assumptions:
   
2001
  
2000
  
1999
Risk free interest rate
  
4.88%
  
6.76%
  
5.36%
Dividend yield
  
1.13%
  
1.46%
  
0.80%
Volatility factor
  
0.453
  
0.417
  
0.414
Weighted average expected option life
  
5 Years
  
5 Years
  
5 Years
Had the compensation cost for the employee stock options been determined in accordance with the fair value based accounting method provided by SFAS 123, net income and net income per common share for the years ended December 31 would have been as follows:
(in millions, except per share amounts)
   
Pro forma
   
As presented
2001
          
Net income
   
$400.7
   
$412.8
Basic and diluted earnings per common share
   
$  3.11
   
$  3.20
2000
          
Net income
   
$425.1
   
$434.9
Basic and diluted earnings per common share
   
$  3.30
   
$  3.38
1999
          
Net income
   
$375.2
   
$381.3
Basic and diluted earnings per common share
   
$  2.92
   
$  2.96
 
(15)  Shareholders’ Equity, Regulatory Risk-Based Capital, Retained Earnings and Dividend Restrictions
 
The Board of Directors of the Company has the authority to issue 50.0 million shares of preferred stock without further action of the shareholders. Preferred stock may be issued in one or more classes with full, special, limited or no voting powers, and designations, preferences and relative, participating, optional or other special rights, and qualifications and limitations or restrictions as stated in any resolution adopted by the Board of Directors of the Company issuing any class of preferred stock. No shares of preferred stock have been issued or are outstanding.
The holders of Class A common stock are entitled to one vote per share. The holders of Class B common stock are entitled to ten votes per share. Class A common stock has no conversion rights. Class B common stock is convertible into Class A common stock, in whole or in part, at any time and from time to time at the option of the holder, on the basis of one share of Class A common stock for each share of Class B common stock converted. If at any time after the initial issuance of shares of Class A common stock the number of outstanding shares of Class B common stock falls below 5% of the aggregate number of issued and outstanding shares of common stock, then each outstanding share of Class B common stock shall

[F-32]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

automatically convert into one share of Class A common stock. In the event of any sale or transfer of shares of Class B common stock to any person or persons other than NMIC or its affiliates, such shares of Class B common stock so transferred shall be automatically converted into an equal number of shares of Class A common stock. Cash dividends of $0.48, $0.46 and $0.38 per common share were declared during 2001, 2000 and 1999, respectively.
Each insurance company’s state of domicile imposes minimum risk-based capital requirements that were developed by the NAIC. The formulas for determining the amount of risk-based capital specify various weighting factors that are applied to financial balances or various levels of activity based on the perceived degree of risk. Regulatory compliance is determined by a ratio of the Company’s insurance regulatory total adjusted capital, as defined by the NAIC, to its authorized control level risk-based capital, as defined by the NAIC. Companies below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. NLIC and its insurance company subsidiary exceed the minimum risk-based capital requirements for all periods presented herein.
The statutory capital and surplus of NLIC as of December 31, 2001, 2000 and 1999 was $1.76 billion, $1.28 billion and $1.35 billion, respectively. The statutory net income of NLIC for the years ended December 31, 2001, 2000 and 1999 was $83.1 million, $158.7 million and $276.2 million, respectively.
The NAIC completed a project to codify statutory accounting principals (Codification), which became effective January 1, 2001 for NLIC and its insurance company subsidiary. The resulting change to NLIC’s January 1, 2001 surplus was an increase of approximately $80.0 million. The significant change for NLIC, as a result of Codification, was the recording of deferred taxes, which were not recorded prior to the adoption of Codification.
Ohio insurance laws limit the payment of dividends in excess of specified amounts without prior regulatory approval. As of December 31, 2001 $141.0 million in dividends could be paid by NLIC without prior approval.
In addition, the payment of dividends by NLIC may also be subject to restrictions set forth in the insurance laws of New York that limit the amount of statutory profits on NLIC’s participating policies (measured before dividends to policyholders) that can inure to the benefit of the Company and its shareholders.
The Company currently does not expect such regulatory requirements to impair its ability to pay operating expenses, interest and shareholder dividends in the future.
 
(16)  Related Party Transactions
 
During 2001, the Company entered into a transaction with NMIC, whereby it sold 78% of its interest in a limited partnership (representing 49% of the limited partnership) to NMIC for $158.9 million. As a result of this sale, the Company recorded a realized gain of $44.4 million, and related tax expense of $15.5 million. The sale price, which was paid in cash, represented the fair value of the limited partnership interest and was based on a valuation of the limited partnership and its underlying investments. The valuation was completed by qualified management of the limited partnership and utilized a combination of internal and independent valuations of the underlying investments of the limited partnership. Additionally, senior financial officers and the Boards of Directors of the Company and NMIC separately reviewed and approved the valuation prior to the execution of this transaction. The Company continues to hold an economic and voting interest in the limited partnership of approximately 14%, with NMIC holding the remaining interests.
The Company has issued group annuity and life insurance contracts and performs administrative services for various employee benefit plans sponsored by NMIC or

[F-33]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

its affiliates. Total account values of these contracts were $4.96 billion and $5.15 billion as of December 31, 2001 and 2000, respectively. Total revenues from these contracts were $154.0 million, $160.2 million, and $150.9 million for the years ended December 31, 2001, 2000, and 1999, respectively, and include policy charges, net investment income from investments backing the contracts and administrative fees. Total interest credited to the account balances were $118.4 million, $131.9 million, and $112.0 million for the years ended December 31, 2001, 2000, and 1999, respectively. The terms of these contracts are consistent in all material respects with what the Company offers to unaffiliated parties.
The Company files a consolidated federal tax return with NMIC, as described in note 2(i). Total payments (from) to NMIC were $(48.7) million, $64.5 million, and $2.3 million for the years ended December 31, 2001, 2000, and 1999, respectively.
During second quarter 1999, NLIC entered into a modified coinsurance arrangement to reinsure the 1999 operating results of an affiliated company, Employers Life Insurance Company of Wausau (ELOW) retroactive to January 1, 1999. In September 1999, NFS acquired ELOW for $120.8 million and immediately merged ELOW into NLIC terminating the modified coinsurance arrangement. During September 1999, NFS also acquired Pension Associates (PA), an affiliated pension plan administrator for $3.4 million. Because ELOW and PA were affiliates, the Company accounted for the purchases similar to poolings-of-interests; however, prior period financial statements were not restated due to immateriality. The combined net assets of the acquired companies exceeded the purchase price by $17.0 million, which is reflected as a direct credit to shareholders’ equity.            
NLIC has a reinsurance agreement with NMIC whereby all of NLIC’s accident and health business is ceded to NMIC on a modified coinsurance basis. The agreement covers individual accident and health business for all periods presented and group and franchise accident and health business since July 1, 1999. Either party may terminate the agreement on January 1 of any year with prior notice. Prior to July 1, 1999 group and franchise accident and health business and a block of group life insurance policies were ceded to ELOW under a modified coinsurance agreement. Under a modified coinsurance agreement, invested assets are retained by the ceding company and investment earnings are paid to the reinsurer. Under the terms of NLIC’s agreements, the investment risk associated with changes in interest rates is borne by the reinsurer. Risk of asset default is retained by NLIC, although a fee is paid to NLIC for the retention of such risk. The ceding of risk does not discharge the original insurer from its primary obligation to the policyholder. The Company believes that the terms of the modified coinsurance agreements are consistent in all material respects with what the Company could have obtained with unaffiliated parties. Revenues ceded to NMIC and ELOW for the years ended December 31, 2001, 2000 and 1999 were $200.7 million, $170.1 million and $193.0 million, respectively, while benefits, claims and expenses ceded were $208.5 million, $168.0 million and $197.3 million, respectively.
Pursuant to a cost sharing agreement among NMIC and certain of its direct and indirect subsidiaries, including the Company, NMIC provides certain operational and administrative services, such as investment management, advertising, personnel and general management services, to those subsidiaries. Expenses covered by such agreement are subject to allocation among NMIC and such subsidiaries. Measures used to allocate expenses among companies include individual employee estimates of time spent, special cost studies, salary expense, commission expense and other methods agreed to by the participating companies that are within industry guidelines and practices. In addition, Nationwide Services Company, a subsidiary of NMIC, provides computer, telephone, mail, employee benefits administration, and other services to

[F-34]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

NMIC and certain of its direct and indirect subsidiaries, including the Company, based on specified rates for units of service consumed. For the years ended December 31, 2001, 2000 and 1999, the Company made payments to NMIC and Nationwide Services Company totaling $145.6 million, $156.6 million and $132.3 million, respectively. The Company does not believe that expenses recognized under these agreements are materially different than expenses that would have been recognized had the Company operated on a stand-alone basis.
Under a marketing agreement with NMIC, NLIC makes payments to cover a portion of the agent marketing allowance that is paid to Nationwide agents. These costs cover product development and promotion, sales literature, rent and similar items. Payments under this agreement totaled $26.4 million, $31.4 million and $34.5 million for the years ended December 31, 2001, 2000 and 1999, respectively.
The Company leases office space from NMIC and certain of its subsidiaries. For the years ended December 31, 2001, 2000 and 1999, the Company made lease payments to NMIC and its subsidiaries of $18.7 million, $14.3 million and $11.4 million, respectively.
The Company also participates in intercompany repurchase agreements with affiliates whereby the seller will transfer securities to the buyer at a stated value. Upon demand or after a stated period, the seller will repurchase the securities at the original sales price plus a price differential. During 2001, the most the Company had outstanding at any given time was $368.5 million and the Company incurred interest expense on intercompany repurchase agreements of $0.2 million for 2001. Transactions under the agreements during 2000 and 1999 were not material. The Company believes that the terms of the repurchase agreements are materially consistent with what the Company could have obtained with unaffiliated parties.
The Company and various affiliates entered into agreements with Nationwide Cash Management Company (NCMC), an affiliate, under which NCMC acts as a common agent in handling the purchase and sale of short-term securities for the respective accounts of the participants. Amounts on deposit with NCMC were $85.6 million and $436.5 million as of December 31, 2001 and 2000, respectively, and are included in short-term investments on the accompanying consolidated balance sheets.
See note 22 regarding discontinued operations as a result of related party transactions.
 
(17)  Bank Lines of Credit
 
The Company has available as a source of funds a $1 billion revolving credit facility entered into by NFS, NLIC and NMIC. The facility is comprised of a five year $700 million agreement and a 364 day $300 million agreement with a group of national financial institutions. The facility provides for several and not joint liability with respect to any amount drawn by any party. The facility provides covenants, including, but not limited to, requirements that the Company maintain consolidated tangible net worth, as defined, in excess of $1.69 billion and NLIC maintain statutory surplus in excess of $935 million. The Company had no amounts outstanding under this agreement as of December 31, 2001. Of the total facility, $300 million is designated to back NLIC’s commercial paper program. Therefore, borrowing capacity under this facility is reduced by any amounts outstanding under the commercial paper program, which totaled $100.0 million as of December 31, 2001.
 
(18)  Contingencies
 
On October 29, 1998, the Company was named in a lawsuit filed in Ohio state court related to the sale of deferred annuity products for use as investments in tax-deferred contributory retirement plans (Mercedes Castillo v. Nationwide Financial Services, Inc., Nationwide Life Insurance Company and Nationwide Life and Annuity Insurance Company). On May 3, 1999, the complaint was amended to, among other things, add Marcus Shore as a

[F-35]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

second plaintiff. The amended complaint is brought as a class action on behalf of all persons who purchased individual deferred annuity contracts or participated in group annuity contracts sold by the Company and the other named Company affiliates which were used to fund certain tax-deferred retirement plans. The amended complaint seeks unspecified compensatory and punitive damages. On June 11, 1999, the Company and the other named defendants filed a motion to dismiss the amended complaint. On March 8, 2000, the court denied the motion to dismiss the amended complaint filed by the Company and the other named defendants. On January 25, 2002, the plaintiffs filed a motion for leave to amend their complaint to add three new named plaintiffs. On February 9, 2002, the plaintiffs filed a motion for class certification. The class has not been certified. The Company intends to defend this lawsuit vigorously.
On August 15, 2001, the Company was named in a lawsuit filed in Connecticut federal court titled Lou Haddock, as trustee of the Flyte Tool & Die, Incorporated Deferred Compensation Plan, et al v. Nationwide Financial Services, Inc. and Nationwide Life Insurance Company. On September 5, 2001, the plaintiffs amended their complaint to include class action allegations. The plaintiffs seek to represent a class of plan trustees who purchased variable annuities to fund qualified ERISA retirement plans. The amended complaint alleges that the retirement plans purchased variable annuity contracts from the Company which invested in mutual funds that were offered by separate mutual fund companies; that the Company was a fiduciary under ERISA and that the Company breached its fiduciary duty when it accepted certain fees from the mutual fund companies that purportedly were never disclosed by the Company; and that the Company violated ERISA by replacing many of the mutual funds originally included in the plaintiffs’ annuities with “inferior” funds because the new funds purportedly paid more in revenue sharing. The amended complaint seeks disgourgement of fees by the Company and other unspecified compensatory damages. On November 15, 2001, the Company filed a motion to dismiss the amended complaint, which has not been decided. On December 3, 2001, the plaintiffs filed a motion for class certification. On January 15, 2002, the plaintiffs filed a response to the Company’s motion to dismiss the amended complaint. On February 22, 2002, the Company filed a reply in support of its motion to dismiss. The class has not been certified. The Company intends to defend this lawsuit vigorously.
There can be no assurance that any such litigation will not have a material adverse effect on the Company in the future.
 
(19)  Pending Transaction
 
On August 8, 2001, NFS announced the signing of an agreement and plan of merger, whereby through a sponsored demutualization, it will acquire Provident Mutual Life Insurance Company (Provident) for $1.555 billion to be paid in a combination of NFS stock, policy credits and cash. The closing of the transaction is subject to various regulatory, NFS shareholder and Provident policyholder approvals.
 
(20)  Segment Information
 
The Company uses differences in products as the basis for defining its reportable segments. The Company historically reported four product segments: Individual Annuity, Institutional Products, Life Insurance and Asset Management. During the second quarter of 2002, the Company entered into a transaction with a related party that resulted in the disposal of a substantial portion of the business that had been reported in the Asset Management segment (see note 22). As a result, the Company no longer reports an Asset Management segment as this business is considered discontinued operations. Structured products transactions previously reported in the Asset Management segment are now reported in the Institutional Products segment. Amounts reported for all periods have been revised to reflect these changes.
The Individual Annuity segment consists of individual The BEST of AMERICA and private label deferred variable annuity products, deferred fixed annuity products, and income products. Individual deferred annuity contracts provide the customer with tax-deferred accumulation of savings and flexible payout options including lump sum, systematic withdrawal or a stream of payments for life. In addition, variable annuity contracts provide the customer

[F-36]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

with access to a wide range of investment options and asset protection in the event of an untimely death, while fixed annuity contracts generate a return for the customer at a specified interest rate fixed for a prescribed periods.
The Institutional Products segment is comprised of the Company’s private and public sector group retirement plans, medium-term note programs and structured products transactions. The private sector includes the 401(k) business generated through fixed and variable annuities, Nationwide Trust Company, FSB and The 401(k) Company. The public sector includes the IRC Section 457 business in the form of fixed and variable annuities as well as administration only business.
The Life Insurance segment consists of investment life products, including both individual variable life and COLI products, traditional life insurance products, universal life insurance and the Company’s investment in TGB Financial, a leading COLI producer. Life insurance products provide a death benefit and generally also allow the customer to build cash value on a tax-advantaged basis.
In addition to the product segments, the Company reports a Corporate segment. The Corporate segment includes net investment income not allocated to the four product segments, unallocated expenses, interest expense on debt and goodwill amortization related to continuing operations. In addition to these operating revenues and expenses, the Company also reports net realized gains and losses on investments, hedging instruments and hedged items related to continuing operations in the Corporate segment.

[F-37]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

The following tables summarize the financial results of the Company’s business segments for the years ended December 31, 2001, 2000 and 1999.
(in millions)
  
Individual Annuity
   
Institutional Products
  
Life Insurance
  
Corporate
    
Total
  
2001
                         
Net investment income
  
$    543.9
   
$     847.8
  
$   323.3
  
$   21.8
 
  
$  1,736.8
 
Other operating revenue
  
557.8
   
278.0
  
511.5
  
1.4
 
  
1,348.7
 
Total operating revenue
  
1,101.7
   
1,125.8
  
834.8
  
23.2
 
  
3,085.5
 
Interest credited to policyholder account balances
  
443.3
   
627.8
  
177.7
  
—  
 
  
1,248.8
 
Amortization of deferred policy acquisition costs
  
220.2
   
47.6
  
80.3
  
—  
 
  
348.1
 
Interest expense on debt and capital and preferred securities of
subsidiary trusts
  
—  
   
—  
  
—  
  
54.9
 
  
54.9
 
Other benefits and expenses
  
211.0
   
241.0
  
387.1
  
11.4
 
  
850.5
 
Total benefits and expenses
  
874.5
   
916.4
  
645.1
  
66.3
 
  
2,502.3
 
Operating income (loss) before federal income tax expense1
  
227.2
   
209.4
  
189.7
  
(43.1
)
  
583.2
 
Net realized losses on investments, hedging instruments and hedged items2
  
—  
   
—  
  
—  
  
(15.0
)
  
(15.0
)
Income (loss) from continuing operations before federal income tax expense and cumulative effect of adoption of accounting principles
  
$    227.2
   
$     209.4
  
$   189.7
  
$   (58.1
)
  
$     568.2
 
Assets as of year end
  
$44,342.4
   
$34,218.4
  
$9,129.0
  
$4,271.1
3
  
$91,960.9
 
1    Excludes net realized gains and losses on investments, hedging instruments and hedged items, discontinued operations and cumulative effect of adoption
      of accounting principles.
2    Realized gains related to securitization transactions are included in operating income.
3    Includes $172.9 million of assets related to discontinued operations (see note 22).
 

[F-38]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

(in millions)
  
Individual Annuity
  
Institutional Products
  
Life Insurance
  
Corporate
    
Total
  
2000
                                  
Net investment income
  
$
486.2
  
$
828.8
  
$
289.2
  
$
57.7
 
  
$
1,661.9
 
Other operating revenue
  
 
626.7
  
 
322.1
  
 
462.1
  
 
3.0
 
  
 
1,413.9
 
Total operating revenue
  
 
1,112.9
  
 
1,150.9
  
 
751.3
  
 
60.7
 
  
 
3,075.8
 
Interest credited to policyholder account balances
  
 
397.9
  
 
628.8
  
 
157.2
  
 
—  
 
  
 
1,183.9
 
Amortization of deferred policy acquisition costs
  
 
238.2
  
 
49.2
  
 
64.2
  
 
—  
 
  
 
351.6
 
Interest expense on debt and capital and preferred securities of subsidiary trusts
  
 
—  
  
 
—  
  
 
—  
  
 
48.5
 
  
 
48.5
 
Other benefits and expenses
  
 
200.5
  
 
248.3
  
 
368.8
  
 
26.9
 
  
 
844.5
 
Total benefits and expenses
  
 
836.6
  
 
926.3
  
 
590.2
  
 
75.4
 
  
 
2,428.5
 
Operating income (loss) before federal income tax expense1
  
 
276.3
  
 
224.6
  
 
161.1
  
 
(14.7
)
  
 
647.3
 
Net realized losses on investments, hedging instruments and hedged items
  
 
—  
  
 
—  
  
 
—  
  
 
(24.9
)
  
 
(24.9
)
Income (loss) from continuing operations before federal income tax expense and cumulative effect of adoption of accounting principles
  
$
276.3
  
$
224.6
  
$
161.1
  
$
(39.6
)
  
$
622.4
 
Assets as of year end
  
$
45,574.6
  
$
37,302.2
  
$
8,103.3
  
$
2,198.5
2
  
$
93,178.6
 
1999
                                  
Net investment income
  
$
459.0
  
$
771.9
  
$
253.1
  
$
41.6
 
  
$
1,525.6
 
Other operating revenue
  
 
511.5
  
 
270.2
  
 
394.9
  
 
3.5
 
  
 
1,180.1
 
Total operating revenue
  
 
970.5
  
 
1,042.1
  
 
648.0
  
 
45.1
 
  
 
2,705.7
 
Interest credited to policyholder account balances
  
 
385.0
  
 
580.9
  
 
130.5
  
 
—  
 
  
 
1,096.4
 
Amortization of deferred policy acquisition costs
  
 
171.0
  
 
41.6
  
 
60.1
  
 
—  
 
  
 
272.7
 
Interest expense on debt and capital and preferred securities of subsidiary trusts
  
 
—  
  
 
—  
  
 
—  
  
 
47.2
 
  
 
47.2
 
Other benefits and expenses
  
 
160.1
  
 
218.1
  
 
334.7
  
 
12.9
 
  
 
725.8
 
Total benefits and expenses
  
 
716.1
  
 
840.6
  
 
525.3
  
 
60.1
 
  
 
2,142.1
 
Operating income (loss) before federal income tax expense1
  
 
254.4
  
 
201.5
  
 
122.7
  
 
(15.0
)
  
 
563.6
 
Net realized losses on investments, hedging instruments and hedged items
  
 
—  
  
 
—  
  
 
—  
  
 
(11.0
)
  
 
(11.0
)
Income (loss) from continuing operations before federal income tax expense and cumulative effect of adoption of accounting principles
  
$
254.4
  
$
201.5
  
$
122.7
  
$
(26.0
)
  
$
552.6
 
Assets as of year end
  
$
45,702.8
  
$
39,127.6
  
$
6,616.7
  
$
1,606.9
3
  
$
93,054.0
 
1    Excludes net realized gains and losses on investments, hedging instruments and hedged items, discontinued operations and cumulative effect of adoption of
     accounting principles.
2    Includes $181.7 million of assets related to discontinued operations (see note 22).
3    Includes $183.9 million of assets related to discontinued operations (see note 22).

[F-39]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued

The Company has no significant revenue from customers located outside of the United States nor does the Company have any significant long-lived assets located outside the United States.
 
(21)  Quarterly
Results of Operations (Unaudited)
 
The following is a summary of the unaudited quarterly results of operations for the years ended December 31, 2001 and 2000.
(in millions, except per share amounts)
  
First Quarter
    
Second Quarter
    
Third Quarter
    
Fourth Quarter
  
2001
                                
Operating revenue
  
$
777.0
 
  
$
774.4
 
  
$
760.4
 
  
$
773.7
 
Realized (losses) gains on investments, hedging instruments and hedged items:
                                
Unrelated parties
  
 
(4.0
)
  
 
3.2
 
  
 
(3.6
)
  
 
(54.9
)
Related party
  
 
—  
 
  
 
—  
 
  
 
44.4
 
  
 
—  
 
Total revenues
  
 
773.0
 
  
 
777.6
 
  
 
801.2
 
  
 
718.8
 
Benefits and expenses
  
 
619.5
 
  
 
620.9
 
  
 
619.5
 
  
 
642.4
 
Income from continuing operations before federal income tax expense and continuing cumulative effect of adoption of accounting principles
  
 
153.5
 
  
 
156.7
 
  
 
181.7
 
  
 
76.4
 
Federal income tax expense
  
 
40.6
 
  
 
41.2
 
  
 
50.9
 
  
 
11.3
 
Income from continuing operations before cumulative effect of adoption of accounting principles
  
 
112.9
 
  
 
115.5
 
  
 
130.8
 
  
 
65.1
 
Discontinued operations, net of tax
  
 
(0.4
)
  
 
0.7
 
  
 
1.8
 
  
 
(6.5
)
Cumulative effect of adoption of accounting principles, net of tax
  
 
(4.8
)
  
 
(2.3
)
  
 
—  
 
  
 
—  
 
Net income
  
$
107.7
 
  
$
113.9
 
  
$
132.6
 
  
$
58.6
 
Income from continuing operations before cumulative effect of adoption of accounting principles per common share:
                                
Basic
  
$
0.88
 
  
$
0.89
 
  
$
1.02
 
  
$
0.50
 
Diluted
  
$
0.87
 
  
$
0.89
 
  
$
1.02
 
  
$
0.50
 
Earnings per common share:
                                
Basic
  
$
0.84
 
  
$
0.88
 
  
$
1.03
 
  
$
0.45
 
Diluted
  
$
0.83
 
  
$
0.88
 
  
$
1.03
 
  
$
0.45
 
2000
                                
Operating revenue
  
$
768.8
 
  
$
759.4
 
  
$
773.5
 
  
$
774.1
 
Realized losses on investments, hedging instruments and hedged items
  
 
(3.0
)
  
 
(10.4
)
  
 
(2.9
)
  
 
(8.6
)
Total revenues
  
 
765.8
 
  
 
749.0
 
  
 
770.6
 
  
 
765.5
 
Benefits and expenses
  
 
615.1
 
  
 
597.2
 
  
 
607.0
 
  
 
609.1
 
Income from continuing operations before federal income tax expense
  
 
150.7
 
  
 
151.8
 
  
 
163.6
 
  
 
156.4
 
Federal income tax expense
  
 
48.7
 
  
 
47.6
 
  
 
46.9
 
  
 
44.1
 
Income from continuing operations
  
 
102.0
 
  
 
104.2
 
  
 
116.7
 
  
 
112.3
 
Discontinued operations, net of tax
  
 
2.8
 
  
 
—  
 
  
 
—  
 
  
 
(3.1
)
Net income
  
$
104.8
 
  
$
104.2
 
  
$
116.7
 
  
$
109.2
 
Basic and diluted income from continuing operations per common share
  
$
0.80
 
  
$
0.81
 
  
$
0.91
 
  
$
0.86
 
Basic and diluted earnings per common share
  
$
0.82
 
  
$
0.81
 
  
$
0.91
 
  
$
0.84
 
 
(22)  Discontinued Operations
 
        On May 22, 2002, NFS entered into a definitive agreement with Nationwide Corp., the majority shareholder of NFS, to exchange the shares of Gartmore Global Investments, Inc. (GGI) owned by NFS for shares of NFS’ common stock owned by Nationwide Corp. Nationwide Corp. is a majority owned subsidiary of NMIC. GGI is a majority owned subsidiary of NFS and comprises the domestic asset management operation of Nationwide.
        As part of the definitive agreement, NFS will also exchange all of the shares of Nationwide Securities, Inc. (NSI), an indirect wholly owned subsidiary of NFS, for shares of NFS common stock owned by Nationwide Corp.
        The transactions value NFS’ interests in GGI and NSI at $362.8 million. The number of shares to be exchanged in both transactions will be determined based on the average closing price a share of NFS’ Class A common stock for the ten consecutive trading days prior to closing of the NSI transaction. As required by NFS’ by-laws, the shares that Nationwide Corp. exchanges will be automatically converted from Class B common stock to Class A common stock.
        These are transactions between related parties and therefore will be recorded at carrying value of the underlying components of the transactions rather than fair value. As a result, NFS will record the NFS shares received as treasury stock at Nationwide Corp.’s carrying value of these shares. NFS will record the excess of Nationwide Corp.’s carrying value of NFS shares exchanged over the carrying value of GGI and NSI, net of transaction costs, as a credit to additional paid-in capital upon closing. It is presently expected that this amount will total approximately $91.7 million.
        These transactions are intended to qualify as tax-free exchanges.
        The consolidated statements of income and cash flows and all affected footnote disclosures have been revised to reflect GGI and NSI as discontinued operations.

[F-40]

SCHEDULE I
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED SUMMARY OF INVESTMENTS—OTHER THAN INVESTMENTS IN RELATED PARTIES
(in millions)
As of December 31, 2001

 
Column A
  
Column B
  
Column C
   
Column D
Type of Investment
  
Cost
  
Market value
   
Amount at which shown in the consolidated balance sheet
Fixed maturity securities available-for-sale:
                   
Bonds:
                   
U.S. Government and government agencies and authorities
  
$
2,284.6
  
$
2,371.7
   
$
2,371.7
States, municipalities and political subdivisions
  
 
7.6
  
 
7.9
   
 
7.9
Foreign governments
  
 
41.8
  
 
44.4
   
 
44.4
Public utilities
  
 
1,205.2
  
 
1,219.3
   
 
1,219.3
All other corporate
  
 
14,596.6
  
 
14,905.0
   
 
14,905.0
Total fixed maturity securities available-for-sale
  
 
18,135.8
  
 
18,548.3
   
 
18,548.3
Equity securities available-for-sale:
                   
Common stocks:
                   
Industrial, miscellaneous and all other
  
 
143.2
  
 
150.5
   
 
150.5
Non-redeemable preferred stock
  
 
—  
  
 
—  
   
 
—  
Total equity securities available-for-sale
  
 
143.2
  
 
150.5
   
 
150.5
Mortgage loans on real estate, net
  
 
7,131.0
         
 
7,113.11
Real estate, net:
                   
Investment properties
  
 
138.0
         
 
116.72,4
Acquired in satisfaction of debt
  
 
23.7
         
 
22.32
Policy loans
  
 
592.7
         
 
592.7
Other long-term investments
  
 
90.6
         
 
86.73,5
Short-term investments, including amounts managed by a related party
  
 
1,112.8
         
 
1,112.8
Total investments
  
$
27,367.8
         
$
27,743.1
 
1    Difference from Column B is primarily due to valuation allowances due to impairments on mortgage loans on real estate (see note 3 to the consolidated
      financial statements), hedges and commitment hedges on mortgage loans on real estate.
 
2    Difference from Column B primarily results from adjustments for accumulated depreciation.
 
3    Difference from Column B is primarily due to operating gains and/or losses of investments in limited partnerships.
 
4    Amount shown does not agree to the consolidated balance sheet due to an unconsolidated related party limited partnership investment in the amount of
     $33.0 million.
 
5    Amount shown does not agree to the consolidated balance sheet due to an unconsolidated related party investments in the amount of $38.3 million.
 
See accompanying independent auditors’ report.

[F-41]

SCHEDULE II
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
CONDENSED FINANCIAL INFORMATION OF REGISTRANT
(in thousands)
Condensed Balance Sheets

 
   
December 31,
   
2001
  
2000
Assets
            
Investment in subsidiaries
  
$
3,912,672
  
$
3,409,753
Short-term investments, including amounts managed by a related party
  
 
7,874
  
 
69,048
Long-term investments
  
 
13,043
  
 
10,000
Cash
  
 
—  
  
 
11,777
Accrued investment income
  
 
855
  
 
105
Investment in surplus note from a subsidiary
  
 
300,000
  
 
—  
Other assets
  
 
137,736
  
 
144,367
   
$
4,372,180
  
$
3,645,050
Liabilities and Shareholders’ Equity
            
Long-term debt
  
$
906,307
  
$
607,703
Other liabilities
  
 
22,562
  
 
39,892
   
 
928,869
  
 
647,595
Shareholders’ equity
  
 
3,443,311
  
 
2,997,455
   
$
4,372,180
  
$
3,645,050
Condensed Statements of Income
 
   
Years Ended December 31,
   
2001
    
2000
    
1999
Revenues:
                      
Dividends received from subsidiaries
  
$
50,000
 
  
$
176,000
 
  
$
243,500
Investment income
  
 
5,365
 
  
 
4,630
 
  
 
5,062
Realized gains (losses) on investments, hedging instruments and hedged items
  
 
4,434
 
  
 
(5,000
)
  
 
—  
   
 
59,799
 
  
 
175,630
 
  
 
248,562
Expenses:
                      
Interest expense on long-term debt
  
 
50,191
 
  
 
48,318
 
  
 
47,900
Other operating expenses
  
 
11,645
 
  
 
9,494
 
  
 
3,515
   
 
61,836
 
  
 
57,812
 
  
 
51,415
(Loss) income before federal income tax benefit
  
 
(2,037
)
  
 
117,818
 
  
 
197,147
Federal income tax benefit
  
 
17,385
 
  
 
21,144
 
  
 
16,951
Income before equity in undistributed net income of subsidiaries
  
 
15,348
 
  
 
138,962
 
  
 
214,098
Equity in undistributed net income of subsidiaries
  
 
397,423
 
  
 
296,014
 
  
 
167,197
Net income
  
$
412,771
 
  
$
434,976
 
  
$
381,295
 
See accompanying notes to condensed financial statements and independent auditors’ report.

[F-42]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SCHEDULE II—CONDENSED FINANCIAL INFORMATION OF REGISTRANT, Continued
(in thousands)
Condensed Statements of Cash Flows

 
   
Years ended December 31,
  
   
2001
    
2000
    
1999
  
Cash flows from operating activities:
                        
Net income
  
$
412,771
 
  
$
434,976
 
  
$
381,295
 
Adjustments to reconcile net income to net cash provided by operating activities:
                        
Equity in net income of subsidiaries
  
 
(397,423
)
  
 
(296,014
)
  
 
(167,197
)
Amortization
  
 
11,038
 
  
 
8,979
 
  
 
2,737
 
Realized (gains) losses on investments, hedging instruments and hedged items
  
 
(4,434
)
  
 
5,000
 
  
 
—  
 
Other, net
  
 
(23,472
)
  
 
57,353
 
  
 
(59,188
)
Net cash (used in) provided by operating activities
  
 
(1,520
)
  
 
210,294
 
  
 
157,647
 
Cash flows from investing activities:
                        
Cash paid to acquire companies and capital contributed to subsidiaries
  
 
(10,000
)
  
 
(22,575
)
  
 
(221,607
)
Cash paid to acquire surplus note from subsidiary
  
 
(300,000
)
  
 
—  
 
  
 
—  
 
Other, net
  
 
61,174
 
  
 
(122,721
)
  
 
111,259
 
Net cash used in investing activities
  
 
(248,826
)
  
 
(145,296
)
  
 
(110,348
)
Cash flows from financing activities:
                        
Net proceeds from issuance of long-term debt
  
 
296,625
 
  
 
—  
 
  
 
—  
 
Cash dividends paid
  
 
(61,840
)
  
 
(56,720
)
  
 
(46,269
)
Other, net
  
 
3,784
 
  
 
2,131
 
  
 
(508
)
Net cash provided by (used in) financing activities
  
 
238,569
 
  
 
(54,589
)
  
 
(46,777
)
Net (decrease) increase in cash
  
 
(11,777
)
  
 
10,409
 
  
 
522
 
Cash, beginning of year
  
 
11,777
 
  
 
1,368
 
  
 
846
 
Cash, end of year
  
$
—  
 
  
$
11,777
 
  
$
1,368
 
 
 
See accompanying notes to condensed financial statements and independent auditors’ report.

[F-43]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SCHEDULE II—CONDENSED FINANCIAL INFORMATION OF REGISTRANT, Continued
(in thousands)
Notes to Condensed Financial Statements, Continued

(1) Organization and Presentation
 
Nationwide Financial Services, Inc. (NFS) is the holding company for Nationwide Life Insurance Company (NLIC) and other companies that comprise the retirement savings operations of the Nationwide group of companies. On March 6, 1997, NFS sold, in an initial public offering, 23.6 million shares of its Class A common stock for net proceeds of $524,191 (the Equity Offering). In March 1997, NFS also sold, in companion public offerings, $300,000 of 8% Senior Notes (the Notes) and, Nationwide Financial Services Capital Trust (NFSCT), a wholly owned subsidiary of NFS, issued $100,000 of 7.899% Capital Securities (the Capital Securities). Concurrent with the sale of the Capital Securities by NFSCT, NFS sold to NFSCT $103,093 in principal amount of its 7.899% Junior Subordinated Deferrable Interest Debentures (Junior Subordinated Debentures). Aggregate net proceeds from the Equity Offering, the offering of the Notes and the sale of the 7.899% Junior Subordinated Debentures totaled $920,053. NFS contributed $836,780 and $3,093 of the proceeds to the capital of NLIC and NFSCT, respectively, and retained $80,180 of the proceeds for general corporate purposes.
Prior to the initial public offering, NFS was a wholly owned subsidiary of Nationwide Corporation (Nationwide Corp.). Nationwide Corp. continues to own all of the outstanding shares of Class B common stock, which represents approximately 97.7% of the combined voting power of the shareholders of NFS.
During 1996 and 1997, Nationwide Corp. and NFS completed certain transactions in anticipation of the initial public offering that focused the business of NFS on long-term savings and retirement products. On September 24, 1996, NLIC declared a dividend payable to Nationwide Corp. on January 1, 1997 consisting of the outstanding shares of common stock of certain subsidiaries that do not offer or distribute long-term savings or retirement products. In addition, during 1996, NLIC entered into two reinsurance agreements whereby all of NLIC’s accident and health and group life insurance business was ceded to two affiliates effective January 1, 1996. On January 27, 1997, Nationwide Corp. contributed the common stock of NLIC and three marketing and distribution companies to NFS. Additionally, NFS received a dividend from NLIC on February 24, 1997 and immediately thereafter paid a dividend to Nationwide Corp. consisting of securities with a fair value of $850,000.
 
(2) Long-term Debt and Guarantees
 
Long-term debt outstanding as of December 31, 2001 and 2000 consists of the following:
 
(in thousands)
  
2001
  
2000
8% Senior Notes due March 1, 2027 (net of unamortized discount of $1,558 in 2001 and $1,576 in 2000)
  
$298,442
  
$298,424
6.25% Senior Notes due November 15, 2011 (net of unamortized discount of $1,414 in 2001 and none in 2000)
  
  298,586
  
      —
7.899% Junior Subordinated Deferrable Interest Debentures due March 1, 2037
  
  103,093
  
  103,093
7.10% Junior Subordinated Deferrable Interest Debentures due October 31, 2028
  
  206,186
  
  206,186
   
$906,307
  
$607,703
 
See accompanying independent auditors’ report.

[F-44]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SCHEDULE II—CONDENSED FINANCIAL INFORMATION OF REGISTRANT, Continued
(in thousands)
Notes to Condensed Financial Statements, Continued

The 8% senior notes are redeemable in whole or in part, at the option of NFS, at any time on or after March 1, 2007 at scheduled redemption premiums through March 1, 2016, and thereafter, at 100% of the principal amount thereof plus, in each case, accrued and unpaid interest. The 6.25% senior notes are not redeemable prior to their maturity date. The senior notes are not subject to any sinking fund payments. The terms of the senior notes contain various restrictive covenants including limitations on the disposition of subsidiaries. As of December 31, 2001, NFS was in compliance with all such covenants. NFS made interest payments on the senior notes of $24,000 in 2001, 2000 and 1999.
The 7.899% Junior Subordinated Debentures are redeemable by NFS in whole at any time or in part from time to time at par plus an applicable make-whole premium. The 7.899% Junior Subordinated Debentures will mature or be called simultaneously with the Capital Securities. The Capital Securities, through obligations of NFS under the 7.899% Junior Subordinated Debentures, the Capital Securities Guarantee Agreement and the related Declaration of Trust and Indenture, are fully and unconditionally guaranteed by NFS. NFS made interest payments on the 7.899% Junior Subordinated Debentures of $8,143 in 2001, 2000 and 1999.
On October 19, 1998, Nationwide Financial Services Capital Trust II (NFSCTII) sold, in a public offering, $200,000 of 7.10% Trust Preferred Securities representing preferred undivided beneficial interests in the assets of NFSCTII generating net proceeds of $193,700. Concurrent with the sale of the Preferred Securities, NFS sold to NFSCTII $206,186 of 7.10% Junior Subordinated Debentures due October 31, 2028. The 7.10% Junior Subordinated Debentures are the sole assets of NFSCTII and are redeemable, in whole or in part, on or after October 19, 2003 at a redemption price equal to the principal amount to be redeemed plus any accrued and unpaid interest. The Preferred Securities have a liquidation amount of $25 per security and must be redeemed by NFSCTII when the 7.10% Junior Subordinated Debentures mature or are redeemed by NFS.
The Preferred Securities, through obligations of NFS under the 7.10% Junior Subordinated Debentures, the Preferred Securities Guarantee Agreement and the related Amended and Restated Declaration of Trust, are fully and unconditionally guaranteed by NFS. Distributions on the Preferred Securities are cumulative and payable quarterly beginning January 31, 1999. NFS made interest payments on the 7.10% Junior Subordinated Debentures of $14,639 in 2001, 2000 and 1999.
 
(3) Related Party Transactions
 
On December 19, 2001 the Company purchased a 7.50%, $300.0 million surplus note from NLIC, maturing on December 17, 2031. The fair value of the investment in the surplus note as of December 31, 2001 was $300.0 million. Principal and interest payments are subject to prior approval by the superintendent of insurance of the State of Ohio. The Company is scheduled to receive interest semi-annually on June 17 and December 17 of each year commencing June 17, 2002.
 
See accompanying independent auditors’ report.

[F-45]

SCHEDULE III
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
(in millions)
As of December 31, 2001, 2000 and 1999 and for each of the years then ended

 
Column A
  
Column B
     
Column C
     
Column D
     
Column E
   
Column F
Segment
  
Deferred policy acquisition costs
     
Future policy benefits, losses, claims and loss expenses
     
Unearned premiums1
     
Other policy claims and benefits payable1
   
Premium revenue
2001: Individual Annuity
  
$
1,971.5
 
   
$
9,132.8
                 
$
60.9
Institutional Products
  
 
307.7
 
   
 
11,872.7
                 
 
—  
Life Insurance
  
 
1,025.2
 
   
 
4,252.3
                 
 
190.2
Corporate
  
 
(90.7
)
   
 
233.8
                 
 
—  
Total
  
$
3,213.7
 
   
$
25,491.6
                 
$
251.1
2000:   Individual Annuity
  
$
1,718.7
 
   
$
7,068.5
                 
$
52.7
Institutional Products
  
 
293.7
 
   
 
10,944.0
                 
 
—  
Life Insurance
  
 
877.8
 
   
 
3,995.6
                 
 
187.3
Corporate
  
 
(17.5
)
   
 
235.2
                 
 
—  
Total
  
$
2,872.7
 
   
$
22,243.3
                 
$
240.0
1999:   Individual Annuity
  
$
1,526.8
 
   
$
7,344.5
                 
$
26.8
Institutional Products
  
 
275.2
 
   
 
10,833.4
                 
 
—  
Life Insurance
  
 
702.9
 
   
 
3,519.9
                 
 
194.0
Corporate
  
 
50.9
 
   
 
170.5
                 
 
—  
Total
  
$
2,555.8
 
   
$
21,868.3
                 
$
220.8
 
1    Unearned premiums and other policy claims and benefits payable are included in Column C amounts.
 
 
See accompanying independent auditors’ report.

[F-46]

NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
SCHEDULE III—SUPPLEMENTARY INSURANCE INFORMATION, Continued
(in millions)
As of December 31, 2001, 2000 and 1999 and for each of the years then ended

 
Column A
  
Column G
  
Column H
   
Column I
   
Column J
     
Column K
Segment
  
Net investment income1
  
Benefits, claims, losses and settlement expenses
   
Amortization of deferred policy acquisition costs
   
Other operating expenses1
     
Premiums written
2001: 
Individual Annuity
  
$
543.9
  
$
511.4
   
$
220.2
   
$
142.9
       
Institutional Products
  
 
847.8
  
 
627.8
   
 
47.6
   
 
241.0
       
Life Insurance
  
 
323.3
  
 
389.4
   
 
80.3
   
 
133.7
       
Asset Management
  
 
2.4
  
 
—  
   
 
—  
   
 
112.3
       
Corporate
  
 
21.8
  
 
—  
   
 
—  
   
 
13.1
       
Total
  
$
1,739.2
  
$
1,528.6
   
$
348.1
   
$
643.0
       
2000:  
Individual Annuity
  
$
486.2
  
$
451.9
   
$
238.2
   
$
146.5
       
Institutional Products
  
 
828.8
  
 
628.8
   
 
49.2
   
 
248.3
       
Life Insurance
  
 
289.2
  
 
344.8
   
 
64.2
   
 
136.7
       
Asset Management
  
 
6.5
  
 
—  
   
 
—  
   
 
114.9
       
Corporate
  
 
57.7
  
 
—  
   
 
—  
   
 
29.9
       
Total
  
$
1,668.4
  
$
1,425.5
   
$
351.6
   
$
676.3
       
1999:   
Individual Annuity
  
$
459.0
  
$
408.8
   
$
171.0
   
$
136.3
       
Institutional Products
  
 
771.9
  
 
580.9
   
 
41.6
   
 
218.1
       
Life Insurance
  
 
253.1
  
 
317.1
   
 
60.1
   
 
105.7
       
Asset Management
  
 
4.9
  
 
—  
   
 
—  
   
 
85.7
       
Corporate
  
 
41.6
  
 
—  
   
 
—  
   
 
15.6
       
Total
  
$
1,530.5
  
$
1,306.8
   
$
272.7
   
$
561.4
       
 
1    Allocations of net investment income and certain operating expenses are based on a number of assumptions and estimates, and reported operating results
      would change by segment if different methods were applied.
 
See accompanying independent auditors’ report.

[F-47]

SCHEDULE IV
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
REINSURANCE
(in millions)
As of December 31, 2001, 2000 and 1999 and for each of the years then ended

 
Column A
  
Column B
  
Column C
   
Column D
   
Column E
     
Column F
  
   
Gross amount
  
Ceded to other companies
   
Assumed from other companies
   
Net amount
     
Percentage of amount assumed to net
  
2001:
                                   
Life insurance in-force
  
$
107,765.8
  
$
37,331.3
   
$
17.1
   
$
70,451.6
     
0.0
%
Premiums:
                                   
Life insurance1
  
$
264.9
  
$
14.0
   
$
0.2
   
$
251.1
     
0.1
%
Accident and health insurance
  
 
176.4
  
 
182.2
   
 
5.8
   
 
—  
     
N/A
 
Total
  
$
441.3
  
$
196.2
   
$
6.0
   
$
251.1
     
2.4
%
2000:
                                   
Life insurance in-force
  
$
95,475.2
  
$
31,101.6
   
$
16.4
   
$
64,390.0
     
0.0
%
Premiums:
                                   
Life insurance1
  
$
254.6
  
$
14.8
   
$
0.2
   
$
240.0
     
0.1
%
Accident and health insurance
  
 
150.8
  
 
156.8
   
 
6.0
   
 
—  
     
N/A
 
Total
  
$
405.4
  
$
171.6
   
$
6.2
   
$
240.0
     
2.6
%
1999:
                                   
Life insurance in-force
  
$
84,845.3
  
$
26,296.5
   
$
14.9
   
$
58,563.7
     
0.0
%
Premiums:
                                   
Life insurance1
  
$
242.2
  
$
22.6
   
$
1.2
   
$
220.8
     
0.6
%
Accident and health insurance
  
 
134.9
  
 
142.8
   
 
7.9
   
 
—  
     
N/A
 
Total
  
$
377.1
  
$
165.4
   
$
9.1
   
$
220.8
     
4.2
%
 
1    The life insurance caption represents principally premiums from traditional life insurance and life-contingent immediate
      annuities and excludes deposits on investment products and universal life insurance products.
 
See accompanying independent auditors’ report.

[F-48]

SCHEDULE V
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
(in millions)
Years ended December 31, 2001, 2000 and 1999

 
Column A
   
Column B
   
Column C
     
Column D
   
Column E
Description
   
Balance at beginning of period
   
Charged (credited) to costs and expenses
     
Charged to other accounts
     
Deductions1
   
Balance at end of period
2001:
                                       
Valuation allowances—mortgage loans on real estate
   
$
45.3
   
$
(1.2
)
   
$
—  
 
   
$
1.2
   
$
42.9
Valuation allowances—real estate
   
 
5.2
   
 
—  
 
   
 
—  
 
   
 
5.2
   
 
—  
Total
   
$
50.5
   
$
(1.2
)
   
$
—  
 
   
$
6.4
   
$
42.9
2000:
                                       
Valuation allowances—mortgage loans on real estate
   
$
44.4
   
$
4.1
 
   
$
—  
 
   
$
3.2
   
$
45.3
Valuation allowances—real estate
   
 
5.5
   
 
0.4
 
   
 
—  
 
   
 
0.7
   
 
5.2
Total
   
$
49.9
   
$
4.5
 
   
$
—  
 
   
$
3.9
   
$
50.5
1999:
                                       
Valuation allowances—fixed maturity securities
   
$
7.5
   
$
—  
 
   
$
—  
 
   
$
7.5
   
$
—  
Valuation allowances—mortgage loans on real estate
   
 
42.4
   
 
0.7
 
   
 
1.3
2
   
 
—  
   
 
44.4
Valuation allowances—real estate
   
 
5.4
   
 
0.9
 
   
 
—  
 
   
 
0.8
   
 
5.5
Total
   
$
55.3
   
$
1.6
 
   
$
1.3
 
   
$
8.3
   
$
49.9
 
1    Amounts represent direct write-downs charged against the valuation allowance.
2    Allowance on acquired mortgage loans.
 
 
See accompanying independent auditors’ report.
 

[F-49]