FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a "safe harbor"
for forward-looking statements. Certain information contained herein or in other
written or oral statements made by or on behalf of National Western Life
Insurance Company or its subsidiaries are or may be viewed as forward-looking.
Although the Company has taken appropriate care in developing any such
information, forward-looking information involves risks and uncertainties that
could significantly impact actual results. These risks and uncertainties
include, but are not limited to, matters described in the Company's SEC filings
such as exposure to market risks, anticipated cash flows or operating
performance, future capital needs, and statutory or regulatory related issues.
However, National Western, as a matter of policy, does not make any specific
projections as to future earnings, nor does it endorse any projections regarding
future performance that may be made by others. Whether or not actual results
differ materially from forward-looking statements may depend on numerous
foreseeable and unforeseeable events or developments. Also, the Company
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future developments, or
otherwise.
Management's discussion and analysis of the financial condition and results of
operations ("MD&A") of National Western Life Insurance Company for the six
months ended June 30, 2012 follows. This discussion should be read in
conjunction with the Company's condensed consolidated financial statements and
related notes beginning on page 3 of this report and with the 2011 Annual Report
filed on Form 10-K with the SEC.
Overview
The Company provides life insurance products on a global basis for the savings
and protection needs of policyholders and annuity contracts for the asset
accumulation and retirement needs of contract holders, both domestically and
internationally. The Company accepts funds from policyholders or
contract-holders and establishes a liability representing future obligations to
pay the policy or contract-holders and their beneficiaries. To ensure the
Company will be able to pay these future commitments, the funds received as
premium payments and deposits are invested in high quality investments,
primarily fixed income securities.
Due to the business of accepting funds to pay future obligations in later years
and the underlying economics, the relevant factors affecting the Company's
business and profitability include the following:
• the level of sales and premium revenues collected
• persistency of policies and contracts
returns on investments sufficient to produce acceptable spread margins over
• interest crediting rates
• investment credit quality which minimizes the risk of default or impairment
• levels of policy benefits and costs to acquire business
• the level of operating expenses
effect of interest rate changes on revenues and investments including asset
• and liability matching
• maintaining adequate levels of capital and surplus
• actual levels of surrenders, withdrawals, claims and interest spreads and
changes in assumptions for amortization of deferred policy acquisition
expenses and deferred sales inducements
• changes in the fair value of derivative index options and embedded
derivatives pertaining to fixed-index life and annuity products
• pricing and availability of adequate reinsurance
The Company monitors these factors continually as key business indicators. The
discussion that follows in this Item 2 includes these indicators and presents
information useful to an overall understanding of the Company's business
performance in 2012, incorporating required disclosures in accordance with the
rules and regulations of the Securities and Exchange Commission.
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Insurance Operations - Domestic
The Company is currently licensed to do business in all states and the District
of Columbia except for New York. Products marketed are annuities, universal life
insurance, fixed-indexed universal life, and traditional life insurance, which
include both term and whole life products. The Company's domestic sales have
historically been more heavily weighted toward annuity products, which include
single and flexible premium deferred annuities, single premium immediate
annuities, and fixed-indexed annuities. Most of these annuities can be sold as
tax qualified or nonqualified products. At June 30, 2012, the Company maintained
approximately 140,600 annuity contracts in force.
National Western markets and distributes its domestic products primarily through
independent national marketing organizations ("NMOs"). These NMOs assist the
Company in recruiting, contracting, and managing independent agents. The Company
currently has approximately 13,300 domestic independent agents contracted.
Roughly 25% of these contracted agents have submitted policy applications to the
Company in the past twelve months.
Insurance Operations - International
The Company's international focus is on foreign nationals in upper socioeconomic
classes. Insurance products are issued primarily to residents of countries in
Central and South America, the Caribbean, Eastern Europe, Asia and the Pacific
Rim. Issuing policies to residents of countries in these different regions
provides diversification that helps to minimize large fluctuations that could
arise due to various economic, political, and competitive pressures that may
occur from one country to another. Products issued to international residents
are almost entirely universal life and traditional life insurance products.
However, certain annuity and investment contracts are also available. At
June 30, 2012, the Company had approximately 73,440 international life insurance
policies in force representing approximately $18.9 billion in face amount of
coverage.
International applications are submitted by independent contractor consultants
and broker-agents. The Company has approximately 3,540 independent international
consultants and brokers currently contracted, 33% of which have submitted policy
applications to the Company in the past twelve months.
There are some inherent risks of accepting international applications which are
not present within the domestic market that are reduced substantially by the
Company in several ways. As previously described, the Company accepts
applications from foreign nationals in upper socioeconomic classes who have
substantial financial resources. This targeted customer base coupled with the
Company's conservative underwriting practices have historically resulted in
claims experience, due to natural causes, similar to that in the United States.
The Company minimizes exposure to foreign currency risks by requiring payment of
premiums, claims and other benefits almost entirely in United States dollars.
The Company's nearly fifty years of experience with the international products
and its longstanding independent consultant and broker-agent relationships
further serve to minimize risks.
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SALES
Life Insurance
The following table sets forth information regarding the Company's life
insurance sales activity as measured by annualized first year premiums. While
the figures shown below are in accordance with industry practice and represent
the amount of new business sold during the periods indicated, they are
considered a non-GAAP financial measure. The Company believes sales are a
measure of distribution productivity and are a leading indicator of future
revenue trends. However, revenues are driven by sales in prior periods as well
as in the current period and therefore, a reconciliation of sales to revenues is
not meaningful or determinable.
Three Months Ended Six Months Ended
June 30, June 30,
2012 2011 2012 2011
(In thousands)
International:
Universal life $ 1,732 1,692 3,177 3,370
Traditional life 843 828 1,528 1,620
Equity-indexed life 3,659 4,898 6,978 9,102
6,234 7,418 11,683 14,092
Domestic:
Universal life 40 30 74 51
Traditional life 13 13 24 20
Equity-indexed life 2,210 1,244 3,834 1,729
2,263 1,287 3,932 1,800
Totals $ 8,497 8,705 15,615 15,892
Life insurance sales as measured by annualized first year premiums declined 2.4%
in the second quarter of 2012 as compared to the second quarter of 2011. By
market segment, the domestic life insurance line of business posted a 76%
increase over the comparable results during the second quarter of 2011 while
international life sales decreased 16% during the same time frame. For the six
months ended June 30th, total life insurance sales declined 1.7% as
international life sales decreased by 17% during this period while domestic life
insurance sales increased 118%.
The Company's international life business consists of applications accepted from
residents of various regions outside of the United States, the volume of which
typically varies based upon changes in the socioeconomic climates of these
regions. Historically, the Company has experienced a simultaneous combination of
rising and declining sales in various countries; however, the appeal of the
Company's dollar-denominated life insurance products overcomes many of the local
and national difficulties. In the "Great Recession" economic climate during
2008-2009, individuals in countries outside of the United States became
increasingly leery of the U.S. economy and the stability of financial
institutions and markets. These concerns resulted in reduced international sales
during this time period. As fiscal and regulatory policies were enacted in
response to the financial market turmoil, the ensuing level of relative
stability served to recapture the confidence of international markets.
Consequently, the Company witnessed an increased level of submitted life
insurance applications beginning during the latter half of 2010.
As reported in the Company's Form 10-Q filing for the quarter ended September
30, 2011, Brazilian insurance regulators publicly stated their intention to
curtail the sales activity of certain foreign multinational insurers, including
National Western, and attempt to levy fines. This public announcement has served
to decrease the number of new applications for insurance from residents of
Brazil since that time.
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Applications submitted from residents of Latin America and the Pacific Rim
perennially have comprised the majority of the Company's international life
insurance sales. Several years ago, new sales efforts were directed toward the
sale of a traditional endowment form of life insurance product for residents of
Eastern Europe and the Commonwealth of Independent States (former Soviet Union).
However, the Company has scaled back its efforts in these areas due to
profitability concerns. As noted previously, the Company's international sales
by geographic market tend to fluctuate with the socio and economic climates in
these regions. The Company's mix of international sales by geographic region is
as follows.
Six Months Ended June 30,
2012 2011
Percentage of International Sales:
Latin America 85.3 % 87.0 %
Pacific Rim 13.4 11.6
Eastern Europe 1.3 1.4
Totals 100.0 % 100.0 %
Year-to-date, the Company has accepted new business from residents outside of
the United States in over thirty different countries with Brazil (21%),
Venezuela (19%), and Taiwan (13%) comprising the largest contributions. Sales to
residents in Venezuela increased 49% in the first six months of 2012 compared to
the same period in 2011.
The Company's domestic operations have historically been more heavily skewed
toward annuity sales rather than life insurance sales. Partially in response to
comments from outside rating agencies who expressed a preference for a greater
proportion of overall Company earnings to derive from the life insurance line of
business, management began placing emphasis on building domestic life insurance
sales as a strategic focus for future growth. The Company revamped its domestic
life operations by changing the way it contracts distribution for life business,
eliminating products and distribution that had not contributed significantly to
earnings, and creating new and competitive products. These new offerings
included single premium universal life ("SPUL") and equity-indexed universal
life ("EIUL") products.
More recently the Company has developed hybrids of its EIUL and SPUL products,
combining features, and discontinued the marketing of smaller premium and volume
life insurance policies. The Company's product development emphasis in creating
SPUL, EIUL, and single or limited pay EIUL products has been positioned to take
advantage of the changing demographic in the marketplace as the "Baby Boomer"
generation began reaching 65 years of age in 2011. These products are designed
to facilitate the wealth transfer of accumulated savings of this segment of the
population via systematic funding mechanisms such as single premium immediate
annuities. These life products have been valuable offerings for the Company's
distributors as evidenced by the 118% increase in domestic life sales in the
first six months of 2012 versus 2011.
The Company's implementation of commission caps on domestic policies in 2009
discouraged sales of larger face amounts resulting in lower sales levels and
amounts of insurance per policy as shown below. While the average new policy
face amounts subsequently declined, the increased sales activity in the past two
years has produced a modest upward trend in this figure. Conversely, the
Company's sales to international residents have witnessed a steady growth in the
average face amount of insurance coverage per policy over the same time period.
Average New Policy Face Amount
Domestic International
Year ended December 31, 2006 315,800 254,700
Year ended December 31, 2007 416,800 251,000
Year ended December 31, 2008 455,200 272,000
Year ended December 31, 2009 201,400 315,300
Year ended December 31, 2010 164,800 338,600
Year ended December 31, 2011 178,500 363,600
Six months ended June 30, 2012 217,300 382,500
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After several challenging years of life insurance sales in the wake of the
global financial crisis, life insurers are looking for new ways to rebuild
premium levels. The Company's focus is directed toward its competitive
advantages in international markets and wealth transfer strategies for domestic
life sales. Critical to these strategies is the Company's portfolio of
fixed-index (equity indexed) life insurance products. Fixed-index life products
accounted for over 69% of total life sales in the first six months of 2012, an
increase from 68% for the same period in 2011.
The table below sets forth information regarding the Company's life insurance in
force for each date presented.
Insurance In Force as of June 30,
2012 2011
($ in thousands)
Universal life:
Number of policies 58,980 61,900
Face amounts $ 7,472,100 7,493,470
Traditional life:
Number of policies 42,630 44,290
Face amounts $ 3,064,900 2,779,660
Fixed-indexed life:
Number of policies 33,340 31,440
Face amounts $ 8,268,910 7,633,830
Rider face amounts $ 2,364,630 2,255,580
Total life insurance:
Number of policies 134,950 137,630
Face amounts $ 21,170,540 20,162,540
The Company's domestic in force business includes final expense policies and
other smaller face amount traditional life policies written over the past
several decades. As the Company's domestic product portfolio has changed to
higher face amount universal life and fixed-indexed life policies, a decline in
the number of traditional life policies in force has been steadily occurring.
At June 30, 2012, the Company's face amount of life insurance in force was
comprised of $18.9 billion from the international line of business and $2.3
billion from the domestic line of business. At December 31, 2011, these amounts
were $18.6 billion and $2.3 billion for the international and domestic lines of
business, respectively.
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Annuities
The following table sets forth information regarding the Company's annuity sales
activity as measured by single and annualized first year premiums. Similar to
life insurance sales, these figures are considered a non-GAAP financial measure
but are shown in accordance with industry practice and depict the Company's
sales productivity.
Three Months Ended June 30, Six Months Ended June 30,
2012 2011 2012 2011
(In thousands)
Fixed-indexed annuities $ 164,901 237,985 318,397 464,901
Other deferred annuities 39,585 101,320 67,335 203,561
Immediate annuities 11,610 12,965 23,840 16,700
Totals $ 216,096 352,270 409,572 685,162
Annuity sales in the second quarter of 2012 were 39% lower than in the second
quarter of 2011. Likewise, annuity sales for the first six months of 2012 were
40% lower than the comparable period in 2011. Although both periods are lower
than the pace of 2011, annuity sales thus far in 2012 are in line with the
Company's sales goals for the 2012 calendar year.
The recessionary contraction and financial market crisis that began in the
latter half of 2007 and persisted into 2009 impacted many annuity carriers.
Losses from investment impairments and equity exposure (for insurers with
variable annuity product offerings) crippled the capital position of numerous
companies and limited their ability to write new business. In contrast, the
Company's substantial capital position attained through profitable operations
and limited investment loss exposure positioned it to write additional levels of
annuity business. In the past two years, the Company sold approximately $1.4
billion of annuity products per year indicative of the Company's enhanced
competitive position in the marketplace.
Under the auspices of the Company's enterprise risk management (ERM) processes,
management evaluated the potential ramifications of continuing a high level of
annuity sales in the current depressed interest rate environment precipitated by
the "quantitative easing" programs enacted by the Federal Reserve and the
European debt crisis. Considered was the Federal Reserve's announced intention
to maintain interest rates at current levels over the next several years and
hints of future quantitative easing initiatives. While the Company does not
subsidize its interest crediting rates on new policies in order to obtain market
share, the Company's ERM considerations determined that managing to a lower
level of annuity sales was prudent in the present environment.
The Company's mix of annuity sales tends to shift with interest rate levels and
the relative performance of the equity market. Over the past several years,
sales of fixed-indexed products have accounted for 55% to 75% of all annuity
sales. During the first six months of 2012 this percentage reached nearly 80%
reflecting the bull market run in equities since bottoming out in the first
quarter of 2009 and the low level of fixed interest rates. For all fixed-indexed
products, the Company purchases over the counter options to hedge the equity
return feature. The options are purchased relative to the issuance of the
annuity contracts in such a manner to minimize timing risk. Generally, the index
return during the indexing period (if the underlying index increases) becomes a
component in a formula (set forth in the annuity), the result of which is
credited as interest to contract holders electing the index formula crediting
method at the beginning of the indexing period. The formula result can never be
less than zero with these products. The Company does not deliberately mismatch
or under hedge for the equity feature of the products. Fixed-indexed products
also provide the contract holder the alternative to elect a fixed interest rate
crediting option.
Although a relatively smaller proportion of total annuity sales, sales of single
premium immediate annuities (SPIAs) have increased during the past year in
conjunction with the Company's life insurance sales strategy of wealth transfer.
SPIAs are often used as the funding mechanism for transferring accumulated
wealth into a life insurance product given its tax deferral advantages.
Consequently, the Company's sales of these products have shown growth during the
periods shown.
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The increased level of annuity sales volume the past several years has required
a greater level of asset/liability analysis. The Company monitors its
asset/liability matching within the self-constraints of desired capital levels
and risk tolerance. Despite the amounts of new business, the Company's capital
level remains substantially above industry averages and regulatory targets.
Management has performed analyses of the capital strain associated with
incrementally higher levels of annuity new business and determined that the
Company's capital position is more than sufficient to handle increased sales
activity.
The following table sets forth information regarding annuities in force for each
date presented.
Annuities In Force as of June 30,
2012 2011
($ in thousands)
Fixed-indexed annuities
Number of policies 57,705 50,730
GAAP annuity reserves $ 3,968,542 3,491,059
Other deferred annuities
Number of policies 65,110 67,730
GAAP annuity reserves $ 2,734,335 2,690,891
Immediate annuities
Number of policies 17,780 17,050
GAAP annuity reserves $ 429,414 427,169
Total annuities
Number of policies 140,595 135,510
GAAP annuity reserves $ 7,132,291 6,609,119
Impact of Recent Business Environment
Economic data has shown mixed signs of improvement and backsliding over the past
several quarters generating uncertainty about the direction of the economy at
least in the near term. While corporate earnings have generally pleasantly
surprised versus expectations in recent quarters, there are various pockets of
anecdotal evidence that suggest tougher times ahead. Retail sales in the U.S.
have fallen three consecutive months for the first time since 2008. Several
municipalities in California have recently defaulted on their debt and filed
petitions for bankruptcy. Severe drought conditions are impacting crop yields
leading to predictions of increases in food costs. It remains uncertain whether
the financial stresses of various countries in the European community will be
contained or disrupt the economic expansion in core Europe. Weaker growth
figures from China seem to indicate a slowing down by one of the major
underlying global economic machines. Concerns about the oncoming "fiscal cliff"
in the U.S. appear to be restraining business owners from making investment
commitments needed to fund future growth. All of the above have served to
decrease interest rate levels to historic lows.
With so much uncertainty regarding the future, it is difficult to confidently
predict the direction that the U.S. and global economies are headed. Strong
economic expansion generally benefits the Company's business. Alternatively, a
tepid economic recovery consisting of higher unemployment, lower personal
income, muted consumer spending and lackluster corporate earnings and business
investment could adversely impact the demand for the Company's products.
Household financial income compression may also cause us to experience a higher
incidence of claims, lapses or surrenders of policies. It is not possible to
predict with certainty whether or when such activity may occur or what impact,
if any, such actions could have on the Company's business, results of
operations, cash flows or financial condition.
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As noted previously, the Company has enjoyed substantially higher annuity sales
the past two years. While there may be many underlying reasons for this
expansion in our annuity business, we believe that at least the following
factors may explain this outcome: (1) during uncertain economic periods,
consumers follow a flight to safety toward lower risk assets such as annuity
products; (2) the Company's strong financial position, upgrade in financial
strength rating from A.M. Best during 2009 and ample capital resources enhanced
our presence in the annuity marketplace with independent distributors and end
market consumers; (3) many of the Company's competitors incurred reductions in
their capital base due to a deterioration in the quality of their investment
portfolios, including investment impairments and losses, which caused them to
curtail sales activity and recruitment of independent distribution; and (4) the
uncertainty surrounding the potential regulation of fixed-indexed annuities by
the SEC was eliminated when the U.S Court of Appeals vacated the proposed
regulation (Rule 151A) and Congress passed the Dodd-Frank Act which exempted
annuities under the Securities Act of 1933. Despite these factors and their
impact on the growth in the Company's annuity sales, the low interest rate
environment expected to last over the next few years will present a different
set of challenges in terms of managing risk and profitability.
The fixed income markets, our primary investment source, have experienced an
improvement in fundamental credit quality on the heels of stronger liquidity,
improving corporate profitability and modest economic growth. Credit downgrades
of fixed income instruments by rating agencies were fairly prevalent during 2008
and 2009. However, credit default rates have since declined. The Company
experienced minimal impairment and degradation of quality in its fixed income
holdings during the financial crisis and subsequent recovery. There is no
certainty that future events may produce the same success in this regard.
The unprecedented low U. S. Treasury yields combined with tightening credit
spreads (difference between bond yields and risk-free interest rates) on fixed
maturity securities has produced new challenges in managing Company
profitability given the resulting "compression" on interest spreads (difference
between the yield on investments and the amounts required to credit on
associated policy values). Industry analysts and observers generally agree that
a sudden jump in interest rate levels would be harmful to life insurers with
interest-sensitive products as it could provide an impetus for abnormal product
surrenders and withdrawals at the same time fixed debt securities held by
insurers declined in market value. The federal government's burgeoning deficit
and initial "quantitative easing" initiatives served to put upward pressure on
longer term interest rates. The second round of initiatives announced by the
Federal Reserve, referred to as "Operation Twist", targeted longer term yields
in the hopes that lowering this end of the yield curve may prompt economic
expansion particularly in the moribund housing sector. At this time, there are
indications the Federal Reserve will pursue additional programs of a stimulative
nature given the sluggishness of the economy. Second quarter GDP growth of 1.4%
was recently released reflecting a migration downward from previous quarters.
Consequently, although it appears that the economy may be in a prolonged period
of low interest rates, it is uncertain what direction and at what pace interest
rate movements may occur in the future and what impact, if any, such movements
would have on the Company's business, results of operations, cash flows or
financial condition.
Our operating strategy continues to be to maintain capital levels substantially
above regulatory and rating agency requirements. The Company maintains resources
more than adequate to fund future growth and absorb abnormal periods of cash
outflows.
RESULTS OF OPERATIONS
The Company's condensed consolidated financial statements are prepared in
accordance with U.S. generally accepted accounting principles ("GAAP"). In
addition, the Company regularly evaluates operating performance using non-GAAP
financial measures which exclude or segregate derivative and realized investment
gains and losses from operating revenues. Similar measures are commonly used in
the insurance industry in order to assess profitability and results from ongoing
operations. The Company believes that the presentation of these non-GAAP
financial measures enhances the understanding of the Company's results of
operations by highlighting the results from ongoing operations and the
underlying profitability factors of the Company's business. The Company excludes
or segregates derivative and realized investment gains and losses because such
items are often the result of events which may or may not be at the Company's
discretion and the fluctuating effects of these items could distort trends in
the underlying profitability of the Company's business. Therefore, in the
following sections discussing condensed consolidated operations and segment
operations, appropriate reconciliations have been included to report information
management considers useful in enhancing an understanding of the Company's
operations to reportable GAAP balances reflected in the condensed consolidated
financial statements.
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