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NATIONAL WESTERN LIFE GROUP, INC. – 10-K – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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 ofNational Western Life Group, Inc. and its subsidiaries (the "Company") 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 filings such as exposure to market risks, anticipated cash flows or operating performance, future capital needs, and statutory or regulatory related issues. However, as a matter of policy, the Company 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") ofNational Western Life Group, Inc. ("NWLGI") for the three years endedDecember 31, 2021 follows. Where appropriate, discussion specific to the insurance operations ofNational Western Life Insurance Company is denoted by "National Western" or "NWLIC". This discussion should be read in conjunction with the Company's Consolidated Financial Statements and related notes beginning on page 97 of this report. EffectiveJanuary 31, 2019 , the Company completed its previously announced acquisition ofOzark National Life Insurance Company ("Ozark National") andN.I.S. Financial Services, Inc. ("NIS") following the receipt of regulatory approvals. NWLGI and National Western paid cash in an aggregate amount of approximately$205.4 million in exchange for all of the outstanding stock of Ozark National (wholly owned by National Western) and NIS (wholly owned by NWLGI). The eleven month results of Ozark National and NIS are included in the Company's Consolidated Financial Statements as of and for the year endedDecember 31, 2019 and reference to each is made in this MD&A where appropriate. 34
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Table of Contents Overview National Western has historically provided life insurance products on a global basis for the savings and protection needs of policyholders and issued annuity contracts for the asset accumulation and retirement needs of contract holders, both domestic and international residents. As disclosed in the Company's 2018 filings, the Company discontinued accepting applications for its international life insurance products from all foreign residents in other countries in the second quarter of 2018.
The Company, National Western and Ozark National, 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
overall business and profitability include the following:
? the level of sales and premium revenues collected ? the volume of life insurance and annuity business in force ? persistency of policies and contracts
the ability to price products to earn acceptable margins over benefit costs and
? expenses
return 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 ability to manage 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
? corporate tax rates and the treatment of financial statement items under tax rules
and accounting
? actual levels of surrenders, withdrawals, claims and interest spreads
? 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 counterparties for reinsurance and index option
? contracts
litigation subject to unfavorable judicial development, including the time and
? expense of litigation The Company monitors these factors continually as key business indicators. The discussion that follows in this Item 6 includes these indicators and presents information useful to an overall understanding of the Company's business performance in 2021, incorporating required disclosures in accordance with the rules and regulations of theSecurities Exchange Commission ("SEC").
Impact of Recent Business Environment
The Company's business is generally aided by an economic environment experiencing growth, whether moderate or vibrant, characterized by improving employment data and increases in personal income. Important metrics indicating sustained economic growth over the longer term principally revolve around employment and confidence, both consumer and business sentiment. The COVID-19 pandemic not only affected how businesses conducted operations but also introduced a great deal of uncertainty to the life insurance industry. The morbidity exposure of COVID-19 translated into a higher death claim incidence throughout the industry and was a frequently discussed item in company earnings releases. In 2021, the Company (National Western and Ozark National) incurred approximately$32 million in net death claims for which COVID-19 was identified as the cause of death, an increase from$8 million in the preceding year. However, composite reports tracking the incidence of COVID-19 death activity appear to suggest that a peak occurred in the third quarter of 2021 with noticeable declines observed thereafter. 35
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Another consequence of the pandemic has been the impact on investment yields and asset valuations. Interest rates have hovered at levels making traditional industry investments in fixed income debt securities insufficient to price products competitively or to meet minimum interest rate guarantees without reducing internal rates of return below required targets. Seizing on this situation, large investment entities have entered the industry through acquisitions or reinsurance transactions in order to tap insurance company portfolios of low yielding assets with the goal of using specific investment expertise to roll these assets into higher yielding, and higher risk, assets. While the COVID-19 environment has not caused widespread declines in the value of invested assets through downgrades in credit market securities, insurers have still faced fair value decreases resulting in unrealized losses, impairment-related losses or sizable additions being made to the allowance for current credit losses in financial statements. In recent years, in an attempt to acquire additional investment yield in the low rate environment, life insurers substantially increased allocations to BBB- rated bonds. In a recession, many of these investment grade corporate credits are at risk for downgrades, as well as the potential to default. Risk-based capital (RBC) formulas assess higher required capital charges as investment quality declines. A meaningful shift of BBB- rated debt securities to non-investment grade categories could have significant implications in terms of required capital levels which would depress RBC ratios of impacted insurers. Life insurance companies also have a large exposure to real estate in its investment portfolios through commercial mortgage, direct real estate investment, alternative investment funds, and mortgage-backed securities. These investments are highly dependent upon occupancy and payment of rent and lease obligations. With regard to the credit market, 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 levels of product surrenders and withdrawals at the same time fixed debt securities held by insurers declined in market value. The current rise of inflation rates has promptedFederal Reserve officials to begin signalling their intent to commence with a series of interest rate increases in order to head off the crippling effects of rising prices. Ultimately, a mix of monetary policy adjustments, fiscal policy, and economic fundamentals will determine the degree of interest rate increases and the speed of such shifts. It is uncertain what impacts, if any, such movements would have on the Company's business, results of operations, cash flows or financial condition. In an environment such as this, the need for a strong capital position that can cushion against unexpected bumps is critical for stability and ongoing business activity. The Company's operating strategy continues to be focused on maintaining capital levels substantially above regulatory and rating agency requirements. In addition, its business model is predicated upon steady growth in invested assets while managing the block of business within profitability objectives. A key premise of the Company's financial management is maintaining a high quality investment portfolio, well matched in terms of duration with policyholder obligations, that continues to outperform the industry with respect to adverse impairment experience. This discipline enables the Company to sustain resources more than adequate to fund future growth and absorb abnormal periods of cash outflows.
Critical Accounting Policies
Accounting policies discussed below are those considered critical to an
understanding of the Company's financial statements.
Impairment ofInvestment Securities . The Company's accounting policy requires that a decline in the value of a security below its amortized cost basis be evaluated to determine if the decline is a result of credit loss. The primary factors considered in evaluating whether a decline in value for fixed income and equity securities without readily determinable fair values is a result of credit loss are: (a) the length of time and the extent to which the fair value has been less than cost, (b) the reasons for the decline in value (credit event, interest rate related, credit spread widening), (c) the overall financial condition as well as the near-term prospects of the issuer, (d) whether the debtor is current on contractually obligated principal and interest payments, and (e) that the Company does not intend or be required to sell the investment prior to recovery. In addition, certain securitized financial assets with contractual cash flows are evaluated periodically by the Company to update the estimated cash flows over the life of the security. If the Company determines that the fair value of the securitized financial asset is less than its carrying amount and there has been a decrease in the present value of the estimated cash flows since the previous purchase or prior impairment, then a credit loss charge is recognized. The Company would recognize impairment of securities due to changing interest rates or market dislocations only if the Company intended to sell the securities prior to recovery. When a security is deemed to be impaired, a charge is recorded equal to the difference between the fair value and amortized cost basis of the security. In compliance with GAAP guidance after adoption of ASU 2016-13, Financial Instruments-Credit Losses the estimated credit loss is recorded as an allowance with changes in the allowance recorded to Net investment income in the Consolidated Statements of Earnings. 36
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Deferred Policy Acquisition Costs ("DPAC"). The Company is required to defer
certain policy acquisition costs and amortize them over future periods. These
costs include commissions and certain other expenses that vary with and are
directly associated with acquiring new business. The deferred costs are recorded
as an asset commonly referred to as deferred policy acquisition costs. The DPAC
asset balance is subsequently charged to income over the lives of the underlying
contracts in relation to the anticipated emergence of revenue or profits. Actual
revenue or profits can vary from Company estimates resulting in increases or
decreases in the rate of amortization. The Company performs regular evaluations
of its universal life and annuity contracts to determine if actual experience or
other evidence suggests that earlier estimates should be revised. Assumptions
considered significant include surrender and lapse rates, mortality, expense
levels, investment performance, and estimated interest spread. Should actual
experience dictate that the Company change its assumptions regarding the
emergence of future revenues or profits (commonly referred to as "unlocking"),
the Company would record a charge or addition to bring its DPAC balance to the
level it would have been if using the new assumptions from the inception date of
each policy.
DPAC is also subject to periodic recoverability and loss recognition
testing. These tests ensure that the present value of future contract-related
cash flows will support the capitalized DPAC balance to be amortized in the
future. The present value of these cash flows, less the benefit reserve, is
compared with the unamortized DPAC balance and if the DPAC balance is greater,
the deficiency is charged to expense as a component of amortization and the
asset balance is reduced to the recoverable amount. For more information about
accounting for DPAC see Note (1), Summary of Significant Accounting Policies, in
the accompanying Notes to Consolidated Financial Statements in this report.
Deferred Sales Inducements ("DSI"). Costs related to sales inducements offered
on sales to new customers, principally on investment type contracts and
primarily in the form of additional credits to the customer's account value or
enhancements to interest credited for a specified period, which are beyond
amounts currently being credited to existing contracts, are deferred and
recorded as other assets. All other sales inducements are expensed as incurred
and included in interest credited to contract holders' funds. Deferred sales
inducements are amortized to income using the same methodology and assumptions
as DPAC, and are included in interest credited to contract holders'
funds. Deferred sales inducements are also periodically reviewed for
recoverability. For more information about accounting for deferred sales
inducements see Note (1), Summary of Significant Accounting Policies, in the
accompanying Notes to Consolidated Financial Statements in this report.
Value of Business Acquired ("VOBA"). VOBA is a purchase accounting convention
for life insurance companies in business combinations based upon an actuarial
determination of the difference between the fair value of policyholder
liabilities acquired and the same policyholder liabilities measured in
accordance with the acquiring company's accounting policies. The difference,
referred to as VOBA, is an intangible asset subject to periodic amortization.
Similar to DPAC and DSI, VOBA is subject to periodic analysis assessing
recoverability.
Future Policy Benefits. Because of the long-term nature of insurance contracts,
the Company is liable for policy benefit payments many years into the
future. The liability for future policy benefits represents estimates of the
present value of the Company's expected benefit payments, net of the related
present value of future net premium collections. For traditional life insurance
contracts, this is determined by standard actuarial procedures, using
assumptions as to mortality (life expectancy), morbidity (health expectancy),
persistency, and interest rates, which are based on the Company's experience
with similar products. The assumptions used are those considered to be
appropriate at the time the policies are issued. An additional provision is made
on most products to allow for possible adverse deviation from the assumptions
assumed. For universal life and annuity products, the Company's liability is the
amount of the contract's account balance. Account balances are also subject to
minimum liability calculations as a result of minimum guaranteed interest rates
in the policies. While management and Company actuaries have used their best
judgment in determining the assumptions and in calculating the liability for
future policy benefits, there is no assurance that the estimate of the
liabilities reflected in the financial statements represents the Company's
ultimate obligation. In addition, significantly different assumptions could
result in materially different reported amounts. A discussion of the assumptions
used to calculate the liability for future policy benefits is reported in Note
(1), Summary of Significant Accounting Policies, in the accompanying Notes to
Consolidated Financial Statements in this report.
Revenue Recognition. Premium income for the Company's traditional life insurance
contracts is generally recognized as the premium becomes due from
policyholders. For annuity and universal life contracts, the amounts collected
from policyholders are considered deposits and are not included in revenue. For
these contracts, fee income consists of policy charges for policy
administration, cost of insurance charges and surrender charges assessed against
policyholders' account balances which are recognized in the period the services
are provided.
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Investment activities of the Company are integral to its insurance operations. Since life insurance benefits may not be paid until many years into the future, the accumulation of cash flows from premium receipts are invested with income reported as revenue when earned. Anticipated yields on investments are reflected in premium rates, contract liabilities, and other product contract features. These anticipated yields are implied in the interest required on the Company's net insurance liabilities (future policy benefits less deferred acquisition costs) and contractual interest obligations in its insurance and annuity products. The Company benefits to the extent actual net investment income exceeds the required interest on net insurance liabilities and manages the rates it credits on its products to maintain the targeted excess or "spread" of investment earnings over interest credited. The Company will continue to be required to provide for future contractual obligations in the event of a decline in investment yield. For more information concerning revenue recognition, investment accounting, and interest sensitivity, please refer to Note (1), Summary of Significant Accounting Policies, and Note (3), Investments, in the accompanying Notes to Consolidated Financial Statements in this report, and the discussions under Investments in Item 6 of this report. Pension Plans and Other Postretirement Benefits. The Company sponsors a qualified defined benefit pension plan, which was frozen effectiveDecember 31, 2007 , covering substantially all employees at that time, and three non-qualified defined benefit plans covering certain senior officers. In addition, the Company has postretirement health care benefits for certain senior officers. The freeze of the qualified benefit pension plan ceased future benefit accruals to all participants and closed the Plan to any new participants. In addition, all participants became immediately 100% vested in their accrued benefits as of that date. In accordance with prescribed accounting standards, the Company annually reviews plan assumptions. The Company annually reviews its pension benefit plans' assumptions which include the discount rate, the expected long-term rate of return on plan assets, and the compensation increase rate. The assumed discount rate is set based on the rates of return on high quality long-term fixed income investments currently available and expected to be available during the period to maturity of the pension benefits. The assumed long-term rate of return on plan assets is generally set at the rate expected to be earned based on the long-term investment policy of the plans, the various classes of the invested funds, input of the plan's investment advisors and consulting actuary, and the plan's historic rate of return. The compensation rate increase assumption is generally set at a rate consistent with current and expected long-term compensation and salary policy, including inflation. These assumptions involve uncertainties and judgment, and therefore actual performance may not be reflective of the assumptions. Other postretirement benefit assumptions include future events affecting retirement age, mortality, dependency status, per capita claims costs by age, health care trend rates, and discount rates. Per capita claims cost by age is the current cost of providing postretirement health care benefits for one year at each age from the youngest age to the oldest age at which plan participants are expected to receive benefits under the plan. Health care trend rates involve assumptions about the annual rate(s) of change in the cost of health care benefits currently provided by the plan, due to factors other than changes in the composition of the plan population by age and dependency status. These rates implicitly consider estimates of health care inflation, changes in utilization, technological advances, and changes in health status of the participants. Share-Based Payments. Liability awards under a share-based payment arrangement have been measured based on the awards' fair value at the reporting date. The Black-Scholes valuation method is used to estimate the fair value of the options. This fair value calculation of the options includes assumptions relative to the following:
? exercise price
expected term based on contractual term and perceived future behavior relative to
? exercise ? current price ? expected volatility ? risk-free interest rates ? expected dividends
These assumptions are continually reviewed by the Company and adjustments may be
made based upon current facts and circumstances.
Other significant accounting policies, although not involving the same level of
measurement uncertainties as those discussed above, but nonetheless important to
an understanding of the financial statements, are described in Note (1), Summary
of Significant Accounting Policies, in the accompanying Notes to Consolidated
Financial Statements in this report.
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Table of Contents RESULTS OF OPERATIONS The Company's Consolidated Financial Statements are prepared in accordance withU.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 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 Consolidated Financial Statements.
Consolidated Operations
Revenues. The following details Company revenues:
Years Ended December 31,
2021 2020 2019
(In thousands)
Universal life and annuity contract charges $ 134,254 145,405 149,721
Traditional life premiums 90,043 92,542 90,248
Net investment income (excluding index option derivatives) 441,812
402,448 432,285 Other revenues 22,314 18,522 17,486 Derivative gain, index options 120,718 14,754 123,207 Net realized investment gains 14,950 21,071 6,241 Total revenues$ 824,091 694,742 819,188 Universal life and annuity contract revenues - Revenues for universal life and annuity products consist of policy charges for the cost of insurance, administration charges, and surrender charges assessed against policyholder account balances, less reinsurance premiums. As depicted in the following table, revenues for universal life and annuity contract charges decreased in 2021 compared to 2020 due to lower surrender charge revenue from terminated policies and lower cost of insurance charges associated with decreased levels of universal life insurance in force. Years Ended December 31, Contract Charges: 2021 2020 2019 (In thousands) Cost of insurance and administrative charges$ 122,961 124,821 126,049 Surrender charges 25,363 26,623 33,079 Other charges 4,347 11,430 8,171 Gross contract revenues 152,671 162,874 167,299 Reinsurance premiums (18,417) (17,469) (17,578) Net contract charges$ 134,254 145,405 149,721 39
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Cost of insurance charges were$95.9 million in 2021 compared to$98.9 million in 2020 and$102.0 million in 2019. Cost of insurance charges typically trend with the size of the universal life insurance block in force and the amount of new business issued during the period. The volume of universal life insurance in force during 2021 decreased to$12.7 billion from$13.5 billion at year-end 2020 and$14.4 billion at year-end 2019. Administrative charges were$27.1 million ,$25.9 million , and$24.1 million for the years endedDecember 31, 2021 , 2020 and 2019, respectively, and correlate with new universal life insurance business sales by the number of policies placed, the amount of premiums received and the volume of insurance issued. Surrender charges assessed against policyholder account balances upon withdrawal were$25.4 million in 2021 compared to$26.6 million in 2020 and$33.1 million in 2019. The Company earns surrender charge income that is assessed upon policy terminations, however, the Company's overall profitability is enhanced when policies remain in force and additional contract revenues are realized and the Company continues to make an interest rate spread equivalent to the difference it earns on its investment and the amounts that it credits to policyholders. While policy lapse rates in 2021 for the domestic life insurance and international life insurance segments were somewhat lower than those experienced in 2020, the annuities segment continued to exhibit a higher lapse rate due to liquidity demands prompted by the pandemic crisis. Surrender charge income recognized is also dependent upon the duration of policies at the time of surrender (i.e. later duration policy surrenders have lower surrender charges assessed and earlier policy surrenders have a higher surrender charge assessed). The declining trend in assessed surrender charges is indicative of policy surrenders later in the surrender charge period. Other charges include the net amortization into income of the premium load on single premium life insurance products which is deferred at the inception of the policy. The net income reported for this activity is dependent upon the level of amortization of accumulated deferrals compared to current premium loads being deferred. In addition, as part of the Company's annual unlocking analysis, a prospective unlocking of the unearned revenue reserve was done for each year shown. The effect of the unlocking in the year endedDecember 31, 2021 was a decrease in other charges revenue of$(0.6) million while the effect of the unlockings increased other charges revenue by$5.9 million and$0.5 million in the years endedDecember 31, 2020 and 2019, respectively. Traditional life premiums - Traditional life premiums include the activity of Ozark National subsequent to their acquisition onJanuary 31, 2019 . Ozark National's principal product is a non-participating whole life insurance policy with premiums remitted primarily on a monthly basis. The product is sold in tandem with a mutual fund investment product offered through its broker-dealer affiliate, NIS. Traditional life insurance premiums for products such as whole life and term life are recognized as revenues over the premium-paying period. A sizable portion of National Western's traditional life business resided in the International Life insurance segment which ceased accepting new applications in 2018. However, National Western's overall life insurance sales focus has historically been primarily centered around universal life products. The addition of Ozark National's business of repetitive paying permanent life insurance adds an important complement to National Western's life insurance sales. Included in the amounts for the years endedDecember 31, 2021 , 2020, and 2019 is$73.5 million ,$74.8 million , and$69.0 million , respectively, of life insurance renewal premium from Ozark National. Universal life products, especially National Western's equity indexed universal life products, which offer the opportunity for consumers to acquire life insurance protection and receive credited interest linked in part to an outside market index, have been the more popular product offerings in the Company's markets. 40
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Net investment income (with and without derivatives) - A detail of net
investment income is provided below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Gross investment income:
Debt and equities $ 309,082 373,479 403,372
Mortgage loans 20,155 13,162 12,595
Policy loans 2,667 3,361 3,539
Short-term investments 293 2,160 2,974
Other invested assets 16,321 12,698 13,057
Total investment income 348,518 404,860 435,537
Less: investment expenses 2,762 2,412 3,252
Net investment income (excluding derivatives and trading
securities)
345,756 402,448 432,285 Index option derivative gain 120,718 14,754 123,207 Embedded derivative on reinsurance 84,725 - - Trading securities market adjustments 11,331 - - Net investment income$ 562,530 417,202 555,492 The Company's strategy is to invest a substantial portion of its cash flows in fixed debt securities within its guidelines for credit quality, duration, and diversification. National Western's debt and equities investment income continues to experience higher yielding debt securities maturing or being called by borrowers and being replaced with lower yielding securities in the current interest rate environment. In addition, the excess of annuity outflows over inflows has caused the debt security portfolio to contract. As part of the acquisition of Ozark National and NIS in the first quarter of 2019, a sizable part of National Western's investable cash resources were applied toward the purchase of the two companies and then subsequently to pay back line of credit borrowings of$75 million used to fund a part of the acquisition price. The Company's investable funds are derived from incremental cash flow from new business and investment income from its portfolio above its operational requirements to pay policy benefits, commissions, and expenses. The debt securities portfolio increased from$10.5 billion atDecember 31, 2019 to$10.8 billion atDecember 31, 2020 , largely the result of recording certain holdings at fair value instead of amortized cost as had been done previously. AtDecember 31, 2021 , the debt securities portfolio declined to$10.1 billion . Investment yields on new bond purchases in 2021 and 2020 were less than the portfolio's weighted average yield after exceeding the portfolio yield in the prior two years. The portfolio weighted average yield was approximately 3.62% atDecember 31, 2021 , while the yield on debt security purchases to fund insurance operations was 3.02%, 3.33%, and 4.06% in 2021, 2020, and 2019, respectively. Ozark National's weighted average portfolio yield atDecember 31, 2021 was 3.62%. Bond portfolio yields have continued to be impacted by higher yielding debt securities maturing or being called by borrowers with the proceeds being reinvested into lower yielding securities. Fair value changes of equity securities are included in the Consolidated Statements of Earnings as a component of net investment income. For the years endedDecember 31, 2021 , 2020, and 2019 an unrealized gain (loss) of$6.0 million ,$(1.0) million , and$3.5 million , respectively, has been included in net investment income reflecting the change in fair value of equity securities during the periods. The carrying value of the Company's portfolio of equity securities was$28.2 million atDecember 31, 2021 . 41
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Prior to 2020, the Company's new mortgage loan activity had been challenged by the low level of interest rates and highly competitive underwriting of commercial properties. The COVID-19 pandemic crisis further impeded the underwriting of new loan applications early in 2020 until clarity regarding the impacts of closing down the economy upon commercial real estate became discernible. Eventually the volume of new mortgage loan originations during the latter half of 2020 resumed a pace closer to that of the pre-pandemic environment. Additional resources were added with the goal of increasing mortgage loan investments to a more appreciable percentage of total invested assets. The Company originated new mortgage loans in the amount of$183.6 million ,$80.2 million , and$121.4 in 2021, 2020, and 2019, respectively. Mortgage loan investment income also benefits from incremental contributions from loan prepayment fees and profit participation receipts. Policy loan and other invested asset balances outstanding have remained relatively stable over the past few years. During the latter part of 2020, National Western, in order to obtain incremental investment yield, expanded its invested asset vehicles to include alternative investments. These assets are typically syndicated, targeted capital pools with specific investment objectives managed by investment firms having specific expertise in designated asset opportunities. AtDecember 31, 2021 and 2020, the Company held balances of$67.7 million and$28.9 million , respectively, in this investment category. EffectiveJanuary 1, 2021 , the Company's net investment income is reduced for amounts ceded to the reinsurer under the funds withheld reinsurance agreement associated with funds withheld assets. For the year endedDecember 31, 2021 , the Company ceded net investment income of$55.1 million , substantially comprised of investment income from debt securities. The Company adopted new accounting guidance pertaining to current expected credit losses on financial instruments ("CECL") in 2020. The adoption as ofJanuary 1, 2020 was reported as a change in accounting with initial balances recorded and$3.0 million , net of taxes, charged to retained earnings. Remeasurement of the CECL allowance during 2020 resulted in a decrease in the allowance of$2.0 million for the year endedDecember 31, 2020 which is netted in gross investment income. During the year endedDecember 31, 2021 , remeasurement of the CECL allowance resulted in an increase to the allowance of$0.5 million . In order to evaluate underlying profitability and results from ongoing operations, net investment income performance is analyzed excluding derivative gain (loss), which is a common practice in the insurance industry. Although this is considered a non-GAAP financial measure, Company management believes this financial measure provides useful supplemental information by removing the swings associated with fair value changes on derivative instruments. Net investment income and average invested assets shown below includes cash and cash equivalents. Net investment income performance is summarized as follows: Years Ended December 31, 2021 2020 2019 (In thousands except percentages) Excluding derivatives and trading securities: Net investment income$ 345,756 402,448 432,285 Average invested assets, at amortized cost 9,420,544 10,994,033 10,881,052 Annual yield on average invested assets 3.67 % 3.66 % 3.97 % Including derivatives and trading securities: Net investment income$ 562,530 417,202 555,492 Average invested assets, at amortized cost 11,163,776 11,139,238 10,967,188 Annual yield on average invested assets 5.04 % 3.75 % 5.07 % The decline in average invested asset yield, excluding derivatives and trading securities, from 2019 to 2020 is due to the Company continuing to obtain lower yields on newly invested cash inflows as higher yielding assets mature or are called. The average invested asset yield in 2021 remained level with 2020 reflecting diversification during 2021 into other invested assets, namely commercial mortgage loans and alternative investments, which have incrementally higher yields. 42
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The pattern in average invested asset yield, including derivatives and trading
securities, incorporates increases and decreases in the fair value of index
options purchased by National Western to support its fixed-index products as
well as net investment income from the embedded derivative funds withheld
liability. Fair values of the purchased call options recorded net gains in 2021,
2020, and 2019 corresponding to the movement in the S&P 500 Index® during these
periods (the primary index the fixed-index products employ). Refer to the
derivatives discussion following this section for a more detailed explanation.
Other revenues - Other revenues pertain to NIS, the broker-dealer affiliate of
Ozark National; the operations of Braker P III ("BP III "), a subsidiary which
owns and manages a commercial office building which includes the home office
operations of National Western; and a maintenance expense allowance earned by
National Western for administering the funds withheld block of annuity policies
ceded to a third party reinsurer. The operations of the Company's previously
owned two nursing home operations in Reno, Nevada and San Marcos, Texas are
included in the results for the year ended December 31, 2019 up to their
respective dates of sales.
NIS revenues were $12.5 million , $9.9 million , and $8.2 million for the years
ended December 31, 2021 , 2020, and 2019, respectively. NIS revenues in 2019 were
for the period subsequent to its acquisition effective January 31, 2019 .
Revenues associated with BP III were $5.1 million , $4.7 million , and $3.9
million in December 31, 2021 , 2020, and 2019, respectively, reflecting
additional tenant leases subsequently executed. The facility is currently fully
leased.
Under terms of the funds withheld reinsurance contract, National Western earns a
monthly expense allowance equal to the average policy count of the funds
withheld reinsurance block of business multiplied by a stated amount per policy.
In the year ended December 31, 2021 , the Company reported $5.4 million as
maintenance expense allowance revenue.
The Company closed on the sale of its Reno nursing home operations effective
February 1, 2019 and on the sale of its San Marcos nursing home operations
effective May 1, 2019 . Revenues associated with these operations were $(0.2)
million , $(0.6) million , and $4.3 million in 2021, 2020, and 2019, respectively.
In addition, net gains from the sale of personal property and equipment at the
Reno facility of $1.4 million are included in 2019 revenues.
The Company's acquisition of Ozark National (by National Western) included a
contingent payment provision that was dependent upon the subsequent persistency
of Ozark National's in force block of business that was acquired. The Company
had been progressively accruing for this potential obligation in its financial
statements. During 2020, the Company executed an agreement with the seller under
which both parties agreed that the Company had fulfilled its payment obligation
under the Stock Purchase Agreement executed October 3, 2018 . Consequently, the
Company reversed the contingent payment amounts previously accrued and
recognized as Other revenues $4.1 million in the year ended December 31, 2020 .
Other revenues also include semi-annual distributions from the life interest in
the Libbie Shearn Moody Trust . Revenues recognized from these distributions were
$5.7 million , $5.3 million , and $6.7 million for the years ended December 31,
2021 , 2020, and 2019, respectively.
Index option derivative gain (loss) - Index options are derivative financial
instruments used to hedge the equity return component of National Western's
fixed-index products. Derivative gain or loss includes the amounts realized from
the sale or expiration of the options. Since the index options do not meet the
requirements for hedge accounting under GAAP, they are marked to fair value on
each reporting date and the resulting unrealized gain or loss is reflected as a
component of net investment income. As the options hedging the notional amount
of policyholder contract obligations are purchased as close as possible to like
amounts, the amount of the options returns tend to correlate closely with
indexed interest credited.
Gains and losses from index options are substantially due to changes in equity
market conditions. Index options are intended to act as hedges to match the
returns on the product's underlying reference index and the rise or decline in
the index relative to the index level at the time of the option purchase which
causes option values to likewise rise or decline. As income from index options
fluctuates with the underlying index, the contract interest expense to
policyholder accounts for the Company's fixed-index products also fluctuates in
a similar manner and direction. The Company recorded derivative gain (loss) and
contract interest amounts as shown below.
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Years Ended December 31,
2021 2020 2019
(In thousands)
Index option derivatives:
Unrealized gain (loss) $ (16,564) (9,740) 152,993
Realized gain (loss) 137,282 24,494 (29,786)
Total gain included in net investment income $ 120,718 14,754 123,207
Total contract interest $ 213,184 206,250 295,330
The economic impact of option performance in the Company's financial statements
is not generally determined solely by the option gain or loss included in net
investment income as there is a corresponding amount recorded in the contract
interest expense line. The Company's profitability with respect to these options
is largely dependent upon the purchase cost of the option remaining within the
financial budget for acquiring options embedded in the product pricing. Option
prices vary with interest rates, volatility, and dividend yields among other
things. As option prices vary, the Company manages for the variability by making
offsetting adjustments to product caps, participation rates, and management
fees. For the periods shown, the Company's option costs have generally been
within the product pricing budgets.
The financial statement investment spread, the difference between investment
income and interest credited to contract holders, is subject to variations from
option performance during any given period. For example, many of the Company's
equity-index annuity products provide for the collection of asset management
fees. These asset management fees are assessed when returns on expiring options
are positive, and they are collected prior to passing any additional returns
above the assessed management fees to the policy contractholders. During periods
of positive returns, the collected asset management fees serve to increase the
financial statement spread by increasing option realized gains reported as
investment income in an amount greater than interest credited to policy
contractholders which is reported as contract interest expense. Asset management
fees collected in 2021, 2020, and 2019 were $5.8 million , $30.7 million , and
$15.9 million , respectively. While the level of asset management fees collected
is dependent upon equity market performance, the reduced amount in 2021 is
primarily the result of the Company's change in option hedging to an
"out-of-the-money" basis during the second quarter of 2020. Consequently, no
asset management fees were collected during the third and fourth quarters of
2021 as the out-of-the-money hedges constituted all hedges maturing during these
time periods. Though asset management fees are no longer being collected, the
costs to purchase the out-of-the-money options similarly decreases.
Net realized investment gains (losses) - Realized gains (losses) on investments
generally include proceeds from bond calls, sales and impairment write-downs, as
well as gains and losses on the sale of real estate property. Net gains reported
in 2021 consisted of gross gains of $16.4 million which were mostly from bond
calls of debt securities in the available-for-sales category, offset by gross
losses of $(1.4) million . Gross losses include $1.4 million pertaining to
property held by Ozark National which was sold during 2021. Gross gains in 2020
and 2019 include proceeds from bond calls of securities classified in the
held-to-maturity category at that time.
Included the year ended December 31, 2019 gross gains is $5.7 million from the
sale of land and building associated with the nursing home in Reno, Nevada and a
$3.2 million gain on the sale of the Company's former Austin, Texas home office
facility. Included in 2019 gross losses is a $2.0 million loss on the sale of
the building pertaining to the San Marcos, Texas nursing home and an
other-than-temporary impairment on a single debt security credit in the amount
of $7.8 million .
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Prior toJanuary 1, 2020 and the adoption of the new accounting guidance on current expected credit losses, the Company recorded impairment write-downs when a decline in value was considered to be other-than-temporary and full recovery of the investment was not expected. Impairments due to credit factors were recorded in the Company's Consolidated Statements of Earnings while non-credit (liquidity) impairment losses were included in the Consolidated Statements of Comprehensive Income (Loss). Under current expected credit loss accounting guidance, credit loss allowances for available-for-sale debt securities are recorded following the same process previously applied for impairment accounting and are recorded through net investment income in the Consolidated Statement of Earnings. Impairment or valuation write-downs recorded prior toJanuary 1, 2020 under previous accounting guidance totaled$7.8 million in the year endedDecember 31, 2019 .
Benefits and Expenses. The following details benefits and expenses.
Years Ended December 31,
2021 2020 2019
(In thousands)
Life and other policy benefits $ 187,577 131,337 137,342
Amortization of deferred transaction costs 69,461 140,503 116,802
Universal life and annuity contract interest 213,184 206,250 295,330
Other operating expenses 126,612 104,584 104,558
Totals $ 596,834 582,674 654,032
Life and other policy benefits - Life and other policy benefits include death
claims of $96.3 million , $72.5 million and $65.8 million for 2021, 2020 and
2019, respectively. Included in the amounts for the years ended December 31,
2021 , 2020, and 2019, are $39.6 million , $37.0 million and $29.3 million in
death claims pertaining to Ozark National. Death claim amounts are subject to
variation from period to period. Death claims reported in 2021 and 2020 include
net benefit amounts (after reinsurance) pertaining to death from COVID-19 of
$23.5 million and $5.1 million for National Western and $8.2 million and $2.8
million for Ozark National. In 2021, the number of National Western life
insurance claims incurred was level with that of 2020 while the average dollar
amount per net claim increased 42% to $61,900 from $43,600 . National Western's
mortality experience has generally been consistent with or better than its
product pricing assumptions. The average net claim for Ozark National during
2021 increased to $15,400 from the 2020 period amount of $14,800 . The average
face amount of insurance in force for Ozark National was $33,600 at December 31,
2021 . Mortality exposure is managed through reinsurance treaties under which the
Company's retained maximum net amount at risk on any one life is capped at
$500,000 . Ozark National's retained maximum net amount at risk is capped at
$200,000 under its reinsurance treaties with limited exceptions related to the
conversion of child protection and guaranteed insurability riders.
Life and other policy benefits also includes policy liabilities held associated
with the Company's traditional life products, including riders such as the
guaranteed minimum withdrawal benefit rider ("WBR"), a popular rider to National
Western's equity-indexed annuity products. The increases in these liabilities
for National Western were $46.5 million , $10.7 million , and $24.4 million in
2021, 2020, and 2019, respectively. In each of these years, National Western
unlocked its policy benefit reserves associated with the WBR which resulted in
an increase/(decrease) to the policy benefit liability of $27.4 million , $(11.9)
million , and $0.7 million in 2021, 2020, and 2019, respectively. The 2020
adjustment included an unlocking amount pertaining to mortality experience on
payout annuities with life contingencies of $(3.3) million .
Life and other policy benefits in the years ended December 31, 2021 , 2020, and
2019 includes changes in traditional life reserves and miscellaneous benefit
payments associated with Ozark National's operations of $29.5 million , $30.7
million , and $30.5 million , respectively, reflecting normal business conditions.
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Amortization of deferred transaction costs - Life insurance companies are
required to defer certain expenses that vary with, and are directly related to,
the cost of acquiring new business. The majority of these acquisition expenses
consist of commissions paid to agents, underwriting costs, and certain marketing
expenses. Recognition of these deferred policy acquisition costs ("DPAC") as an
expense in the Consolidated Financial Statements occurs over future periods in
relation to the expected emergence of profits priced into the products
sold. This emergence of profits is based upon assumptions regarding premium
payment patterns, mortality, persistency, investment performance, and expense
patterns. Companies are required to review universal life and annuity contract
assumptions periodically to ascertain whether actual experience has deviated
significantly from that assumed. If it is determined that a significant
deviation has occurred, the emergence of profits pattern is to be "unlocked" and
reset based upon the actual experience. DPAC balances are also adjusted each
period to reflect current policy lapse or termination rates, expense levels and
credited rates on policies as compared to anticipated experience ("true-up")
with the adjustment reflected in current period amortization expense. In
accordance with GAAP guidance, the Company must also write off deferred
acquisition costs and unearned revenue liabilities upon internal replacement of
certain contracts as well as annuitizations of deferred annuities.
The following table identifies the effects of unlocking adjustments on DPAC
balances recorded through amortization expense separate from recurring
amortization expense components for 2021, 2020, and 2019.
Years Ended December 31,
Amortization of DPAC 2021 2020 2019
(In thousands)
Unlocking adjustments $ (36,510) 22,358 (8,643)
Other amortization components 84,349 107,917 117,748
Totals $ 47,839 130,275 109,105
The amortization amounts for the years ended December 31, 2021 , 2020, and 2019
were comprised of DPAC amortization by National Western of $47.2 million , $129.7
million , and $108.4 million and by Ozark National of $0.6 million , $0.6 million ,
and $0.7 million . Ozark National's deferred policy acquisition cost balance was
initiated February 1, 2019 following its acquisition by National Western.
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In 2021, the Company unlocked its DPAC balances for: (1) mortality rates, lapse
rates, portfolio yield rates and spreads, and increased cost of insurance
("COI") charges on International universal life products inforce which
collectively increased DPAC balances (and decreased amortization expense) on its
Life segment by $33.3 million ; and (2) surrender rates, annuitization rates,
portfolio yield rates and spreads, mortality experience on payout annuities, and
utilization of the Company's withdrawal benefit rider which collectively
increased DPAC balances (and decreased amortization expense) on its Annuity
segment by $3.2 million .
In 2020, the Company unlocked its DPAC balances for: (1) mortality rates, lapse
rates, portfolio yield rates and spreads, which collectively decreased DPAC
balances (and increased amortization expense) on its Life segment by $7.4
million ; and (2) surrender rates, annuitization rates, portfolio yield rates and
spreads, mortality experience on payout annuities, and utilization of the
Company's withdrawal benefit rider which collectively decreased DPAC balances
(and increased amortization expense) on its Annuity segment by $15.0 million .
In 2019, the Company unlocked its DPAC balances for: (1) mortality rates, lapse
rates, portfolio yield rates and spreads, and maintenance expense on its
International life business which collectively increased DPAC balances (and
reduced amortization expense) on its Life segment by $11.2 million ; and (2)
surrender rates, annuitization rates, portfolio yield rates and spreads, and
utilization of the Company's withdrawal benefit rider which collectively
decreased DPAC balances (and increased amortization expense) on its Annuity
segment by $2.6 million .
As the DPAC balance is an asset on the Company's Consolidated Balance Sheets,
GAAP provides for an earned interest return on the unamortized balance each
period. The earned interest serves to increase the DPAC balance and reduce other
amortization component expense. The rate at which the DPAC balance earns
interest is the average credited interest rate on universal life and annuity
policies in force, including credited interest on equity-indexed policies. The
amount of earned interest on DPAC balances was $32.7 million , $17.2 million , and
$12.0 million in 2021, 2020, and 2019, respectively, each decreasing other
amortization component expense. The increasing interest amounts reflect larger
realized returns on equity-index products, particularly life insurance products.
As part of the purchase accounting required with the acquisition of Ozark
National effective January 31, 2019 , the Company recorded an intangible asset of
$145.8 million referred to as the value of business acquired ("VOBA"). VOBA
represents the difference between the acquired assets and liabilities of Ozark
National measured in accordance with the Company's accounting policies and the
fair value of these same assets and liabilities. During the year ended December
31, 2020 , the cash value of certain acquired reserves was increased which
resulted in a commensurate $35.1 million increase in both the traditional life
reserve liability and the related VOBA balance reported on the Consolidated
Balance Sheets. The VOBA balance sheet amount is amortized following a
methodology similar to that used for amortizing deferred policy acquisition
costs. In the years ended December 31, 2021 , 2020, and 2019 the Company's VOBA
amortization was $8.5 million , and $10.2 million , and $7.7 million ,
respectively.
Universal life and annuity contract interest - The Company closely monitors its
credited interest rates on interest sensitive policies (National Western
products), taking into consideration such factors as profitability goals,
policyholder benefits, product marketability, and economic market conditions. As
long-term interest rates change, the Company's credited interest rates are often
adjusted accordingly, taking into consideration the factors described above. The
difference between yields earned on investments over policy credited rates is
often referred to as the "interest spread."
Contract interest reported in the financial statements also encompasses the
performance of the index options associated with the Company's fixed-index
products. As previously noted, the market value changes of these derivative
features resulted in net realized and unrealized gains/(losses) in 2021, 2020,
and 2019 of $120.7 million , $14.8 million , and $123.2 million , respectively. In
2021, this figure was comprised of unrealized losses totaling $(16.6) million
offset by realized gains of $137.3 million . In 2020, this figure was comprised
of unrealized losses totaling $(9.7) million offset by realized gains of $24.5
million . In 2019, the amount consisted of unrealized gains of $153.0 million
offset by realized losses of $(29.8) million . These returns similarly
increased/(decreased) the computed average credited rates for the periods shown
above. Policyholders of equity-indexed products cannot receive an interest
credit below 0% according to the policy contract terms.
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Contract Interest Expense December 31,
2021 2020 2019
Gross reserve changes $ 24,250 18,748 26,893
Ceded reserve changes under funds withheld (26,429) -
-
Unlocking adjustments, net (14,547) 17,180
10,274
Asset management fees collected (5,835) (30,675)
(15,856)
Projected asset management fees 6,477 34,426
(33,600)
Other embedded derivative components 5,814 (5,188) 6,389 Totals$ (10,270) 34,491 (5,900) Contract interest expense includes reserve changes for immediate annuities, two tier annuities, excess death benefit reserves, excess annuitizations, and amortization of deferred sales inducement balances. These gross reserve items are offset by policy charges assessed for policies having the withdrawal benefit rider (WBR). As changes in these items collectively impact contract interest expense, financial statement interest spread is also affected. Netted against reserve changes in the years endedDecember 31, 2021 , 2020, and 2019 are WBR assessed policy charges of$28.2 million ,$24.8 million , and$23.8 million , respectively. Beginning in 2021, reserve changes associated with funds withheld annuity policies are ceded to the reinsurer and no longer reflected in the financial statements of the Company. Accordingly, contract interest expense is adjusted to remove these expense items which are shown in the above table for the year endedDecember 31, 2021 . In addition to these amounts, the Company also cedes the fixed interest credited on the funds withheld annuity policies. For the year endedDecember 31, 2021 , the fixed interest credited ceded was$29.8 million . Generally, the impact of the market value change of index options on asset values aligns closely with the movement of the embedded derivative liability held for the Company's fixed-index products such that the net effect upon pretax earnings is negligible (i.e. net realized and unrealized gains/(losses) included in net investment income approximate the change in contract interest associated with the corresponding embedded derivative liability change). However, other aspects of the embedded derivatives can cause deviations to occur between the change in index option asset values included in net investment income and the change in the embedded derivative liability included in contract interest. As noted in the discussion of net investment income, the collection of asset management fees in a period can cause investment income to increase marginally higher than contract interest expense since these collected fees are deducted from indexed interest credited to policyholders. As shown in the table above, the collection of asset management fees are deductions from contract interest expense. Accounting rules require the embedded derivative liability to include a projection of asset management fees estimated to be collected in the succeeding fiscal year due to the Company's historical practice of purchasing options priced to incorporate an expected probability of collecting asset management fees (referred to as "at the money hedging"). This projection for the embedded derivative liability is based upon the most recent performance of the reference equity index. Increases in projected asset management fees to be collected reduce contract interest expense while decreases in projected asset management fees to be collected increase contract interest expense. During the years endedDecember 31, 2021 , 2020, and 2019, contract interest was increased/(decreased) by$6.5 million ,$34.4 million , and$(33.6) million , respectively, for the projected change in asset management fees to be collected. During 2020, the Company changed its embedded derivative hedging process to incorporate "out-of-the-money" hedging which reduces option costs and eliminates the requirement for estimating probability projections of collected asset management fees. The remaining inventory of at the money option hedges purchase with a one year term completed its roll over to out-of-the-money hedges during the second quarter of 2021. Consequently, the embedded derivative liability component for projected asset management fees to be collected was phased out as of the end of the 2021 second quarter. Refer to Note (3) Derivative Investments in the accompanying Notes to Consolidated Financial Statements in this report for further information. 48
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Other embedded derivative components include changes pertaining to other modeling differences, changes in future interest adjustments, and the change in the host contract component of the embedded derivative products. In the first quarter of 2020, the Company incurred an additional charge to contract interest of$12.1 million pertaining to an assumption regarding the embedded derivative option budget which was made several years ago when the Company's investment portfolio yield was higher. The combination of the embedded derivative option budget being out of date relative to the Company's current investment portfolio yield and the historically low interest rate levels introduced an embedded derivative floor which prevented the Company's contract interest expense from declining in tandem with the option value decreases recorded in net investment income. The Company subsequently unlocked for this out of date embedded derivative option budget assumption to reflect the Company's current investment portfolio yield. The effect of the unlocking was to remove the embedded derivative floor and reverse the contract interest charge recorded in the first quarter of 2020 so that there was no effect for this occurrence for the year endedDecember 31, 2020 . Another contract interest expense component is the amortization of deferred sales inducements (included in Gross reserve changes above). Similar to deferred policy acquisition costs, the Company defers sales inducements in the form of first year credited interest bonuses on annuity products that are directly related to the production of new business. These bonus interest charges are deferred and amortized using the same methodology and assumptions used to amortize other capitalized acquisition costs and the amortization is included in contract interest. In addition, deferred sales inducement balances ("DSI") are also reviewed periodically to ascertain whether actual experience has deviated significantly from that assumed (unlock) and are adjusted to reflect current policy lapse or termination rates, expense levels and credited rates on policies compared to anticipated experience (true-up). These adjustments, plus or minus, are included in contract interest expense. As part of the DPAC balance unlockings for the Annuity segment previously discussed for 2021, 2020, and 2019, the Company also unlocked its DSI balance. The effect of these prospective unlockings was to increase/(decrease) the DSI balance by$1.0 million ,$(4.4) million , and$(0.6) million , respectively. These amounts are included in the previous table in the Unlocking adjustments line. Other operating expenses - Other operating expenses consist of general administrative expenses, licenses and fees, commissions not subject to deferral, real estate expenses, brokerage expenses, compensation costs, and reinsurance ceded commission expense. These are summarized in the table that follows. Years Ended December 31, 2021 2020 2019 (In thousands) General administrative expenses $ 51,317 42,688 42,353 Compensation expenses 40,178 30,372 31,956 Commission expenses 10,810 11,159 10,502 Real estate expenses 5,947 5,598 5,236 Brokerage expenses (NIS) 6,123 5,085 4,372 Reinsurance ceded commission expense 12 - - Taxes, licenses and fees 12,225 9,682 10,139 Totals $ 126,612 104,584 104,558 General administrative expenses include software amortization of previously capitalized information technology (IT) expenditures including National Western's proprietary policy administration systems. Software costs, including amortization expense, for 2021, 2020, and 2019 were$13.8 million ,$12.6 million , and$12.7 million , respectively. Other IT expenditures include consulting costs for system implementations, assistance with analysis involving a security incident experienced by National Western, and contractor resources to fill IT staffing shortages. These amounts in the years endedDecember 31, 2021 and 2020 were$17.5 million and$10.4 million , respectively. General administrative expenses also include payments and provisions made relating to potential or contingent legal liabilities and legal fees. Expenses in this category were$6.0 million ,$2.8 million , and$3.8 million in 2021, 2020, and 2019, respectively. The 2021 amount includes$4.4 million accrued for potential settlement of a class action lawsuit pertaining to the IT security incident experienced by National Western. General administrative expenses for the year endedDecember 31, 2019 include a$3.3 million broker fee paid in connection with the acquisition of Ozark National and NIS which closed early in 2019. GAAP precludes this fee from being part of the purchase price for acquiring these businesses. General administrative expenses in the years endedDecember 31, 2021 , 2020, and 2019 include Ozark National expenses in the amount of$4.3 million ,$4.4 million , and$4.2 million , respectively. 49
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General administrative expenses include nursing home expenses that reflect the operations of the Company's two facilities which were sold during 2019. TheReno, Nevada nursing home was sold effectiveFebruary 1, 2019 , while theSan Marcos, Texas nursing home sale closed effectiveMay 1, 2019 . Expenses shown for 2019 reflect operations up to the date of sale for each facility. The Company must maintain the legal entities for a specified time period subsequent to each sale and incur various record safekeeping and other administrative expenses in the interim. Compensation expenses include share-based compensation costs related to outstanding vested and nonvested stock appreciation rights ("SARs"), restricted stock units ("RSUs"), and performance share units ("PSUs"). The related share-based compensation costs move in tandem not only with the number of awards outstanding but also with the movement in the market price of the Company's Class A common stock as a result of marking the SARs, RSUs, and PSUs to fair value under the liability method of accounting. Consequently, the related expense amount varies positive or negative in any given period. In the amounts shown above, share-based compensation expense totaled$5.8 million in 2021,$(2.2) million in 2020, and$2.4 million in 2019. The negative expense level in 2020 reflects a change in the Company's Class A common share price to$206.44 atDecember 31, 2020 from$290.88 atDecember 31, 2019 . In addition to the changes in price of the Company's Class A common shares, there were 64,157, 40,990, and 20,380 SARs granted to officers in 2021, 2020, and 2019, respectively. Refer to Note (12) Stockholders' Equity in the accompanying Notes to Consolidated Financial Statements of this report for a discussion of performance share awards.
Commission expenses in 2021, 2020, and 2019 include Ozark National
non-deferrable commissions of
respectively.
Real estate expenses pertain to the commercial building operated by Braker P III. The building was acquired at year-end 2016 and National Western relocated to this facility during the fourth quarter of 2017. The trending increase in the level of operating expenses reflects the addition of new tenants and associated operating expenses. AtDecember 31, 2021 , the facility was fully occupied. Taxes, licenses and fees include premium taxes and licensing fees paid to state insurance departments, guaranty fund assessments, the company portion of social security and Medicare taxes, real estate taxes, state income taxes, and other state and municipal taxes. Ozark National taxes, licenses and fees were$2.5 million in 2021,$2.3 million in 2020, and$2.2 million in 2019. The increase in taxes, licenses and fee expenses in 2021 is due to theState of Colorado , National Western's domiciliary state, enacting a premium tax on non-qualified annuities effectiveJanuary 1, 2021 . While the impact uponColorado premiums taxes was not significant, theColorado law increased the Company's retaliatory premium tax burden with other states by$3.5 million . Segment Operations
Summary of Segment Earnings
A summary of segment earnings from continuing operations for the years ended
exclude realized gains and losses on investments, net of taxes.
Domestic Life
Insurance International Life Insurance Annuities ONL & Affiliates All Others Totals
(In thousands)
Segment earnings (loss):
2021 $ 2,548 51,420 81,868 14,550 18,485 168,871
2020 1,499 51,609 (9,308) 14,036 17,830 75,666
2019 2,163 34,818 53,582 16,617 19,506 126,686
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Domestic Life Insurance Operations
A comparative analysis of results of operations for the Company's domestic life
insurance segment is detailed below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Premiums and other revenues:
Premiums and contract revenues $ 51,294 53,834 45,709
Net investment income 90,006 54,516 77,672
Other revenues 105 58 313
Total premiums and other revenues 141,405 108,408 123,694
Benefits and expenses:
Life and other policy benefits 24,416 18,471 18,948
Amortization of deferred transaction costs 9,580 17,661 11,797
Universal life insurance contract interest 77,246 44,782 69,849
Other operating expenses 26,959 25,730 20,376
Total benefits and expenses 138,201 106,644 120,970
Segment earnings before Federal income taxes 3,204 1,764 2,724
Provision for Federal income taxes 656 265 561
Segment earnings $ 2,548 1,499 2,163
Revenues from domestic life insurance operations include life insurance premiums
on traditional type products and contract revenues from universal life
insurance. Revenues from traditional products are simply premiums collected,
while revenues from universal life insurance consist of policy charges for the
cost of insurance, policy administration fees, and surrender charges assessed
during the period. A comparative detail of premiums and contract revenues is
provided below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Universal life insurance revenues $ 58,637 60,664 51,591
Traditional life insurance premiums 4,620 4,349 5,063
Reinsurance premiums (11,963) (11,179) (10,945)
Totals $ 51,294 53,834 45,709
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National Western's domestic life insurance in force, in terms of policy counts, has been declining for some time. The pace of new policies issued has lagged the number of policies terminated from death or surrender causing a declining level of policies in force from which contract revenue is received. Consequently, the number of domestic life insurance policies in force has declined from 47,900 atDecember 31, 2019 to 46,900 atDecember 31, 2020 and to 46,100 atDecember 31, 2021 . Policy lapse rates in 2021 remained level with the 6.0% experienced in 2020. While policy counts have declined, the face amount of life insurance in force has increased from$3.4 billion atDecember 31, 2019 to$3.5 billion atDecember 31, 2020 and to$3.7 billion atDecember 31, 2021 . Universal life insurance revenues are also generated with the issuance of new business based upon amounts per application and percentages of the face amount (volume) of insurance issued. The number of domestic policies issued during 2021 increased 2% over that in 2020 and the volume of insurance issued increased 5% from that in 2020. Universal life insurance revenues also include surrender charge income realized on terminating policies and, in the case of domestic universal life, amortization into income of the premium load on single premium policies which is deferred. Amounts deferred are amortized into revenues over future periods corresponding with the duration of the policies. The net premium load amortization associated with this activity was$4.3 million ,$11.4 million , and$8.2 million in 2021, 2020, and 2019, respectively. The net amortization amount in 2020 includes$5.9 million from the Company's annual unlocking of actuarial assumptions.
Premiums collected on universal life products are not reflected as revenues in
the Company's Consolidated Statements of Earnings in accordance with
GAAP. Actual domestic universal life premiums collected are detailed below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Universal life insurance:
First year and single premiums $ 203,329 194,520 180,457
Renewal premiums 16,870 17,905 18,124
Totals $ 220,199 212,425 198,581
Domestic life insurance sales for some time have consisted substantially of
single premium policies which do not have much in the way of recurring premium
payments. These products utilize wealth transfer strategies involving the
movement of accumulated wealth in alternative investment vehicles, including
annuities, into life insurance products. As a result, renewal premium levels
have not been exhibiting a corresponding level of increase as that of first year
and single premiums.
Net investment income for this segment of business, excluding derivative
gain/(loss), has been gradually increasing due to the increased new business
activity described above (single premium policies) and a higher level of
investments needed to support the corresponding growth in policy obligations,
especially those for single premium policies. The increase in net investment
income has been partially muted by lower investment yields from debt security
investment purchases during this time frame. Net investment income also includes
the gains and losses on index options purchased to back the index crediting
mechanism on fixed-index universal life products. A detail of net investment
income for domestic life insurance operations is provided below.
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Years Ended December 31,
2021 2020 2019
(In thousands)
Net investment income (excluding index option
derivatives) $ 51,733 47,380 44,399
Index option derivative gain 38,273 7,136 33,273
Net investment income $ 90,006 54,516 77,672
Universal life insurance contract interest $ 77,246 44,782 69,849
Life and policy benefits for a smaller block of business are subject to
variation from period to period. Claim count activity during 2021 decreased 5%
compared to 2020 while the average net claim amount increased to $37,700 from
$30,600 . In 2021, National Western's domestic life insurance segment incurred
129 COVID-19 claims with a net benefit amount (after reinsurance) of $4.5
million , roughly 9% of the total net claims for this segment. In 2020, National
Western's domestic life insurance segment incurred 70 COVID-19 claims with a net
benefit amount (after reinsurance) of $2.4 million , roughly 6% of the total net
claims for this segment. The low face amount per domestic life claim relative to
the current issued amounts of insurance per policy reflects the older block of
domestic life insurance policies sold which were final expense type products
(i.e. purchased to cover funeral costs). The overall mortality experience for
this segment has been consistent with pricing assumptions.
Included in amortization of deferred transaction costs is DPAC amortization. As
noted previously in the discussion of results from Consolidated Operations, the
Company records true-up adjustments to DPAC balances each period to reflect
current policy lapse or termination rates, expense levels and credited rates on
policies as compared to anticipated experience with the adjustment reflected in
current period amortization expense. To the extent required, unlocking
adjustments may also be recorded to DPAC balances. The following table
identifies the effects of unlocking adjustments on domestic life insurance DPAC
balances recorded through amortization expense separate from recurring
amortization expense components for 2021, 2020, and 2019.
Years Ended December 31,
2021 2020 2019
(In thousands)
Amortization of DPAC
Unlocking adjustments $ 495 7,391 (360)
Other amortization components 9,085 10,270 12,157
Totals $ 9,580 17,661 11,797
In 2021, DPAC balances were unlocked for this segment for mortality, lapse
rates, and portfolio yield (interest spread) increasing amortization expense by
$0.5 million . In 2020, DPAC balances were unlocked for this segment for
mortality, lapse rates, and investment spread also increasing amortization
expense. In 2019, DPAC balances were unlocked for this segment for mortality
rates, lapse rates, and portfolio yield rates (investment spread margin) which
cumulatively had the effect of marginally increasing DPAC balances (and reducing
amortization expense).
In the Consolidated Operations discussion of amortization of deferred
acquisition costs it was noted that interest earned on DPAC balances serves to
offset (decrease) amortization expense and that the interest rate used is the
crediting rate experience during the period. The decrease in the core
amortization expense in 2021 relative to 2020 reflects higher interest earned on
universal life DPAC balances due to increased realized gains from index options.
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Contract interest expense includes the fluctuations that are the result of the effect upon the embedded derivative for the performance of the underlying equity indices associated with fixed-indexed universal life products. For liability purposes, the embedded option in the Company's policyholder obligations for this feature is bifurcated and reserved for separately. Accordingly, the impact for the embedded derivative component in the equity-index universal life product is reflected in contract interest expense for approximately the same amounts as in net investment income for each respective period. Contract interest also includes certain policy reserve balance changes which are also subject to unlocking adjustments in conjunction with DPAC. As part of the unlockings discussed above, the Company increased its domestic life insurance excess benefit reserve balance by$0.5 million ,$1.4 million , and$0.3 million in 2021, 2020, and 2019, respectively (increasing contract interest expense). Operating expenses are allocated to lines of business based upon a functional cost analysis of the business activity giving rise to incurred expenses. With the Company's decision to cease accepting applications from international residents and the lower level of annuity sales, a higher proportion of operating expenses were allocated to the Domestic Life segment in 2021 and 2020 given the increase in activity in this segment and its greater share of the overall operational resources.
International Life Insurance Operations
A comparative analysis of results of operations for the Company's international
life insurance segment is detailed below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Premiums and other revenues:
Premiums and contract revenues $ 79,085 88,167 99,417
Net investment income 52,227 27,273 47,004
Other revenues 95 67 86
Total premiums and other revenue 131,407 115,507 146,507
Benefits and expenses:
Life and other policy benefits 26,481 14,084 17,064
Amortization of deferred transaction costs (11,118) 24,929 17,593
Universal life insurance contract interest 31,696 (2,087) 48,561
Other operating expenses 19,679 17,829 19,447
Total benefits and expenses 66,738 54,755 102,665
Segment earnings before Federal income taxes 64,669 60,752 43,842
Provision for Federal income taxes 13,249 9,143 9,024
Segment earnings $ 51,420 51,609 34,818
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As with Domestic Life operations, revenues from the International Life insurance
segment include both premiums on traditional type products and contract revenues
from universal life insurance. A comparative detail of premiums and contract
revenues is provided below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Universal life insurance revenues $ 77,225 85,185 95,391
Traditional life insurance premiums 8,314 9,272 10,659
Reinsurance premiums (6,454) (6,290) (6,633)
Totals $ 79,085 88,167 99,417
Universal life revenues and operating earnings are largely generated from the
amount of life insurance in force. Over the past three years, the volume of
insurance in force for this segment has contracted from $13.7 billion at
December 31, 2019 to $12.4 billion at December 31, 2020 and to $11.3 billion at
December 31, 2021 . The decline in volume of in force reflects the decision to
begin progressively disengaging from certain countries and ultimately making the
decision in 2018 to cease accepting international policy applications from
residents from all remaining countries.
Another component of international universal life revenues include surrender
charges assessed upon surrender of contracts by policyholders. In addition to
termination rates trending lower, the resulting surrender charge fee revenue has
been less due to policy contract provisions which provide for lower surrender
charge fees to be assessed later in the contract term. The following table
illustrates National Western's recent international life termination experience.
Volume In Force Terminations Amount in $'s Annualized Termination Rate
(millions)
Year Ended December 31, 2021 $ 1,080.1 8.7 %
Year Ended December 31, 2020 1,295.2 9.5 %
Year Ended December 31, 2019 1,671.5 10.9 %
Year Ended December 31, 2018 1,706.3 10.0 %
Year Ended December 31, 2017 2,309.7
12.2 %
As noted previously, premiums collected on universal life products are not
reflected as revenues in the Company's Consolidated Statements of Earnings in
accordance with GAAP. Actual international universal life premiums collected are
detailed below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Universal life insurance:
First year and single premiums $ - - 989
Renewal premiums 50,518 55,383 67,066
Totals $ 50,518 55,383 68,055
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National Western's most popular international products were its fixed-index universal life products in which the policyholder could elect to have the interest rate credited to their policy account values linked in part to the performance of an outside equity index. These products issued were not generally available in the local markets when sold. Included in the totals in the above table are collected premiums for fixed-index universal life products of approximately$28.9 million ,$32.4 million , and$41.3 million for the years ended 2021, 2020, and 2019, respectively. The declining trend in renewal premiums during these periods corresponds with the decline in policies in force due to the elimination of new sales and the termination activity as discussed above. As previously noted, net investment income and contract interest include period-to-period changes in fair values pertaining to call options purchased to hedge the interest crediting feature on the fixed-index universal life products. With the relatively large size of the fixed-index universal life block of business, the period-to-period changes in fair values of the underlying options have a significant effect on net investment income and universal life contract interest. A detail of net investment income for international life insurance operations is provided below. Years Ended December 31, 2021 2020 2019 (In thousands)
Net investment income (excluding index option derivatives)
26,938 30,126 Index option derivative gain 29,361 335 16,878 Net investment income$ 52,227 27,273 47,004 Universal life insurance contract interest$ 31,696 (2,087) 48,561 The gain or loss on index options follows the movement of the reference indice with realized gains or losses being recognized on the anniversary of each index option based upon the reference indice level at the expiration date relative to the index level at the time the index option was purchased. Unrealized gains and losses are recorded for index options outstanding based upon their fair values, largely determined by the reference indice level, at the balance sheet reporting date as compared to the original purchase cost of each respective option. Life and policy benefits primarily consist of death claims on policies. National Western's clientele for international products are generally wealthy individuals with access toU.S. dollars and quality medical care. Consequently, the amounts of coverage purchased historically tended to be larger amounts. Life and policy benefit expense for the international life segment reflects the larger policies historically purchased, however mortality due to natural causes is comparable to that inthe United States . The Company's maximum risk exposure per insured life is capped at$500,000 through reinsurance. The average international life net claim amount (after reinsurance) in 2021 increased to$202,900 from$158,200 while the number of claims incurred increased 43% from the amount incurred in 2020. Included in International Life death claims for 2021 were 72 with a cause of death identified as COVID-19 which aggregated to$19.0 million in net claims. Included in International Life death claims for 2020 were 18 with a cause of death identified as COVID-19 which aggregated to$2.7 million in net claims. The increased number of reported COVID-19 death claims accounts for substantially most of the increase in claim activity. 56
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Included in amortization of deferred transaction costs is DPAC amortization. The
Company records true-up adjustments to DPAC balances each period to reflect
current policy lapse or termination rates, expense levels, and credited rates on
policies as compared to anticipated experience as well as unlocking adjustments
as necessary. The following table identifies the effects of unlocking
adjustments on international life insurance DPAC balances recorded through
amortization expense separate from recurring amortization expense components for
2021, 2020, and 2019.
Years Ended December 31,
2021 2020 2019
(In thousands)
Amortization of DPAC
Unlocking adjustments $ (33,800) (20) (10,860)
Other amortization components 22,682 24,949 28,453
Totals $ (11,118) 24,929 17,593
In 2021, the Company unlocked DPAC balances associated with its International
Life segment for lapse rates, mortality, investment portfolio yields and cost of
insurance ("COI") charge increases. The effect of the prospective unlocking,
particularly for the COI charge increases, was to increase DPAC balances (and
decrease amortization expense) by $33.8 million .
In 2020, the Company unlocked DPAC balances for lapse rates, mortality, and
investment spread. While this unlocking had a relatively small impact on the
International Life segment DPAC balance, a substantially larger effect was
recorded in benefit reserves the change of which is reflected in contract
interest expense as discussed below.
In 2019, DPAC balances were unlocked for mortality rates, lapse rates, maintenance expenses, and investment spread which increased DPAC balances and reduced amortization expense. Favorable mortality experience on the block of business was the primary cause behind the DPAC balance increase and the amortization expense decrease. Contract interest expense includes the fluctuations that are the result of the effect upon the embedded derivative for the performance of the underlying equity indices associated with fixed-indexed universal life products. For liability purposes, the embedded option in the Company's policyholder obligations for this feature is bifurcated and reserved for separately. Accordingly, the impact for the embedded derivative component in the equity-index universal life product is reflected in the contract interest expense for approximately the same amounts as the purchased call options are reported in net investment income for each respective period. Amounts realized on purchase call options generally approximate the amounts credited to policyholders. As part of the mortality unlocking analysis done in 2021, the Company decreased its excess death benefit reserves by$14.1 million for favorable experience. The reduction in reserve is reported as an offset to contract interest expense. In 2020, the Company's excess benefit reserve was also unlocked resulting in a decrease in the amount of$22.8 million which served to decrease contract interest expense by a like amount. In 2019, the excess death benefit was unlocked producing a$7.9 million increase in the reserve and a similar increase in contract interest expense. As noted in the Domestic Life segment discussion, operating expenses are allocated to lines of business based upon a functional cost analysis of the activity by business area giving rise to incurred expenses. A greater proportion of the Company's overall operating expenses have been allocated toward the Domestic Life and Annuity segments and away from the International Life segment due to the decreased activity in this segment relative to the former two segments. 57
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Annuity Operations
A comparative analysis of results of operations for the Company's annuity
segment is detailed below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Premiums and other revenues:
Premiums and contract revenues $ 16,809 17,025 20,317
Net investment income 368,234 290,576 380,357
Other revenues 5,374 43 (34)
Total premiums and other revenues 390,417 307,644 400,640
Benefits and expenses:
Life and other policy benefits 67,515 31,043 41,487
Amortization of deferred transaction costs 61,881 87,133 79,064
Annuity contract interest 104,242 163,555 176,920
Other operating expenses 53,817 36,870 35,699
Total benefits and expenses 287,455 318,601 333,170
Segment earnings (loss) before Federal income taxes 102,962 (10,957) 67,470
Provision (benefit) for Federal income taxes 21,094 (1,649) 13,888
Segment earnings (loss) $ 81,868 (9,308) 53,582
Premiums and contract charges primarily consist of surrender charge income
recognized on terminated policies. The amount of the surrender charge income
recognized is determined by the volume of surrendered contracts as well as the
duration of each contract at the time of surrender given the pattern of
declining surrender charge rates over time that is common to most annuity
contracts. The Company's lapse rate for annuity contracts during 2021 was 8.6%,
an increase from a rate of 8.1% in 2020 and the 7.4% rate experienced in 2019.
The 2021 and 2020 lapse rates are elevated as an outcome of the COVID-19
pandemic crisis with consumers fortifying their liquidity positions. This has
manifested by consumers accessing funds available from their policies through
greater withdrawal and surrender activity. In addition, annuity contracts with
fixed interest rates are more prone to terminate as contracts approach the end
of their surrender charge period and in periods of rising interest rates.
Deposits collected on annuity contracts are not reflected as revenues in the
Company's Consolidated Statements of Earnings in accordance with GAAP. Actual
annuity deposits collected are detailed below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Fixed-index annuities $ 425,734 330,899 241,253
Other deferred annuities 3,727 7,355 14,747
Immediate annuities 32,488 20,627 8,648
Totals $ 461,949 358,881 264,648
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Fixed-index products are more attractive for consumers when interest rate levels remain low and equity markets produce positive returns. Since National Western does not offer variable products or mutual funds, fixed-index products provide an important alternative to the Company's existing fixed interest rate annuity products. Fixed-index annuity deposits as a percentage of total annuity deposits were 92%, 92%, and 91% for the years endedDecember 31, 2021 , 2020, and 2019, respectively. The percentage of fixed-index products to total annuity sales reflects the low interest rate environment and the overall positive performance in the equities market. Some of the Company's deferred products, including fixed-index annuity products, contain a first year interest bonus, in addition to the base first year interest rate, which is credited to the account balance when premiums are applied. These sales inducements are deferred in conjunction with other capitalized policy acquisition costs. The amounts currently deferred to be amortized over future periods amounted to approximately$18.1 million ,$10.3 million , and$3.2 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively. Amortization of deferred sales inducements is included as a component of annuity contract interest as described later in this discussion of Annuity Operations.
A detail of net investment income for annuity operations is provided below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Net investment income (excluding derivatives and trading
securities)
$ 219,094 283,293 307,301 Index option derivative gain 53,084 7,283 73,056 Embedded derivative liability decrease 84,725 - - Trading securities market adjustment 11,331 - - Net investment income$ 368,234 290,576 380,357 As noted in the Consolidated Operations discussion, the Company ceded net investment income of$55.1 million to the reinsurer under the funds withheld reinsurance agreement. This amount consisted entirely of net investment income from investments supporting the fixed and payout annuities ceded under the agreement. As seen in the above table, net investment income also includes the derivative gains and losses on index options purchased to back the index crediting mechanism on fixed-index products. The derivative gain or loss on index options follows the movement of the reference indice with realized gains and losses being recognized on the anniversary of each index option based upon the reference indice at the expiration date relative to the index level at the time the index option was purchased. Unrealized gains and losses are recorded for index options outstanding based upon their fair value, largely determined by the reference indice level, at the balance sheet reporting date as compared to the original purchase cost of each respective option. Since the embedded derivative option in the policies is bifurcated when determining the contract reserve liability, the impact of the market value change of index options on asset values generally aligns closely with the movement of the embedded derivative liability such that the net effect upon pretax earnings is negligible (i.e. net realized and unrealized gains/(losses) included in net investment income approximate the change in contract interest associated with the corresponding embedded derivative liability change). See further discussion below regarding contract interest activity. The funds withheld reinsurance agreement executedDecember 31, 2020 introduced embedded derivative accounting with respect to the annuity policyholder obligations reinsured. During the year endedDecember 31, 2021 , the embedded derivative liability decreased$84.7 million which was recorded as a component of investment income. Debt securities supporting the funds withheld policyholder obligations classified as trading securities incurred an$11.3 million market value increase in the year endedDecember 31, 2021 which was also recorded as a component of net investment income. The total of these two amounts, the embedded liability decrease and the change in market value of trading securities, or$96.0 million , increased net investment income for the Annuity segment. Other revenues in the year endedDecember 31, 2021 , includes$5.4 million of maintenance expense allowance revenue. Under the terms of the funds withheld reinsurance contract, National Western earns from the reinsurer a monthly expense allowance equal to the average policy count of the funds withheld reinsured block of business multiplied by a stated amount per policy. 59
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Life and other policy benefits for the Annuity segment include the effects of the annual prospective unlocking exercise performed by the Company. In 2021, the Company unlocked updating assumptions for the ultimate election rates associated with guaranteed minimum withdrawal benefit (GMWB) riders on its annuity contracts, GMWB utilization rates in certain durations, and portfolio yield rates supporting this business. The effect of the prospective unlocking was to increase the GMWB reserve by$27.4 million which increased Life and other policy benefits. Life and other policy benefits for the Annuity segment in 2020 also included the effects of the annual prospective unlocking exercise performed by the Company. The Company unlocked updating assumptions for the ultimate election rates associated with guaranteed minimum withdrawal benefit (GMWB) riders on its annuity contracts. The effect of the prospective unlocking was to reduce the GMWB reserve by$8.5 million which reduced Life and other policy benefits. The Company also unlocked for the mortality assumption associated with it payout annuity business. The effect of the prospective unlocking was to accelerate the deferred profit liability for this business by$3.3 million which also reduced Life and other policy benefits. Combined, the two unlockings decreased Life and other policy benefits by$11.8 million in 2020. As part of the unlockings performed in 2019, the Company also unlocked its policy benefits reserves associated with the assumptions regarding policyholder utilization of the GMWB rider. The assumptions were updated for actual utilization experience versus that which was previously assumed. The effect of this prospective unlocking was to increase policy reserves by$0.7 million (and increase Life and other policy benefits expense) in 2019. Included in amortization of deferred transaction costs is DPAC amortization. Consistent with the domestic and international life segments, the Company records true-up adjustments to DPAC balances each period to reflect current policy lapse or termination rates, expense levels and credited rates on policies as compared to anticipated experience as well as unlocking adjustments as necessary. The following table identifies the effects of unlocking adjustments on annuity DPAC balances recorded through amortization expense separate from recurring amortization expense components for 2021, 2020, and 2019. Years Ended December 31, 2021 2020 2019 (In thousands) Amortization of deferred transaction costs Unlocking adjustments$ (3,205) 14,987 2,577 DPAC amortization expense 51,932 72,146 76,487 Cost of reinsurance amortization expense 13,154 - - Totals$ 61,881 87,133 79,064 In 2021, the Company unlocked Annuity segment DPAC balances for assumptions pertaining to lapse rates, annuitization rates, portfolio investment yield rates supporting the block of business, and expenses. The effect of the prospective unlocking was to increase DPAC balances by$3.2 million (and decrease amortization expense).
In 2020, the Company unlocked Annuity segment DPAC balances for assumptions
pertaining to lapse rates, annuitization rates, and portfolio investment yield
rates supporting the block of business which increased amortization expense
approximately
DPAC balances associated with the Annuity segment were unlocked in 2019 for assumptions pertaining to lapse rates, annuitization rates, investment spreads, and utilization of the Company's withdrawal benefit rider. The effect of the prospective unlocking was to increase amortization expense$2.6 million . Amortization of DPAC balances is proportional to estimated expected gross profits ("EGPs") for a line of business. The EGPs of the block of annuity policies have been steadily decreasing with the declining amount of policies in force, as well as DPAC unlocking in recent years for unfavorable experience. In addition, experience which deviates from the EGPs assumed, such as the amounts of asset fees collected, can similarly increase or decrease the amortization of DPAC. In the year endedDecember 31, 2021 , DPAC amortization expense was reduced by$6.2 million for DPAC ceded to a reinsurer under the funds withheld reinsurance agreement entered into atDecember 31, 2020 . 60
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Amortization of deferred transaction costs includes amortization of the cost of reinsurance recorded at year-end 2020 associated with the funds withheld reinsurance agreement. AtDecember 31, 2020 , the Company recorded as an asset on the Consolidated Balance Sheet a deferred Cost of Reinsurance ("COR") amount of$102.8 million associated with the funds withheld reinsurance transaction. This represents the amount of assets transferred at the closing date of the funds withheld agreement (debt securities, policy loans, and cash) in excess of the GAAP liability ceded plus a$48 million ceding commission paid to the reinsurer. The COR balance is amortized commensurate with the runoff of the ceded block of funds withheld business. In the year endedDecember 31, 2021 , COR amortization expense of$13.2 million is included in Amortization of deferred transaction costs. Annuity contract interest includes the equity component return associated with the call options purchased to hedge National Western's fixed-index annuities. The detail of fixed-index annuity contract interest as compared to contract interest for all other annuities is as follows: Years Ended December 31, 2021 2020 2019 (In thousands) Fixed-indexed annuities$ 108,878 65,785 100,292 All other annuities (281) 85,307 59,434 Gross contract interest 108,597 151,092 159,726 Bonus interest deferred and capitalized (18,117) (10,344) (3,160) Bonus interest amortization 13,762 22,807 20,354 Total contract interest$ 104,242 163,555 176,920 The fluctuation in reported contract interest amounts for fixed-index annuities is driven by sales levels, the level of the business in force, and the effect of positive or negative market returns of option values on projected interest credits. As noted in the net investment income discussion, the amounts shown for contract interest for fixed-index annuities generally align with the derivative gains/(losses) included in net investment income due to the market change of index options aligning closely with the movement of the embedded derivative liability held for these products. In the year endedDecember 31, 2020 , in addition to the effects of the unlocking adjustments on Life and other policy benefits and amortization of DPAC expenses, the unlocking assumption changes impacted certain annuity benefit reserves. The Company unlocked the mortality assumption with regards to payout annuities (contracts paying systematic benefits), with the effect of the prospective unlocking increasing annuity benefit reserves by$22.8 million which increased contract interest expense by a like amount. For other deferred fixed rate annuities, 2020 unlocking assumption changes pertaining to lapse rates, annuitization rates and portfolio yields supporting the block of business increased annuitization and excess death benefit reserves by$11.3 million which similarly increased contract interest expense. Collection of asset management fees on positive returns of expiring options is subtracted from contract interest credited to policyholders. This offset serves to lessen the increase in contract interest expense relative to the option gains reported in the Company's net investment income. Asset management fees collected during 2021, 2020, and 2019 were$5.8 million ,$30.7 million , and$15.9 million , respectively. As previously noted, the Company changed its option hedging methodology during 2020 to an "out-of-the-money" approach. During 2021, all outstanding options had been converted to this methodology which no longer hedges for the collection of asset management fees. Consequently, asset management fees collected during 2021 exhibited a decline. 61
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As previously noted, accounting rules require the embedded derivative liability to include a projection of asset management fees estimated to be collected in the succeeding fiscal year due to the Company's historical practice of purchasing options priced to incorporate an expected probability of collecting asset management fees (referred to as "at the money hedging"). This projection for the embedded derivative liability is based upon the recent performance of the reference equity index. Increases in projected asset management fees to be collected reduce contract interest expense while decreases in projected asset management fees to be collected increase contract interest. During the years endedDecember 31, 2021 , 2020, and 2019, contract interest was increased/(decreased) by$6.5 million ,$34.4 million , and$(33.6) million , respectively, for this occurrence. As noted above, the Company changed its option hedging methodology during 2020 to an "out-of-the-money" approach. By the end of the second quarter of 2021, all outstanding options had been converted to this methodology which no longer hedges for the collection of asset management fees. As a result, projections of collected asset management fees were no longer applicable in the second half of 2021 (as the inventory of annual at the money hedges rolled over to only out-of-the-money hedges). Annuity contract interest includes true-up adjustments for the deferred sales inducement balance which are done each period similar to that done with respect to DPAC balances with the adjustment reflected in current period contract interest expense. To the extent required, the Company may also record unlocking adjustments to deferred sales inducement balances in conjunction with DPAC balance unlockings. In conjunction with the previously discussed unlocking adjustments, the Company unlocked its deferred sales inducement balance during the years endedDecember 31, 2021 , 2020, and 2019 the effect of which was to increase/(decrease) bonus interest amortization by$(1.0) million ,$4.4 million , and$0.6 million , respectively.
As noted in the Domestic Life insurance and International Life insurance
segments, the Company's overall operating expenses are allocated based upon
functional business activity and volumes.
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Table of Contents ONL & Affiliates EffectiveJanuary 31, 2019 , Ozark National and NIS were acquired and their results included in the Consolidated Financial Statements of the Company. Ozark National and NIS have been combined into a separate segment "ONL & Affiliates" given their inter-related marketing and sales approach which consists of a coordinated sale of a non-participating whole life insurance product (Ozark National) and a mutual fund investment product (NIS). An analysis of results of operations for the Company's acquired businesses segment is detailed below. The 2019 results include activity subsequent to the acquisition date. 2021 2020 2019 (In thousands) Premiums and contract revenues: Premiums and contract charges$ 77,109 78,921 74,526 Net investment income 26,989 26,383 22,593 Other revenues 12,654 10,118 8,445 Total revenues 116,752 115,422 105,564 Benefits and expenses: Life and other policy benefits 69,165 67,739
59,843
Amortization of deferred transaction costs 9,118 10,780
8,348 Other operating expenses 20,244 18,454 17,056 Total benefits and expenses 98,527 96,973 85,247
Segment earnings before Federal income taxes 18,225 18,449
20,317
Provision for Federal income taxes 3,675 4,413 3,700 Segment earnings$ 14,550 14,036 16,617 Revenues from acquired businesses principally include life insurance premiums on traditional type products. Unlike universal life, revenues from traditional products are simply life premiums recognized as income over the premium-paying period of the related policies. The detail of premiums is provided below. 2021 2020
2019
(In thousands)
Traditional life insurance premiums $ 79,450 81,222
76,576
Other insurance premiums and considerations 423 434 419 Reinsurance premiums (2,764) (2,735) (2,469) Totals$ 77,109 78,921 74,526 63
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Ozark National's traditional life block of business atDecember 31, 2021 included 175,610 policies in force representing$5.9 billion of life insurance coverage. The repetitive pay nature of Ozark National's business promotes a higher level of persistency with an annualized lapse rate of 4.0% for the year endedDecember 31, 2021 as compared to 4.1% in 2020. Traditional life premiums by first year and renewal are detailed below. 2021 2020 2019 (In thousands) Traditional life insurance premiums: First year premiums$ 3,419 3,943 5,332 Renewal premiums 76,031 77,279 71,244 Totals$ 79,450 81,222 76,576 Other revenues consists primarily of brokerage revenue of NIS. Brokerage revenues of$12.5 million for 2021,$9.9 million for 2020, and$8.2 million for 2019 had associated brokerage expenses of$6.1 million ,$5.1 million , and$4.4 million , respectively, which are included in Other operating expenses. The 2019 figures are for the eleven months subsequent to its acquisition by the Company. The average face value of Ozark National's policies in force atDecember 31, 2021 was approximately$33,600 . Consequently, life and policy benefits for smaller face amounts are subject to variation from quarter to quarter. Incurred death claims in 2021 were$39.6 million representing an average net claim of$15,400 . Incurred death claims in 2020 were$37.0 million representing an average net claim of$14,800 . For the eleven months of operations in 2019 incurred death claims were$29.3 million representing an average net claim of$15,300 . Included in 2021 death claims were 458 reported claims with a cause of death identified as COVID-19 which aggregated to$8.2 million in net claims. Included in 2020 death claims were 191 claims with a reported cause of death identified as COVID-19 which aggregated to$2.8 million in net claims. Ozark National's maximum retention on any single insured life is$200,000 with limited exceptions related to the conversion of child protection and guaranteed insurability riders. The balance of life and policy benefits during 2021, 2020, and 2019 consists of increases in insurance reserves and payments of other policy benefits. 64
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Amortization of deferred transaction costs for this segment includes amortizatioin of DPAC and the value of business acquired. As part of the purchase accounting required with the acquisition of Ozark National effectiveJanuary 31, 2019 , the Company recorded an intangible asset of$145.8 million referred to as the value of business acquired ("VOBA"). VOBA represents the difference between the acquired assets and liabilities of Ozark National measured in accordance with the Company's accounting policies and the fair value of these same assets and liabilities. The VOBA balance sheet amount is amortized following a methodology similar to that used for amortizing deferred policy acquisition costs. During the year endedDecember 31, 2020 , the cash value of certain acquired reserves was increased which resulted in a commensurate increase in both the traditional life reserve liability and the related VOBA balance reported on the Consolidated Balance Sheets. Subsequent to its acquisition effectiveJanuary 31, 2019 , Ozark National began deferring policy acquisition costs and amortizing these deferrals similar to the methodology employed by National Western. The following table identifies the amortization expense of Ozark National's DPAC and VOBA for the years shown. Amortization of deferred transaction costs 2021 2020 2019 (In thousands) Unlocking $ - - - VOBA amortization expense 8,468 10,228 7,697 DPAC amortization expense 650 552 651 Totals$ 9,118 10,780 8,348 Other Operations The Company's primary business encompasses its domestic and international life insurance operations, its annuity operations, and ONL & Affiliates. However, the Company also has real estate and other investment operations through its wholly owned subsidiaries, and owned nursing home operations through the early part of 2019. As discussed in the Consolidated Operations section, the Company closed on the sales of its two nursing home facilities during 2019. Operating results for each entity are included to the date of their respective sales. Nursing home operations generated$(0.2) million ,$(0.7) million , and$0.8 million of pre-tax earnings in 2021, 2020, and 2019, respectively. The results for 2019 include net gains of$1.4 million from the sale ofReno personal property and equipment. Pre-tax operating amounts include the results ofBP III , the entity owning and operating the Company's home office facility inAustin, Texas .BP III incurred pre-tax losses of$(0.8) million ,$(0.9) million , and$(1.4) million in 2021, 2020, and 2019, respectively. National Western maintains its home office in the facility leasing approximately 40% of the space available. Lease and operating expense payments made by National Western toBP III have been eliminated in consolidation. The remaining pre-tax earnings in Other Operations of$24.2 million ,$22.6 million , and$25.2 million for the years endedDecember 31, 2021 , 2020, and 2019, respectively, includes investment income from real estate, municipal bonds, and common and preferred equities held in subsidiary company portfolios principally for tax-advantage purposes. Included in these amounts are semi-annual distributions from a life interest in theLibbie Shearn Moody Trust which is held inNWLSM, Inc. Pretax distributions from this trust were$5.7 million ,$5.3 million , and$6.7 million in 2021, 2020, and 2019, respectively. In addition, the Company holds a modest portfolio of equity securities, primarily inNWL Financial, Inc. , whose fair value changes are recorded in net investment income. For the years endedDecember 31, 2021 , 2020, and 2019, the market value changes for these securities were$6.0 million ,$(1.0) million , and$3.5 million , respectively. Pre-tax earnings in 2020 include other revenue of$4.1 million pertaining to the release of a contingent purchase price liability associated with the Ozark National acquisition which the buyer and seller mutually agreed had been satisfied. Pre-tax earnings in 2019 include expenses of$3.3 million related to the purchase of Ozark National and NIS which were not eligible for inclusion in the purchase price. 65
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Table of Contents INVESTMENTS General
The Company's investment philosophy emphasizes the careful handling of
policyowners' and stockholders' funds to achieve security of principal, to
obtain the maximum possible yield while maintaining security of principal, and
to maintain liquidity in a measure consistent with current and long-term
requirements of the Company.
The Company's overall investment philosophy is reflected in the allocation of its investments, which is detailed below as ofDecember 31, 2021 and 2020. The Company has historically emphasized investment grade debt securities. December 31, 2021 December 31, 2020 Carrying Value % Carrying Value % (In thousands) (In thousands) Debt securities available-for-sale$ 9,068,946 82.7$ 10,770,923 94.2 Debt securities trading 1,077,438 9.8 - - Mortgage loans 487,304 4.4 332,521 2.9 Policy loans 71,286 0.6 74,083 0.6 Derivatives, index options 101,622 0.9 132,821 1.2 Real estate 28,606 0.3 33,783 0.3 Equity securities 28,217 0.3 17,744 0.2 Other 109,064 1.0 70,330 0.6 Totals$ 10,972,483 100.0$ 11,432,205 100.0 Invested assets atDecember 31, 2021 include Ozark National amounts as follows: Debt securities of$823.0 million ; Policy loans of$23.3 million ; and Real estate of$0.0 million . These amounts as ofDecember 31, 2020 consisted of: Debt securities of$811.6 million ; Policy loans of$25.5 million ; and Real estate of$4.6 million . The Company's investment portfolio decreased 4% to$11.0 billion atDecember 31, 2021 compared to$11.4 billion atDecember 31, 2020 primarily reflecting a reduction in unrealized gains for investments recorded at their fair market values and higher balances maintained in cash and cash equivalents atDecember 31, 2021 . EffectiveDecember 31, 2020 , National Western entered into a Funds Withheld Coinsurance Agreement ("Agreement") withProsperity Life Assurance Limited ("Prosperity") under which it ceded a 100% quota share of contractual statutory annuity reserve liabilities approximating$1.7 billion . Under terms of the Agreement, National Western, on behalf of Prosperity, transferred debt securities to a funds withheld account on its Consolidated Balance Sheet. These securities had previously been classified as held-to-maturity with an amortized cost value of$964.8 million and as available-for-sale at a fair market value of$712.5 million . Prosperity, as investment manager of the funds withheld account, indicated their intention to actively trade these securities in an effort to secure higher yields. Since Prosperity's intent was to not hold the funds withheld debt securities to maturity, the Company was required to reclassify the transferred holdings in the held-to-maturity category to the available-for-sale portfolio category for financial statement purposes. An unrealized gain of$67.1 million was recorded as a result of this transfer and resulted in all funds withheld debt securities recorded at fair market value as ofDecember 31, 2020 . During 2021, the reinsurer actively engaged in selling debt securities in the funds withheld account and purchasing other debt securities. The debt securities acquired by the reinsurer remain as invested assets on the Company's financial statements and have been classified as trading debt securities. The designation as trading debt securities allows the market value fluctuation of these securities to be recorded directly in the Consolidated Statements of Earnings. This results in offsetting the embedded derivative liability change due to market value fluctuations which is also recorded directly in the Consolidated Statements of Earnings. 66
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The Company historically designated approximately 70% of its debt securities in the held-to-maturity portfolio category, which is reported at amortized cost, with the remainder designated in the available-for-sale portfolio, which is reported at fair market value. As an outcome of the accounting for the securities involved in the Agreement with Prosperity, the Company's remaining held-to-maturity securities not included in the Agreement were also precluded from retaining the held-to-maturity classification. Accordingly, atDecember 31, 2020 the Company reclassified debt securities with a$5.7 billion amortized cost to the available-for-sale category and recognized an unrealized gain of$523.8 million in reporting the securities at their fair market values. Consequently, the increase in the investment portfolio during 2020 was primarily due to reporting balances at fair market value. Derivatives are call options purchased to hedge the interest crediting mechanism associated with the Company's fixed-index universal life and annuity policies. These options are reported on the Consolidated Balance Sheets at fair value in accordance with GAAP. The unrealized gain position of options held atDecember 31, 2021 was$54.4 million which was$16.6 million lower than the unrealized gain position atDecember 31, 2020 of$71.0 million . The decrease is due to the Company moving to an "out-of-the-money" option approach during 2020 which reduces the cost of options by not hedging for potential collection of asset management fees on the associated equity-indexed annuity contracts. The purchase cost of options outstanding atDecember 31, 2021 was$47.2 million and atDecember 31, 2020 was$61.8 million . The Other investment category primarily consists of investments in alternative investment opportunities which have the potential for higher yields than that available with other investment securities. The typical structure involves a fund under the management of an investment management firm with direct lending expertise in a particular market niche which seeks to construct portfolios comprised of senior secured debt. The Company participates through capital funding commitments approved by its Board of Directors based upon the recommendation of the Company's senior investment management team. The funds have targeted dollar sizes and targeted internal rates of return. The Company strategically targeted increasing the portion of its investment portfolio allocated to mortgage loans and alternative investments in the past two years.
The Company maintains a diversified debt securities portfolio which consists mostly of corporate, mortgage-backed, and public utility fixed income securities. Investments in mortgage-backed securities primarily includeU.S. government agency pass-through securities and collateralized mortgage obligations ("CMO"). The Company's investment guidelines prescribe limitations by type of security as a percent of the total investment portfolio and all holdings were within these threshold limits. As ofDecember 31 , the Company's debt securities portfolio classified as available-for-sale consisted of the following for 2021 and 2020: December 31, 2021 December 31, 2020 Carrying Value % Carrying Value % (In thousands) (In thousands) Corporate$ 6,700,953 73.8$ 8,098,973 75.2 Residential mortgage-backed 549,623 6.1 953,788 8.9 Public utilities 784,969 8.7 909,910 8.4 State and political subdivisions 505,960 5.6 566,089 5.3 U.S. agencies 44,543 0.5 75,441 0.7 Asset-backed securities 390,260 4.3 120,524 1.1 Commercial mortgage-backed 27,757 0.3 31,471 0.3 Foreign governments 62,391 0.7 11,449 0.1 U.S. Treasury 2,490 - 3,278 - Totals$ 9,068,946 100.0$ 10,770,923 100.0 67
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A substantial portion of the Company's investable cash flows are directed toward the purchase of long-term debt securities. The Company's investment policy calls for investing in debt securities that are investment grade, meet quality and yield objectives, and provide adequate liquidity for obligations to policyholders. Particular attention is paid to avoiding concentration in any one industry classification or in large singular credit exposures. Debt securities with intermediate maturities are targeted by the Company as they more closely match the intermediate nature of the Company's policy liabilities and provide an appropriate strategy for managing cash flows. In the past several years, the Company has purchased a higher level of longer maturity debt securities to match the increased duration of its growing life insurance policy liabilities. The Company holds minimal levels ofU.S. Treasury securities due to their low yields and deposits most of these holdings with various state insurance departments in order to meet security deposit on hand requirements in these jurisdictions. AtDecember 31, 2021 , the Company has no investments in debt securities in businesses based inRussia orUkraine and has minimal, if any, holdings in debt securities with exposure to these areas.
Long-term debt securities purchased to fund National Western insurance company
operations are summarized below.
Years Ended December 31,
2021 2020
(Dollars in thousands)
Cost of acquisitions $ 1,104,009 $ 727,947
Average S&P quality A- BBB+
Effective annual yield 3.02 % 3.33 %
Spread to treasuries 1.31 % 2.10 %
Effective duration 10.5 years 12.2 years
The Company has deemphasized mortgage-backed securities for a number of years
given the low interest rate environment and the lack of incremental yield
relative to other classes of debt securities. Rating agencies generally view
mortgage-backed securities as having additional risk for insurers holding
interest sensitive liabilities given the potential for asset/liability
disintermediation. Consequently, the Company holds predominantly agency
mortgage-backed securities. Because mortgage-backed securities are subject to
prepayment and extension risk, the Company has substantially reduced these risks
by investing in collateralized mortgage obligations ("CMO"), which have more
predictable cash flow patterns than pass-through securities. These securities,
known as planned amortization class I ("PAC I"), very accurately defined
maturity ("VADM"), and sequential tranches, are designed to amortize in a more
predictable manner than other CMO classes or pass-throughs. The Company does not
purchase tranches, such as PAC II and support tranches, that subject the
portfolio to greater than average prepayment risk. Using this strategy, the
Company can more effectively manage and reduce prepayment and extension risks,
thereby helping to maintain the appropriate matching of the Company's assets and
liabilities.
In addition to diversification, an important aspect of the Company's investment
approach is managing the credit quality of its investment in debt
securities. Thorough credit analysis is performed on potential corporate
investments including examination of a company's credit and industry outlook,
financial ratios and trends, and event risks. This emphasis is reflected in the
high average credit rating of the Company's debt securities portfolio with
98.3%, as of December 31, 2021 , held in investment grade securities. In the
table below, investments in debt securities available-for-sale are classified
according to credit ratings by nationally recognized statistical rating
organizations.
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December 31, 2021 December 31, 2020
Carrying Value % Carrying Value %
(In thousands) (In thousands)
AAA $ 126,954 1.4 $ 116,147 1.1
AA 2,474,572 27.3 1,818,879 16.9
A 1,861,686 20.5 3,188,008 29.6
BBB 4,452,694 49.1 5,344,412 49.6
BB and other below investment grade 153,040 1.7 303,477 2.8
Totals $ 9,068,946 100.0 $ 10,770,923 100.0
Historically, the Company's investment guidelines have not permitted the
purchase of below investment grade securities. Recently, these guidelines were
amended to allow for purchases of below investment grade securities that are
part of an alternative investment ("Schedule BA assets"). The Company continues
its longstanding practice of not purchasing any other below investment grade
securities. Investments held in available-for-sale debt securities may become
below investment grade as the result of subsequent downgrades of the
securities. These below investment grade holdings, including structured notes
associated with the Schedule BA assets category, are further summarized below.
% of Invested
Amortized Cost Carrying Value Fair Value Assets
(In thousands except percentages)
December 31, 2021 $ 150,447 153,040 153,040 1.4 % December 31, 2020 $ 300,417 303,477 303,477 2.7 % The Company's percentage of below investment grade securities compared to total invested assets atDecember 31, 2021 decreased compared to year-end 2020 primarily due to the disposal of below investment grade securities during 2021. The Company's holdings of below investment grade securities are relatively small and as a percentage of total invested assets remain low compared to industry averages. 69
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Holdings in below investment grade securities by category as ofDecember 31, 2021 are summarized below, including their comparable fair value as ofDecember 31, 2020 for those debt securities rated below investment grade atDecember 31, 2021 . The Company continually monitors developments in these industries for issues that may affect security valuation.
Fair Value Fair Value
Industry Category Amortized Cost 2021 Carrying Value 2021 2021 2020
(In thousands)
Asset-backed securities 1,139 1,154 1,154 1,156
Oil & gas 93,581 95,772 95,772 91,982
Manufacturing 37,823 38,032 38,032 39,510
Other 17,904 18,082 18,082 6,352
Total before allowance for credit losses 150,447 153,040 153,040 139,000
Allowance for credit losses - - - -
Totals $ 150,447 153,040 153,040 139,000
The Company closely monitors its below investment grade holdings by reviewing
investment performance indicators, including information such as issuer
operating performance, debt ratings, analyst reports and other economic factors
that may affect these specific investments. While additional losses are not
currently anticipated, based on the existing status and condition of these
securities, credit deterioration of some securities or the markets in general is
possible, which may result in future allowances or write-downs.
Generally accepted accounting principles through the end of 2019 required that
investments in debt securities be written down to fair value when declines in
value were judged to be other-than-temporary. Fair value is the price that would
be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date (an exit price
methodology). Refer to Note (4), Fair Values of Financial Instruments, of the
accompanying Notes to Consolidated Financial Statements for further discussion.
During 2019, the Company recorded a $7.8 million other-than-temporary impairment
on a single debt security issuer. Under the GAAP guidance at that time
pertaining to the recognition and accounting for other-than-temporary
impairments and their classification as either a credit loss or non-credit loss,
the Company recognized a cumulative total of $7.8 million of
other-than-temporary impairments of which $7.8 million was deemed credit related
and recognized as realized investment losses in earnings, and $0.0 million , net
of amortization, which was deemed non-credit related and recognized in other
comprehensive income.
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As disclosed in Note (1) Summary of Significant Accounting Policies in the accompanying Notes to Consolidated Financial Statements in this report, the Company adopted new accounting guidance effectiveJanuary 1, 2020 for credit loss recognition of certain financial assets, including debt securities classified in the "held-to-maturity" category. The Company employed a cohort cumulative loss rate method in estimating current expected credit losses with respect to its held-to-maturity debt securities as ofJanuary 1, 2020 and derived an initial allowance of$3.3 million . This method applied publicly available industry wide statistics of default incidence by defined segmentations of debt security investments combined with future assumptions regarding economic conditions (i.e. GDP forecasts) both in the near term and the long term. As noted previously, atDecember 31, 2020 , the Company was required to reclassify all of its held-to-maturity debt securities to the available-for-sale category eliminating the allowance previously recorded. The following table presents the allowance for credit losses activity for the period shown. December 31, 2021 2020 Debt Securities Allowance for Credit Losses: Balance, beginning of the period $ - $ - Impact of adopting new accounting guidance -
3,334
(Releases)/provision during the period - (3,334) Balance, end of period $ - $ - The Company is required to classify its investments in debt securities into one of three categories: (a) trading securities; (b) securities available-for-sale; or (c) securities held-to-maturity. The Company's investment philosophy calls for purchases of securities with the intent to hold to maturity. Historically, a determination was made on categorization based on various factors including the type and quality of the particular security and how it will be incorporated into the Company's overall asset/liability management strategy. As shown in the table below, atDecember 31, 2021 , 89.4% of the Company's total debt securities were classified as securities available-for-sale, including the debt securities in the funds withheld account. These holdings in available-for-sale provide flexibility to the Company to react to market opportunities and conditions and to practice active management within the portfolio to provide adequate liquidity to meet policyholder obligations and other cash needs. December 31, 2021 Allowance For Fair Value Amortized Cost Credit Loss Net Unrealized Gains (In thousands) Debt securities available-for-sale$ 9,068,946 8,604,250 - 464,696 Debt securities trading 1,077,438 1,066,108 - 11,330 Totals$ 10,146,384 9,670,358 - 476,026 Under the terms of the funds withheld reinsurance agreement, effectiveDecember 31, 2020 , the Company, on behalf of the reinsurer, transferred debt securities approximating$1.7 billion to a funds withheld account. Due to the nature of the reinsurance transaction, these debt securities remained as invested assets on the Company's financial statements and were included in the available-for-sale category. In accordance with the terms of the agreement, the reinsurer, or their appointed sub-advisor, was granted investment management authority with respect to these securities following agreed upon investment guidelines defined in the reinsurance agreement. During 2021, the reinsurer actively engaged in selling debt securities in the funds withheld account and purchased other debt securities. The debt securities acquired by the reinsurer remain as invested assets on the Company's financial statements and have been classified as trading debt securities. The designation as trading debt securities allows the market value fluctuation of these securities to be recorded directly in the Consolidated Statements of Earnings. This results in offsetting the embedded derivative liability change due to market value fluctuations which is also recorded directly in the Consolidated Statements of Earnings. 71
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The Company's trading debt securities portfolio consisted of the following
classes of securities:
December 31, 2021 December 31, 2020
Carrying % Carrying %
Value Value
(In thousands) (In thousands)
Corporate $ 423,778 39.4 $ - -
Residential mortgage-backed securities 44,772 4.2 - -
Public utilities 36,973 3.4 - -
State and political subdivisions 17,487 1.6 - -
Asset-backed securities 313,855 29.1 - -
Commercial mortgage-backed 240,573 22.3 - -
Totals $ 1,077,438 100.0 $ - -
In the table below, investments in trading debt securities are classified
according to credit ratings by nationally recognized statistical rating
organizations.
December 31, 2021 December 31, 2020
Carrying Carrying
Value % Value %
(In thousands) (In thousands)
AAA $ 6,473 0.6 $ - -
AA 251,507 23.3 - -
A 207,637 19.3 - -
BBB 573,139 53.2 - -
BB and other below investment grade 38,682 3.6 - -
Totals $ 1,077,438 100.0 $ - -
The investments in the trading debt securities below investment grade are
summarized below.
Below
Amortized Carrying Fair % of
Cost Value Value Invested
Assets
(In
thousands, except percentages)
December 31, 2021 $ 39,470 38,682 38,682 0.4 %
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Mortgage Loans and Real Estate
The Company originates loans on high quality, income-producing properties such as shopping centers, freestanding retail stores, office buildings, industrial and sales or service facilities, selected apartment buildings, hotels, and health care facilities. The location of these properties is typically in major metropolitan areas that offer a potential for property value appreciation. Credit and default risk is minimized through strict underwriting guidelines and diversification of underlying property types and geographic locations. In addition to being secured by the property, mortgage loans with leases on the underlying property are often guaranteed by the lease payments. This approach has proved over time to result in quality mortgage loans with few defaults. Mortgage loan interest income is recognized on an accrual basis with any premium or discount amortized over the life of the loan. Prepayment and late fees are recorded on the date of collection. The Company targets a minimum specified yield on mortgage loan investments determined by reference to currently available debt security instrument yields, plus a desired amount of incremental basis points. A low interest rate environment, along with a competitive marketplace, more recently resulted in fewer loan opportunities being available that met the Company's required rate of return. During 2020, mortgage loan originations were further impeded by the COVID-19 pandemic and its effects upon the commercial real estate market. As stabilization returned to the commercial real estate market, the Company directed resources and effort towards expanding its mortgage loan investment portfolio. Mortgage loans originated by the Company totaled$183.6 million and$80.2 million for the years 2021 and 2020, respectively. Principal repayments on mortgage loans in 2021 and 2020 were$28.8 million and$14.8 million , respectively. Loans in foreclosure, loans considered impaired or loans past due 90 days or more are placed on a non-accrual status. If a mortgage loan is determined to be on non-accrual status, the mortgage loan does not accrue any revenue into the Consolidated Statements of Earnings. The loan is independently monitored and evaluated as to potential impairment or foreclosure. If delinquent payments are made and the loan is brought current, then the Company returns the loan to active status and accrues income accordingly. The Company currently has no loans past due 90 days which are accruing interest. As a result of the economic climate change induced by the COVID-19 virus, during 2020 various mortgage loan borrowers of the Company requested a temporary forbearance of principal payments on loans in the range of three to nine months. There were eight loans representing an aggregate principal balance of$29.2 million with borrowers meeting specified criteria of the Company that forbearance terms were agreed to. AtDecember 31, 2020 , only one of these loans with a principal balance of$4.7 million remained in forbearance. All forbearance loans returned to the terms of the original loan agreements during the first quarter of 2021. Included in the mortgage loan investment balance atDecember 31, 2021 , are three mortgage loan investments made by the reinsurer under the funds withheld reinsurance agreement totaling$8.5 million . Similar to trading debt securities, these loans are reported at fair market values in order to allow the market value fluctuation to be recorded directly in the Consolidated Statements of Earnings and to offset the embedded derivative liability change due to market value fluctuations. 73
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The Company held net investments in mortgage loans, after allowances for
possible losses, totaling
and 2020, respectively. The diversification of the portfolio by geographic
region, property type, and loan-to-value ratio was as follows:
December 31, 2021 December 31, 2020
Amount % Amount %
(In (In
thousands) thousands)
Mortgage Loans by Geographic Region :
West South Central $ 237,644 48.5 $ 201,501 60.1
East North Central 61,397 12.6 16,478 4.9
South Atlantic 81,847 16.7 51,857 15.5
East South Central 20,069 4.1 27,590 8.2
West North Central 12,213 2.5 12,423 3.7
Pacific 13,800 2.8 6,228 1.9
Middle Atlantic 36,296 7.4 1,975 0.6
Mountain 26,613 5.4 16,955 5.1
Gross balance 489,879 100.0 335,007 100.0
Market value adjustment 412 0.1 - -
Allowance for credit losses (2,987) (0.6) (2,486) (0.7)
Totals $ 487,304 99.5 $ 332,521 99.3
December 31, 2021 December 31, 2020
Amount % Amount %
(In (In
thousands) thousands)
Mortgage Loans by Property Type:
Retail $ 164,895 33.7 $ 92,173 27.5
Office 142,824 29.2 111,735 33.3
Hotel 23,748 4.8 8,372 2.5
Storage Facility 73,401 15.0 53,591 16.0
Industrial 34,212 7.0 29,131 8.7
Land/Lots 4,597 0.9 4,680 1.4
Apartments 38,920 7.9 29,743 8.9
Residential 1,905 0.4 - -
All other 5,377 1.1 5,582 1.7
Gross balance 489,879 100.0 335,007 100.0
Market value adjustment 412 0.1 - -
Allowance for credit losses (2,987) (0.6) (2,486) (0.7)
Totals $ 487,304 99.5 $ 332,521 99.3
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December 31, 2021 December 31, 2020
Amount % Amount %
(In (In
thousands) thousands)
Mortgage Loans by Loan-to-Value Ratio (1):
Less than 50% $ 100,806 20.6 $ 66,635 19.9
50% to 60% 128,191 26.2 64,536 19.3
60% to 70% 202,670 41.3 153,414 45.8
70% to 80% 58,212 11.9 50,422 15.0
80% to 90% - - - -
Gross balance 489,879 100.0 335,007 100.0
Market value adjustment 412 0.1 - -
Allowance for credit losses (2,987) (0.6) (2,486) (0.7)
Totals $ 487,304 99.5 $ 332,521 99.3
(1) Loan-to-Value Ratio using the most recent appraised value. Appraisals are
required at the time of funding and may be updated if a material change occurs
from the original loan agreement.
All mortgage loans are analyzed quarterly in order to monitor the financial
quality of these assets. Based on ongoing monitoring, mortgage loans with a
likelihood of becoming delinquent are identified and placed on an internal
"watch list". Among the criteria that would indicate a potential problem are:
major tenant vacancies or bankruptcies, late payments, and loan
relief/restructuring requests. The mortgage loan portfolio is analyzed for the
need for a valuation allowance on any loan that is on the internal watch list,
in the process of foreclosure, or that currently has a valuation allowance.
Prior to January 1, 2020 , mortgage loans were considered impaired when, based on
current information and events, it was probable that the Company would be unable
to collect all amounts due according to the contractual terms of the loan
agreement. When it was determined that a loan was impaired, a loss was
recognized for the difference between the carrying amount of the mortgage loan
and the estimated value reduced by the cost to sell. Estimated value was
typically based on the loan's observable market price or the fair value of the
collateral less cost to sell. Impairments and changes in the valuation allowance
were reported in net realized investment gains (losses) in the Consolidated
Statements of Earnings. The Company held a valuation allowance of $0.7 million
at December 31, 2019 .
As disclosed in Note (1) Summary of Significant Accounting Policies in the
accompanying Notes to Consolidated Financial Statements in this report, the
Company adopted new accounting guidance for credit loss recognition criteria for
certain financial assets, including mortgage loans. For mortgage loan
investments the Company employed the Weighted Average Remaining Maturity
("WARM") method in estimating current expected losses with respect to mortgage
loan investments as of January 1, 2020 and each succeeding calendar quarter-end.
The WARM method applies publicly available data of default incidence of
commercial real estate properties by several defined segmentations combined with
future assumptions regarding economic conditions (i.e. GDP forecasts) both in
the near term and the long term. Under this new accounting guidance, at January
1, 2020 a balance of $1.2 million was recorded for mortgage loan investments
which incorporated the previous year-end balance under the prior accounting
method. The adjustment resulted in a charge to retained earnings as a change in
accounting, net of tax, of $0.4 million . Subsequent changes in the allowance for
current expected credit losses are reported in net investment income in the
Consolidated Statements of Earnings.
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The following table represents the mortgage loan allowance for credit losses.
Years Ended December 31,
2021 2020
(In thousands)
Mortgage Loans Allowance for Credit Losses:
Balance, beginning of the period $ 2,486
675
Impact of adoption of new accounting guidance - 504 Provision during the period 501 1,307 Releases - - Balance, end of period $ 2,987 2,486
The Company had no mortgage loans past due six months or more at
2021
2020, or 2019.
The contractual maturities of mortgage loan principal balances at
2021
December 31, 2021 December 31, 2020
Amount % Amount %
(In (In
thousands) thousands)
Principal Balance by Contractual Maturity:
Due in one year or less $ 13,422 2.7 $ 4,208 1.3
Due after one year through five years 127,766 26.1 60,826 18.1
Due after five years through ten years 222,444 45.4 154,787 46.1
Due after ten years through fifteen years 115,313 23.5 107,662 32.1
Due after fifteen years 11,280 2.3 7,977 2.4
Totals $ 490,225 100.0 $ 335,460 100.0
The Company's direct investments in real estate total approximately $28.6
million at December 31, 2021 and $33.8 million at December 31, 2020 , and consist
primarily of income-producing properties which are being operated by a wholly
owned subsidiary of National Western. Included in the amount at December 31,
2020 was a surface parking property owned by Ozark National in Kansas City,
Missouri which contracted it out for rent. The value of this real estate
investment was appraised at $4.3 million at January 31, 2019 as part of the
purchase accounting done as of that date. During 2021, Ozark National sold its
home office properties, including the surface parking property. The Company
recognized operating income on its direct investments in real estate of
approximately $2.9 million , $2.9 million and $2.9 million for the years ended
December 31, 2021 , 2020, and 2019, respectively. The Company monitors the
conditions and market values of these properties on a regular basis and makes
repairs and capital improvements to keep the properties in good condition.
The Company recorded net realized investment gains (losses) of $(1.4) million ,
$2.7 million and $6.9 million associated with real estate investments in the
years ended December 31, 2021 , 2020 and 2019, respectively. The net real estate
loss for the year ended December 31, 2021 was related to Ozark National sale of
the home office, parking garage and parking lot described above. Net realized
investment gains for the year ended December 31, 2020 pertain to property
located in Travis County, Texas which was sold. Included in net realized
investment gains during 2019 are the sale of the Company's former home office
facility in Austin, Texas at a gain of $3.2 million and the sale of the
Company's two nursing home facilities at a net gain of $3.7 million .
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Other invested asset balances outstanding have remained relatively stable over the past few years. National Western, in order to obtain incremental investment yield, began expanding its invested asset vehicles to include alternative investments during 2020. These assets consist of syndicated, targeted capital pools with specific investment objectives managed by investment firms having expertise in designated asset opportunities. AtDecember 31, 2021 and 2020, the Company held balances of$67.7 million and$28.9 million , respectively, in this investment type which are included in the Other category in the investment table at the beginning of this section.
Derivatives, Index Options
The Company offers fixed-index universal life and annuity products that guarantee the return of principal to policyholders and, at the policyholder's election, credit interest based on a percentage gain in a specified equity market index (policyholders may alternatively elect a fixed interest rate). Premiums and deposits received on these products are predominantly invested in investment grade fixed income securities with a portion used to purchase derivatives consisting of call options on the applicable market index to fund the index credits due to fixed-index policyholders. The call options purchased are one year over-the-counter option contracts coinciding with the initial issuance of the policy and subsequent annual renewal periods in order to match the Company's funding requirements for the underlying policies. On the respective anniversary dates of the index policies, the index used to compute the annual index credit is reset and a new one-year call option is purchased to fund the next annual index credit. Although the call options are employed to be effective hedges against the Company's policyholder obligations from an economic standpoint, they do not meet the requirements for hedge accounting under GAAP. Accordingly, the call options are marked to fair value on each reporting date with the change in fair value, plus or minus, included as a component of net investment income. The change in fair value of the call options includes the realized gains or losses recognized at the expiration of the option term and the unrealized gain or loss changes in fair value for open contracts. The Company's design of its fixed-index products incorporates a budget for the purchase of over-the-counter call options to fund the index credits due to policyholders. Management monitors current prices of these call options and manages component features of the fixed-index products in accordance with the terms of the policy contracts in order to control the cost of purchases. These terms permit the Company to change caps, participation rates, and asset fees, subject to guaranteed minimums, thus managing the cost of the call options quoted by counterparties. In addition, the Company's product terms allow for the Company to withdraw from offering a particular index option at any time effective on the next policy anniversary date. The fair value of derivative instruments presented in the Company's Consolidated Financial Statements totaling$101.6 million atDecember 31, 2021 and$132.8 million atDecember 31, 2020 pertain to notional policyholder account values of$2.1 billion and$2.1 billion atDecember 31, 2021 and 2020, respectively, electing interest credits based upon applicable market index performance.
Market Risk
Market risk is the risk of change in market values of financial instruments due to changes in interest rates, currency exchange rates, commodity prices, or equity prices. The most significant market risk exposure for the Company is interest rate risk. Substantial and sustained increases and decreases in market interest rates can affect the profitability of insurance products and the fair value of investments. The yield realized on new investments generally increases or decreases in direct relationship with interest rate changes. The fair values of fixed income debt securities correlate to external market interest rate conditions as market values typically increase when market interest rates decline and decrease when market interest rates rise. However, market values may fluctuate for other reasons, such as changing economic conditions, market dislocations, declination in credit quality, or increasing event-risk concerns.
Interest Rate Risk
A gradual increase in interest rates from current levels would generally be a
positive development for the Company. Rate increases would be expected to
provide incremental net investment income, produce increased sales of fixed rate
products, and limit the potential erosion of the Company's interest rate spread
on products due to minimum guaranteed crediting rates in products.
Alternatively, a rise in interest rates would reduce the fair value of the
Company's investment portfolio and if long-term rates rise dramatically within a
relatively short time period the Company could be exposed to disintermediation
risk. Disintermediation risk is the risk that policyholders will surrender their
policies in a rising interest rate environment forcing the Company to liquidate
assets when they are in an unrealized loss position.
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A decline in interest rates could cause certain mortgage-backed securities in the Company's portfolio to be more likely to pay down or prepay. In this situation, the Company typically will be unable to reinvest the proceeds at comparable yields. Lower interest rates will likely also cause lower net investment income, subject the Company to reinvestment rates risks, and possibly reduce profitability through reduced interest rate margins associated with products having minimum guaranteed crediting rates. Alternatively, the fair value of the Company's investment portfolio will increase when interest rates decline.
The correlation between fair values and interest rates for available-for-sale
debt securities is reflected in the tables below.
December 31,
2021 2020
(In thousands except percentages)
Available-for-Sale Debt securities - fair value $ 9,068,946 10,770,923
Available-for-Sale Debt securities - amortized cost $ 8,604,250 9,874,543
Fair value as a percentage of amortized cost 105.40 % 109.08 %
Unrealized gains at year-end $ 464,696 896,380
Ten-year
0.59 % (1.00) %
The Company's trading debt securities, which are exclusively in the funds
withheld assets managed by the reinsurer, are recorded at fair value upon
purchase. While the recorded value of these trading debt securities subsequently
fluctuates with market prices, the fair value movement of the securities is
entirely offset by an identical fair value movement of the associated funds
withheld liabilities.
The Company's unrealized gain balance for available-for-sale and trading debt securities held atDecember 31, 2021 and 2020 is shown in the following table. Unrealized Gain Balance Net Balance at Net Balance at December 31, December 31, Change in Net 2021 2020 Balance (In thousands) Debt securities available-for-sale$ 464,696 896,380 (431,684) Debt securities trading 11,331 - 11,331 Totals$ 476,027 896,380 (420,353) The change in the unrealized balance pertaining to debt securities available-for-sale is recorded in Other comprehensive income in the Consolidated Statements of Comprehensive Income while the change in the unrealized balance pertaining to trading debt securities is recorded in net investment income in the Consolidated Statements of Earnings. Changes in interest rates typically have a sizable effect on the fair values of the Company's debt securities. During 2021, the market interest rate of the ten-yearU.S. Treasury bond increased 59 basis points from 0.92% at year-end 2020 to 1.51% at year-end 2021. Therefore, the decrease in the unrealized gain position is an expected portfolio value movement. 78
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The Company manages interest rate risk principally through ongoing cash flow
testing as required for insurance regulatory purposes. Computer models are used
to perform cash flow testing under various commonly used stress test interest
rate scenarios to determine if existing assets would be sufficient to meet
projected liability outflows. Sensitivity analysis allows the Company to measure
the potential gain or loss in fair value of its interest-sensitive instruments
and to protect its economic value and achieve a predictable spread between what
is earned on invested assets and what is paid on liabilities. The Company seeks
to minimize the impact of interest risk through surrender charges that are
imposed to discourage policy surrenders. Interest rate changes can be
anticipated in computer models and the corresponding risk addressed by
management actions affecting asset and liability instruments. However, potential
changes in the values of financial instruments indicated by hypothetical
interest rate changes will likely be different from actual changes experienced,
and the differences could be significant.
The Company has the ability to adjust interest rates, participation rates, and
asset management fees and caps, as applicable, in response to changes in
investment portfolio yields for a substantial portion of its business in force.
The ability to adjust these rates is subject to competitive forces in the market
for the Company's products. Surrender rates could increase and new sales could
be negatively affected if crediting rates are not competitive with the rates on
competing products offered by other insurance companies and financial service
entities. The Company designs its interest sensitive and annuity products with
features encouraging persistency, such as surrender and withdrawal penalty
provisions. Typically, surrender charge rates gradually decrease each year the
contract is in force.
The Company seeks to minimize the impact of interest rate risk through surrender
charges that are imposed to discourage policy surrenders and to offset
unamortized deferred policy acquisition costs. Certain products, such as
supplementary contracts with life contingencies, are not subject to surrender or
discretionary withdrawal. The Company may also include a market value adjustment
("MVA") feature on its annuity products which could increase or decrease the
amount paid to contract holders upon surrender of their contract as a means to
further mitigate interest rate risk.
The following table profiles the Company's insurance liabilities at December 31,
2021 for annuities, deposit-type contracts and supplementary contracts with life
contingencies by surrender and discretionary withdrawal characteristics.
December 31, 2021
Amount %
(In thousands)
Subject to discretionary withdrawal:
With market value adjustment $ 145,634 2.2
With surrender charge of 5% or more 4,439,039 65.9
With surrender charge of 5% or less 1,761,750 26.2
Not subject to discretionary withdrawal 385,937 5.7
Total Gross 6,732,360 100.0
Reinsurance ceded 1,504,044
Total Net $ 5,228,316
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Interest Rate Sensitivity
The following table illustrates the market risk sensitivity of the Company's
interest rate sensitive assets. The table shows the effect of a change in
interest rates on the fair value of the portfolio using models that measure the
change in fair value arising from an immediate and sustained change in interest
rates in increments of 100 basis points.
Fair Values of Assets
Changes in Interest Rates in Basis Points
-100 0 100 200 300
(In thousands)
Debt and equity securities $ 10,790,199
10,174,601 9,631,667 9,145,271 8,706,995 Mortgage loans 544,575 513,246 484,481 458,028 433,663 Other loans 25,500 25,085 24,683 24,291 23,911 Derivatives 100,148 101,622 103,083 104,559 106,040 The selection of the 100 basis point parallel shift in the yield curve was made as an illustration of the potential hypothetical impact of such an event and should not be construed as a prediction of future market events. Actual results could vary materially from those illustrated due to the nature of the estimates and assumptions used in the above analysis. Expected maturities of debt securities may differ from contractual maturities due to call or prepayment provisions. The models assume that prepayments on mortgage-backed securities are influenced by agency and pool types, the level of interest rates, loan age, refinancing incentive, month of the year, and underlying coupon. During periods of declining interest rates, principal payments on mortgage-backed securities and collateralized mortgage obligations tend to increase as the underlying mortgages are prepaid. Conversely, during periods of rising interest rates, the rate of prepayment slows. Both of these situations can expose the Company to the possibility of asset-liability cash flow and yield mismatch. The model uses a proprietary method of sampling interest rate paths along with a mortgage prepayment model to derive future cash flows. The initial interest rates used are based on the currentU.S. Treasury yield curve as well as current mortgage rates for the various types of collateral in the portfolio. Mortgage and other loans were modeled by discounting scheduled cash flows through the scheduled maturities of the loans, starting with interest rates currently being offered for similar loans to borrowers with similar credit ratings. Policy loans were modeled by discounting estimated cash flows usingU.S. Treasury Bill interest rates as base rates atDecember 31, 2021 . The estimated cash flows include assumptions as to whether such loans will be repaid by the policyholders or settled upon payment of death or surrender benefits on the underlying insurance contracts and incorporate both Company experience and mortality assumptions associated with such contracts. In addition to the securities analyzed above, the Company invests in index options which are derivative financial instruments used to hedge the equity return component of the Company's indexed annuity and life products. The values of these options are primarily impacted by equity price risk, as the options' fair values are dependent on the performance of the underlying reference index. However, increases or decreases in investment returns from these options are substantially offset by corresponding increases or decreases in amounts paid to indexed policyholders, subject to minimum guaranteed policy interest rates. The Company's market risk liabilities, which include policy liabilities for annuity and supplemental contracts, are managed for interest rate risk through cash flow testing as previously described. As part of this cash flow testing, the Company has analyzed the potential impact on net earnings of a 100 basis point decrease and increases in increments of 100 basis points in theU.S. Treasury yield curve as ofDecember 31, 2021 . The potential impact on net earnings from these interest rate changes are summarized below. Changes in
Interest Rates in Basis Points
-100 100 200 300
(In thousands)
Impact on net earnings $ (1,189) 1,485 4,280 10,357
These estimated impacts on earnings are net of tax effects and the estimated
effects of deferred policy acquisition costs.
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The above described scenarios produce estimated changes in cash flows as well as cash flow reinvestment projections. Estimated cash flows in the Company's model assume cash flow reinvestments, which are representative of the Company's current investment strategy. Calls and prepayments include scheduled maturities and those expected to occur which would benefit the security issuers. Assumed policy surrenders consider differences and relationships between credited interest rates and market interest rates as well as surrender charges on individual policies. The impact to earnings also includes the expected effects on amortization of deferred policy acquisition costs. The model considers only annuity and supplemental contracts in force atDecember 31, 2021 , and does not consider new product sales or the possible impact of interest rate changes on sales. Credit Risk The Company is exposed to credit risk through counterparties and within its investment portfolio. Credit risk relates to the uncertainty associated with an obligor's continued ability to make timely payments of principal and interest in accordance with the contractual terms of an instrument or contract. As previously discussed, the Company manages credit risk through established investment credit policies and guidelines which address the quality of creditors and counterparties, concentration limits, diversification practices and acceptable risk levels. These policies and guidelines are regularly reviewed and approved by senior management and the Company's Board of Directors. In connection with the Company's use of call options to hedge the equity return component of its fixed-indexed annuity and life products, the Company is exposed to the risk that a counterparty fails to perform under terms of the option contract. The Company purchases one-year option contracts from multiple counterparties and evaluates the creditworthiness of all counterparties prior to the purchase of the contracts. For consideration in contracting with a counterparty the rating required by the Company is a credit rating of "A" or higher. Accordingly, all options are purchased from nationally recognized financial institutions with a demonstrated performance for honoring their financial obligations and possessing substantial financial capacity. In addition, each counterparty is required to execute a credit support agreement obligating the counterparty to provide collateral to the Company when the fair value of the Company's exposure to the counterparty exceeds specified amounts. Counterparty credit ratings and credit exposure are monitored continuously by National Western'sInvestment Department with adjustments to collateral levels managed as incurred under the credit support agreements. The Company follows the industry practice of reinsuring (ceding) portions of its insurance risks with a variety of reinsurance companies on either a coinsurance or a modified coinsurance basis in order to limit risk. Use of reinsurance does not relieve the Company of its primary liability to pay the full amount of the insurance benefit in the event the reinsurer (counterparty) fails to honor its contractual obligation. Consequently, the Company avoids concentrating reinsurance counterparty credit risk with any one reinsurer and only maintains reinsurance agreements with reputable carriers which are well-capitalized and highly rated by independent rating agencies. With respect to the funds withheld coinsurance arrangement entered into by National Western, assets backing the reserves for the policyholder obligations under the agreement are retained by the Company and are available to meet benefit payment commitments. In addition, National Western is the beneficiary of an incremental collateral trust account provided by the reinsurer providing additional security for the payment of all amounts due under the reinsurance agreement. 81
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The Company's net exposure to loss due to credit risk if option counterparties failed to completely perform according to the terms of their one-year contracts is as follows atDecember 31, 2021 and 2020. December 31, 2021 Moody/ Fair Collateral Net Counterparty S&P Rating Value Held Exposure (In thousands) Credit Suisse WR/A+ $ 12,659 12,965 - Wells Fargo Aa2/A+ 19,169 19,868 - Bank of America Aa2/A+ 13,451 13,740 - Barclays Bank A1/A 8,119 8,597 - BNP Paribas Aa3/A+ 25,906 27,004 - Royal Bank of Canada Aa2/AA- 5,923 6,845 - Canadian Imperial Bank Aa2/A+ 6,125 6,592 - Societe Generale A1/A 10,270 10,660 - $ 101,622 106,271 - December 31, 2020 Moody/ Fair Collateral Net Counterparty S&P Rating Value Held Exposure (In thousands) Credit Suisse Aa3/A+ $ 14,044 13,485 559 Wells Fargo Aa2/A+ 30,278 30,611 - Bank of America Aa2/A+ 14,677 14,976 - Barclays Bank A1/A 34,088 33,717 371 BNP Paribas Aa3/A+ 7,361 6,657 704 Royal Bank of Canada Aa2/AA- 5,108 5,083 25 Canadian Imperial Bank Aa2/A+ 12,572 12,388 184 Societe Generale A1/A 14,693 14,480 213 $ 132,821 131,397 2,056
The Company has never incurred a loss on index options due to counterparty
default.
The Company is also exposed to credit spread risk related to market prices of
investment securities and cash flows associated with changes in credit spreads.
Credit spread tightening will reduce net investment income associated with new
purchases of fixed debt securities but will also increase the fair value of the
investment portfolio. Credit spread widening will reduce the fair value of the
investment portfolio but will also increase net investment income on new
purchases.
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LIQUIDITY AND CAPITAL RESOURCES
Liquidity
Liquidity requirements are met primarily by funds provided from operations. Premium deposits and annuity considerations, investment income, and investment maturities and prepayments are the primary sources of funds while investment purchases, policy benefits in the form of claims, and payments to policyholders and contract holders in connection with surrenders and withdrawals as well as operating expenses are the primary uses of funds. To ensure the Company will be able to pay future commitments, the funds received as premium payments and deposits are invested in high quality investments, primarily fixed income securities. Funds are invested with the intent that the income from investments, plus proceeds from maturities, will meet the ongoing cash flow needs of the Company. The approach of matching asset and liability durations and yields requires an appropriate mix of investments. Although the Company historically has not been put in the position of having to liquidate invested assets to provide cash flow, its investments consist primarily of marketable debt securities that could be readily converted to cash for liquidity needs. National Western maintains a line of credit facility of$75 million which it may access for short-term cash needs. As part of the acquisition of Ozark National and NIS effectiveJanuary 31, 2019 , National Western borrowed$75 million to partly fund the closing cash purchase price of$205.4 million . The amounts borrowed were subsequently repaid during the first quarter of 2019 and there have been no borrowings under the line of credit since that time including as atDecember 31, 2021 . In addition, National Western became a member of theFederal Home Loan Bank of Dallas (FHLB) during 2020 through an initial minimum required stock investment of$4.3 million . Through this membership, National Western is able to create a specified borrowing capacity based upon the amount of collateral it elects to establish. AtDecember 31, 2021 , cash and securities in the amount of$57.3 million (fair value of$60.6 million ) were pledged as collateral to FHLB. A primary liquidity concern for life insurers is the risk of an extraordinary level of early policyholder withdrawals, particularly with respect to annuity products which can move more rapidly with interest rate changes. The Company includes provisions within its annuity and universal life insurance policies, such as surrender and market value adjustments, that help limit and discourage early withdrawals. The following table sets forth withdrawal characteristics of National Western's annuity reserves and deposit liabilities (based on statutory reporting liability values) as of the dates indicated. December 31, 2021 December 31, 2020 Amount % of Total Amount % of Total (In thousands except percentages) Not subject to discretionary withdrawal provisions $ 385,937 5.7 % $ 369,627 5.4 % Subject to discretionary withdrawal, with adjustment: With market value adjustment 145,634 2.2 % 290,794 4.2 % At contract value less current surrender charge of 5% or more 4,439,039 65.9 % 4,644,808 67.6 % Subtotal 4,970,610 73.8 % 5,305,229 77.2 % Subject to discretionary withdrawal at contract value with no surrender charge or surrender charge of less than 5% 1,761,750 26.2 % 1,564,485 22.8 % Total annuity reserves and deposit liabilities - Gross 6,732,360 100.0 % 6,869,714 100.0 % Reinsurance ceded 1,504,044 1,707,361 Total annuity reserves and deposit liabilities - Net$ 5,228,316 $ 5,162,353 83
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The actual amounts paid out by product line in connection with surrenders and
withdrawals are noted in the table below.
Years Ended December 31,
2021 2020 2019
(In thousands)
Product Line:
Traditional Life $ 16,348 17,022 17,614
Universal Life 95,628 96,031 101,187
Annuities 658,403 643,223 705,892
Total $ 770,379 756,276 824,693
The above contractual withdrawals, as well as the level of surrenders
experienced, and the associated cash outflows did not have an adverse impact on
overall liquidity. The amounts shown includes funds withheld policyholder
obligations in 2021 and Ozark National cash outflows (subsequent to their
acquisition on January 31, 2019 ). Individual life insurance policies are
typically less susceptible to withdrawal than annuity reserves and deposit
liabilities because policyholders may need to undergo a new underwriting process
in order to obtain a new insurance policy elsewhere. Annuity dollar outflows are
generally more sensitive to economic conditions, interest rate levels, and the
level of surrender charges assessed upon withdrawal or termination. Cash flow
projections and tests under various market interest rate scenarios and
assumptions are performed to assist in evaluating liquidity needs and
adequacy. With economic decline precipitated by the COVID-19 pandemic, Company
management conducted additional liquidity scenario testing during 2020 using
more severe assumptions and concluded that liquid assets were more than adequate
under these scenarios. Accordingly, the Company currently expects available
liquidity sources and future cash flows to be more than adequate to meet the
demand for funds.
Cash flows from the Company's insurance operations have historically been
sufficient to meet current needs. Cash flows from operating activities were
$276.8 million , $373.1 million , and $329.0 million in 2021, 2020, and 2019,
respectively. The Company also has significant cash flows from both scheduled
and unscheduled investment security maturities, redemptions, and prepayments.
These cash flows totaled $1,582.0 million , $1,294.8 million , and $995.8 million
in 2021, 2020, and 2019, respectively. Operating and investing activity cash
flow items could be reduced if interest rates rise at an accelerated rate in the
future. Net cash inflows/(outflows) from the Company's universal life and
annuity product operations totaled $(322.2) million , $(437.4) million , and
$(584.7) million in 2021, 2020, and 2019, respectively. The lower net outflow in
2021 reflects a higher level of fixed-index annuity sales.
Capital Resources
The Company relies on stockholders for its capital resources as there is no
long-term debt outstanding and the Company does not anticipate the need for any
long-term debt in the near future. As of
maintained commitments for its normal operating and investment activities.
The Company has declared and paid an annual dividend on its common shares since 2005. The Company's practice has been to take a conservative approach to dividends, and the Board of Directors has adopted a strategic position to substantially reinvest earnings internally. This conservative approach yields the following benefits: (1) providing capital to finance the development of new business; (2) enabling the Company to take advantage of potential acquisitions and other competitive situations as they arise; (3) building a strong capital base to support the Company's financial strength ratings; (4) maintaining the Company's liquidity and solvency during difficult economic and market conditions; and (5) enhancing the Company's regulatory capital position. For similar reasons, despite the fact the Company's market price of its Class A common shares has been trading at a discount to the book value per share for some time, there are no imminent plans for the Company to repurchase its shares. As the largest subsidiary of NWLGI, National Western serves as the primary funding source for NWLGI. The capacity of National Western to pay dividends to NWLGI is limited by law in the state ofColorado to earned profits (statutory unassigned surplus). AtDecember 31, 2021 , the maximum amount legally available for distribution during 2022 without further regulatory approval is$64.4 million . 84
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TheNational Association of Insurance Commissioners ("NAIC") has established risk-based capital ("RBC") standards forU.S. life insurers as well as a risk-based capital model act ("RBC Model Act"). The RBC Model Act requires that life insurers annually submit a report to state regulators regarding their RBC amounts based upon four categories of risk (asset risk, insurance risk, interest rate risk, and business risk). The capital requirement for each is determined by applying factors that vary based upon the degree of risk to various asset, premium and policy benefit reserve items. The formula is an early warning tool to identify potential weakly capitalized companies for purposes of initiating further regulatory action. Independent rating agencies utilize proprietary versions similar to the NAIC RBC model incorporating additional risk factors identified in their respective rating methodology. AtDecember 31, 2021 , National Western and Ozark National each maintained statutory capital substantially in excess of applicable statutory requirements. It is Company practice to not enter into off-balance sheet arrangements or to issue guarantees to third parties, other than in the normal course of issuing insurance contracts. Commitments related to insurance products sold are reflected as liabilities for future policy benefits. Insurance contracts guarantee certain performances by National Western and Ozark National. Insurance reserves are the means by which life insurance companies determine the liabilities that must be established to assure that future policy benefits are provided for and can be paid. These reserves are required by law and based upon standard actuarial methodologies to ensure fulfillment of commitments guaranteed to policyholders and their beneficiaries, even though the obligations may not be due for many years. Refer to Note (1) Summary of Significant Accounting Policies in the accompanying Notes to Consolidated Financial Statements in this report for a discussion of reserving methods.
The table below summarizes future estimated cash payments under existing
contractual obligations.
Payment Due by Period
Total Less Than 1 Year 1 - 3 Years 3 - 5 Years More Than 5 Years
(In thousands)
Loan commitments $ 18,500 18,500 - -
-
Commitments for capital calls to investment funds 256,392 85,882 126,010 - 44,500 Lease obligations (1) 1,346 343 659 344 - Claims payable (2) 77,536 77,536 - - - Other long-term reserve liabilities reflected on the balance sheet under GAAP (3) 12,632,010 1,017,321 1,924,228 1,683,675 8,006,786 Total$ 12,985,784 1,199,582 2,050,897 1,684,019 8,051,286
(1) Refer to Note (17) Commitments and Contingencies in the accompanying Notes
to Consolidated Financial Statements in this report relating to Company leases.
(2) Claims payable include benefit and claim liabilities for life, accident and
health policies which the Company believes the amount and timing of the payment
is essentially fixed and determinable. Such amounts generally relate to incurred
and reported death, critical illness, accident and health claims including an
estimate of claims incurred but not reported.
(3) Other long-term liabilities include estimated life and annuity obligations
related to death claims, policy surrenders, policy withdrawals, maturities and
annuity payments based on mortality, lapse, annuitization, and withdrawal
assumptions consistent with the Company's historical experience. These estimated
life and annuity obligations are undiscounted projected cash outflows that
assume interest crediting and market growth consistent with assumptions used in
amortizing deferred acquisition costs. They do not include any offsets for
future premiums or deposits. Other long-term liabilities also include
determinable payout patterns related to immediate annuities. Due to the
significance of the assumptions used, the actual cash outflows will differ both
in amount and timing, possibly materially, from these estimates.
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ACCOUNTING STANDARDS AND CHANGES IN ACCOUNTING
Changes in Accounting Principles
EffectiveJanuary 1, 2020 , the Company implemented ASU 2016-13, Financial Instruments - Credit Losses. This standard replaced the previous incurred loss recognition model with an expected loss recognition model for certain financial assets. Adoption of the standard resulted in an incremental allowance for credit losses as ofJanuary 1, 2020 of$3.8 million , and a charge to retained earnings, net of tax, of$3.0 million as a change in accounting. There were no other changes in accounting principles during the periods reported in this Form 10-K.
Recently Issued Accounting Standards
Refer to Note (1), Summary of Significant Accounting Policies in the
accompanying Notes to Consolidated Financial Statements in this report.
Correction of Errors
None.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK
The information called for by Item 6A is set forth in the Investments section of
the Management's Discussion and Analysis of Financial Condition and Results of
Operations.
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