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NWLI > SEC Filings for NWLI > Form 10-Q on 9-Nov-2012All Recent SEC Filings

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Form 10-Q for NATIONAL WESTERN LIFE INSURANCE CO


9-Nov-2012

Quarterly Report


ITEM 2. 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 of National Western Life Insurance Company or its subsidiaries are or may be viewed as forward-looking. Although the Company has taken appropriate care in developing any such information, forward-looking information involves risks and uncertainties that could significantly impact actual results. These risks and uncertainties include, but are not limited to, matters described in the Company's SEC filings such as exposure to market risks, anticipated cash flows or operating performance, future capital needs, and statutory or regulatory related issues. However, National Western, as a matter of policy, does not make any specific projections as to future earnings, nor does it endorse any projections regarding future performance that may be made by others. Whether or not actual results differ materially from forward-looking statements may depend on numerous foreseeable and unforeseeable events or developments. Also, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future developments, or otherwise.

Management's discussion and analysis of the financial condition and results of operations ("MD&A") of National Western Life Insurance Company for the nine months ended September 30, 2012 follows. This discussion should be read in conjunction with the Company's condensed consolidated financial statements and related notes beginning on page 3 of this report and with the 2011 Annual Report filed on Form 10-K with the SEC.

Overview

The Company provides life insurance products on a global basis for the savings and protection needs of policyholders and annuity contracts for the asset accumulation and retirement needs of contract holders, both domestically and internationally. The Company accepts funds from policyholders or contract-holders and establishes a liability representing future obligations to pay the policy or contract-holders and their beneficiaries. To ensure the Company will be able to pay these future commitments, the funds received as premium payments and deposits are invested in high quality investments, primarily fixed income securities.

Due to the business of accepting funds to pay future obligations in later years and the underlying economics, the relevant factors affecting the Company's business and profitability include the following:

the level of sales and premium revenues collected
persistency of policies and contracts returns on investments sufficient to produce acceptable spread margins over
interest crediting rates
investment credit quality which minimizes the risk of default or impairment
levels of policy benefits and costs to acquire business
the level of operating expenses effect of interest rate changes on revenues and investments including asset
and liability matching
maintaining adequate levels of capital and surplus
actual levels of surrenders, withdrawals, claims and interest spreads and changes in assumptions for amortization of deferred policy acquisition expenses and deferred sales inducements
changes in the fair value of derivative index options and embedded derivatives pertaining to fixed-index life and annuity products
pricing and availability of adequate reinsurance

The Company monitors these factors continually as key business indicators. The discussion that follows in this Item 2 includes these indicators and presents information useful to an overall understanding of the Company's business performance in 2012, incorporating required disclosures in accordance with the rules and regulations of the Securities and Exchange Commission.


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Insurance Operations - Domestic

The Company is currently licensed to do business in all states and the District of Columbia except for New York. Products marketed are annuities, universal life insurance, fixed-indexed universal life, and traditional life insurance, which include both term and whole life products. The Company's domestic sales have historically been more heavily weighted toward annuity products, which include single and flexible premium deferred annuities, single premium immediate annuities, and fixed-indexed annuities. Most of these annuities can be sold as tax qualified or nonqualified products. At September 30, 2012, the Company maintained approximately 141,000 annuity contracts in force.

National Western markets and distributes its domestic products primarily through independent national marketing organizations ("NMOs"). These NMOs assist the Company in recruiting, contracting, and managing independent agents. The Company currently has approximately 13,300 domestic independent agents contracted. Roughly 22% of these contracted agents have submitted policy applications to the Company in the past twelve months.

Insurance Operations - International

The Company's international clientele consists mainly of foreign nationals in upper socioeconomic classes. Insurance products are issued primarily to residents of countries in Central and South America, the Caribbean, Eastern Europe, Asia and the Pacific Rim based upon applications received in the Company's home office in Austin, Texas. Issuing policies to residents of countries in these different regions provides diversification that helps to minimize large fluctuations that could arise due to various economic, political, and competitive pressures that may occur from one country to another. Products issued to international residents are almost entirely universal life and traditional life insurance products. However, certain annuity and investment contracts are also available. At September 30, 2012, the Company had approximately 73,110 international life insurance policies in force representing approximately $18.9 billion in face amount of coverage.

International applications are submitted by independent contractor consultants and broker-agents. The Company has approximately 3,520 independent international consultants and brokers currently contracted, 31% of which have submitted policy applications to the Company in the past twelve months.

There are some inherent risks of accepting international applications which are not present within the domestic market that are reduced substantially by the Company in several ways. As previously described, the Company accepts applications from foreign nationals in upper socioeconomic classes who have substantial financial resources. This targeted customer base coupled with the Company's conservative underwriting practices have historically resulted in claims experience, due to natural causes, similar to that in the United States. The Company minimizes exposure to foreign currency risks by requiring payment of premiums, claims and other benefits almost entirely in United States dollars. The Company's fifty years of experience with the international products and its longstanding independent consultant and broker-agent relationships further serve to minimize risks.


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SALES

Life Insurance

The following table sets forth information regarding the Company's life insurance sales activity as measured by annualized first year premiums. While the figures shown below are in accordance with industry practice and represent the amount of new business sold during the periods indicated, they are considered a non-GAAP financial measure. The Company believes sales are a measure of distribution productivity and are a leading indicator of future revenue trends. However, revenues are driven by sales in prior periods as well as in the current period and therefore, a reconciliation of sales to revenues is not meaningful or determinable.

                        Three Months Ended           Nine Months Ended
                           September 30,               September 30,
                           2012           2011        2012         2011
                                       (In thousands)

International:
Universal life      $     1,502          2,198       4,679         5,568
Traditional life            876            827       2,404         2,447
Equity-indexed life       3,464          5,030      10,442        14,131

                          5,842          8,055      17,525        22,146
Domestic:
Universal life               73            163         147           214
Traditional life             72             13          96            33
Equity-indexed life       2,898          1,535       6,732         3,264

                          3,043          1,711       6,975         3,511

Totals              $     8,885          9,766      24,500        25,657

Life insurance sales as measured by annualized first year premiums declined 9% in the third quarter of 2012 as compared to the third quarter of 2011. By market segment, the domestic life insurance line of business posted a 78% increase over the comparable results during the third quarter of 2011 while international life sales decreased 27.5% during the same time frame. For the nine months ended September 30th, total life insurance sales declined 4.5% as international life sales decreased by 21% during this period while domestic life insurance sales increased 99%.

The Company's international life business consists of applications accepted from residents of various regions outside of the United States, the volume of which typically varies based upon changes in the socioeconomic climates of these regions. Historically, the Company has experienced a simultaneous combination of rising and declining sales in various countries; however, the appeal of the Company's dollar-denominated life insurance products overcomes many of the local and national difficulties. In the "Great Recession" economic climate during 2008-2009, individuals in countries outside of the United States became increasingly leery of the U.S. economy and the stability of financial institutions and markets. These concerns resulted in reduced international sales during this time period. As fiscal and regulatory policies were enacted in response to the financial market turmoil, the ensuing level of relative stability served to recapture the confidence of international markets. Consequently, the Company witnessed an increased level of submitted life insurance applications beginning during the latter half of 2010.

As reported in the Company's Form 10-Q filing for the quarter ended September 30, 2011, Brazilian insurance regulators publicly stated their intention to curtail the sales activity of certain foreign multinational insurers, including National Western, and attempt to levy fines. This public announcement has served to decrease the number of new applications for insurance from residents of Brazil since that time. Excluding sales to residents of Brazil, international life sales increased 5% in the nine months ended September 30, 2012 compared to the comparable period in 2011.


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Applications submitted from residents of Latin America and the Pacific Rim perennially have comprised the majority of the Company's international life insurance sales. Several years ago, new sales efforts were directed toward the sale of a traditional endowment form of life insurance product for residents of Eastern Europe and the Commonwealth of Independent States (former Soviet Union). However, the Company has scaled back its efforts in these areas due to profitability concerns. As noted previously, the Company's international sales by geographic market tend to fluctuate with the socio and economic climates in these regions. The Company's mix of international sales by geographic region is as follows.

                                     Nine Months Ended September 30,
                                         2012                2011

Percentage of International Sales:
Latin America                              87.9 %               87.9 %
Pacific Rim                                10.7                 10.8
Eastern Europe                              1.4                  1.3

Totals                                    100.0 %              100.0 %

Year-to-date, the Company has accepted new business from residents outside of the United States in over thirty different countries with Brazil (21%), Venezuela (21%), and Taiwan (10%) comprising the largest contributions. Sales to residents in Venezuela increased 44% in the first nine months of 2012 compared to the same period in 2011.

The Company's domestic operations have historically been more heavily skewed toward annuity sales rather than life insurance sales. Partially in response to comments from outside rating agencies who expressed a preference for a greater proportion of overall Company earnings to derive from the life insurance line of business, management began placing emphasis on building domestic life insurance sales as a strategic focus for future growth. The Company revamped its domestic life operations by changing the way it contracts distribution for life business, eliminating products and distribution that had not contributed significantly to earnings, and creating new and competitive products. These new offerings included single premium universal life ("SPUL") and equity-indexed universal life ("EIUL") products.

More recently the Company has developed hybrids of its EIUL and SPUL products, combining features, and discontinued the marketing of smaller premium and volume life insurance policies. The Company's product development emphasis in creating SPUL, EIUL, and single or limited pay EIUL products has been positioned to take advantage of the changing demographic in the marketplace as the "Baby Boomer" generation began reaching 65 years of age in 2011. These products are designed to facilitate the wealth transfer of accumulated savings of this segment of the population via systematic funding mechanisms such as single premium immediate annuities. These life products have been valuable offerings for the Company's distributors as evidenced by the 99% increase in domestic life sales in the first nine months of 2012 versus 2011.

The Company's implementation of commission caps on domestic policies in 2009 discouraged sales of larger face amounts resulting in lower sales levels and amounts of insurance per policy as shown below. While the average new policy face amounts subsequently declined, the increased sales activity in the past two years has produced a modest upward trend in this figure. Conversely, the Company's sales to international residents have witnessed a steady growth in the average face amount of insurance coverage per policy over the same time period.

                                             Average New Policy Face Amount
                                                Domestic              International

Year ended December 31, 2006                315,800                         254,700
Year ended December 31, 2007                416,800                         251,000
Year ended December 31, 2008                455,200                         272,000
Year ended December 31, 2009                201,400                         315,300
Year ended December 31, 2010                164,800                         338,600
Year ended December 31, 2011                178,500                         363,600
Nine months ended September 30, 2012        234,700                         372,000


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After several challenging years of life insurance sales in the wake of the global financial crisis, life insurers are looking for new ways to rebuild premium levels. The Company's focus is directed toward its competitive advantages in international markets and wealth transfer strategies for domestic life sales. Critical to these strategies is the Company's portfolio of fixed-index (equity indexed) life insurance products. Fixed-index life products accounted for 70% of total life sales in the first nine months of 2012, a slight increase from 68% for the same period in 2011.

The table below sets forth information regarding the Company's life insurance in force for each date presented.

Insurance In Force as of

                              September 30,
                           2012            2011
                            ($ in thousands)

Universal life:
Number of policies            58,140        61,200
Face amounts          $    7,406,390     7,495,130

Traditional life:
Number of policies            41,860        43,890
Face amounts          $    3,102,580     2,852,560

Fixed-indexed life:
Number of policies            33,740        32,180
Face amounts          $    8,379,160     7,873,690

Rider face amounts    $    2,403,570     2,291,630

Total life insurance:
Number of policies           133,740       137,270
Face amounts          $   21,291,700    20,513,010

The Company's domestic in force business includes final expense policies and other smaller face amount traditional life policies written over the past several decades. As the Company's domestic product portfolio has changed to higher face amount universal life and fixed-indexed life policies, a decline in the number of traditional life policies in force has been steadily occurring.

At September 30, 2012, the Company's face amount of life insurance in force was comprised of $18.9 billion from the international line of business and $2.4 billion from the domestic line of business. At December 31, 2011, these amounts were $18.6 billion and $2.3 billion for the international and domestic lines of business, respectively.


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Annuities

The following table sets forth information regarding the Company's annuity sales
activity as measured by single and annualized first year premiums. Similar to
life insurance sales, these figures are considered a non-GAAP financial measure
but are shown in accordance with industry practice and depict the Company's
sales productivity.

                                                                       Nine Months Ended September
                                  Three Months Ended September 30,                 30,
                                        2012               2011            2012             2011
                                                           (In thousands)

Fixed-indexed annuities          $         166,318        238,473           484,715        703,374
Other deferred annuities                    49,746        120,863           117,081        324,423
Immediate annuities                         10,136         10,427            33,976         27,127

Totals                           $         226,200        369,763           635,772      1,054,924

Annuity sales in the third quarter of 2012 were 39% lower than in the third quarter of 2011. Likewise, annuity sales for the first nine months of 2012 were 40% lower than the comparable period in 2011. Although both periods are lower than the pace of 2011, annuity sales thus far in 2012 are in line with the Company's sales goals for the 2012 calendar year.

The recessionary contraction and financial market crisis that began in the latter half of 2007 and persisted into 2009 impacted many annuity carriers. Losses from investment impairments and equity exposure (for insurers with variable annuity product offerings) crippled the capital position of numerous companies and limited their ability to write new business. In contrast, the Company's substantial capital position attained through profitable operations and limited investment loss exposure positioned it to write additional levels of annuity business. In the past two years, the Company sold approximately $1.4 billion of annuity products per year indicative of the Company's enhanced competitive position in the marketplace.

Under the auspices of the Company's enterprise risk management (ERM) processes, management evaluated the potential ramifications of continuing a high level of annuity sales in the current depressed interest rate environment precipitated by the "quantitative easing" programs enacted by the Federal Reserve and the European debt crisis. Considered was the Federal Reserve's announced intention to maintain interest rates at current levels over the next several years and hints of future quantitative easing initiatives. While the Company does not subsidize its interest crediting rates on new policies in order to obtain market share, the Company's ERM considerations determined that managing to a lower level of annuity sales was prudent in the present environment.

The Company's mix of annuity sales tends to shift with interest rate levels and the relative performance of the equity market. Over the past several years, sales of fixed-indexed products have accounted for 55% to 75% of all annuity sales. During the first nine months of 2012 this percentage reached 76% reflecting the bull market run in equities since bottoming out in the first quarter of 2009 and the low level of fixed interest rates. For all fixed-indexed products, the Company purchases over the counter options to hedge the equity return feature. The options are purchased relative to the issuance of the annuity contracts in such a manner to minimize timing risk. Generally, the index return during the indexing period (if the underlying index increases) becomes a component in a formula (set forth in the annuity), the result of which is credited as interest to contract holders electing the index formula crediting method at the beginning of the indexing period. The formula result can never be less than zero with these products. The Company does not deliberately mismatch or under hedge for the equity feature of the products. Fixed-indexed products also provide the contract holder the alternative to elect a fixed interest rate crediting option.

Although a relatively smaller proportion of total annuity sales, sales of single premium immediate annuities (SPIAs) have increased during the past year in conjunction with the Company's life insurance sales strategy of wealth transfer. SPIAs are often used as the funding mechanism for transferring accumulated wealth into a life insurance product given its tax deferral advantages. Consequently, the Company's sales of these products have shown growth during the periods shown.


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The increased level of annuity sales volume the past several years has required a greater level of asset/liability analysis. The Company monitors its asset/liability matching within the self-constraints of desired capital levels and risk tolerance. Despite the amounts of new business, the Company's capital level remains substantially above industry averages and regulatory targets. Management has performed analyses of the capital strain associated with incrementally higher levels of annuity new business and determined that the Company's capital position is more than sufficient to handle increased sales activity.

The following table sets forth information regarding annuities in force for each date presented.

                             Annuities In Force as of
                                  September 30,
                                2012              2011
                                 ($ in thousands)

Fixed-indexed annuities
Number of policies               58,730           53,100
GAAP annuity reserves    $    4,098,748        3,626,488

Other deferred annuities
Number of policies               64,470           67,670
GAAP annuity reserves    $    2,725,878        2,744,797

Immediate annuities
Number of policies               17,840           17,260
GAAP annuity reserves    $      422,103          430,716

Total annuities
Number of policies              141,040          138,030
GAAP annuity reserves    $    7,246,729        6,802,001

Impact of Recent Business Environment

Economic data has shown mixed signs of improvement and backsliding over the past several quarters generating uncertainty about the direction of the economy at least in the near term. Recently, corporate earnings have displayed a degree of softness versus previous quarters, and there are various pockets of anecdotal evidence of a global slowdown that suggest tougher times ahead. It remains uncertain whether the financial stresses of various countries in the European community will be contained or disrupt the economic expansion in core Europe. Weaker growth figures from China seem to indicate a slowing down by one of the major underlying global economic machines. Concerns about the oncoming "fiscal cliff" in the U.S. appear to be restraining business owners from making investment commitments needed to fund future growth. The recent elections create an additional unknown regarding the ability to quickly address fiscal imbalances at the same time that the Federal Reserve's resolve to extend "QE" programs provide questionable stimulus for accelerating the grinding pace of economic activity. All of the above have served to decrease interest rate levels to historic lows.

With so much uncertainty regarding the future, it is difficult to confidently predict the direction that the U.S. and global economies are headed. While U.S. economic activity seems to be barely holding its own, global economies appear to be contracting or moving to slower levels of activity. Strong economic expansion generally benefits the Company's business. Alternatively, a tepid economic pace consisting of higher unemployment, lower personal income, muted consumer spending and lackluster corporate earnings and business investment could adversely impact the demand for the Company's products. Household financial income compression may also cause us to experience a higher incidence of claims, lapses or surrenders of policies. It is not possible to predict with certainty whether or when such activity may occur or what impact, if any, such actions could have on the Company's business, results of operations, cash flows or financial condition.


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As noted previously, the Company has enjoyed substantially higher annuity sales the past two years. While there may be many underlying reasons for this expansion in our annuity business, we believe that at least the following factors may explain this outcome: (1) during uncertain economic periods, consumers follow a flight to safety toward lower risk assets such as annuity products; (2) the Company's strong financial position, upgrade in financial strength rating from A.M. Best during 2009 and ample capital resources enhanced our presence in the annuity marketplace with independent distributors and end market consumers; (3) many of the Company's competitors incurred reductions in their capital base due to a deterioration in the quality of their investment portfolios, including investment impairments and losses, which caused them to curtail sales activity and recruitment of independent distribution; and (4) the . . .

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