Operating Segments

The Company manages its business between Domestic Insurance operations and International Insurance operations. For segment reporting purposes, the Company's annuity business, which is predominantly domestic, is separately identified.

Domestic Insurance Operations. 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, and traditional life insurance, which includes both term and whole life products. The majority of domestic sales are the Company's annuities. National Western markets and distributes its domestic products primarily through independent marketing organizations ("IMOs"). These IMOs assist the Company in recruiting, contracting, and managing independent agents. The Company's agents are independent contractors who are compensated on a commission basis. At December 31, 2003, the Company's IMO relationships had contracted nearly 11,100 independent agents with the Company. Over 34% of these contracted agents have submitted policy applications to the Company in the past twelve months.

International Insurance Operations. National Western's international operations focus on foreign nationals in upper socioeconomic classes. Insurance products are issued primarily to residents of countries in Central and South America, the Caribbean, the Pacific Rim, and beginning in 2003 Eastern Europe. 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 investment contracts are also available. At December 31, 2003, the Company had nearly 60,000 international life insurance policies inforce representing approximately $10.2 billion in face amount of coverage.

International applications are submitted by independent contractor broker-agents, many of whom have been submitting policy applications to National Western for 20 or more years. The Company had approximately 4,300 independent international broker-agents contracted at December 31, 2003, nearly 49% 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 National Western's conservative underwriting practices have historically resulted in claims experience, due to natural causes, similar to that in the United States with the exception of a small life insurance block in Haiti. The Company minimizes exposure to foreign currency risks by requiring payment of premiums and claims in United States dollars. Finally, over thirty-seven years of experience with the international products and its longstanding independent broker-agent relationships further serve to minimize risks.

Geographical Distribution of Business. The following table depicts the distribution of the Company's premium revenues and deposits.

Although many agents sell National Western's products, a sizable portion of the Company's annuity sales were sold through agents of two independent marketing organizations in recent years. These two organizations combined accounted for 40% of domestic annuity sales in 2003. Life insurance sales in 2003 were geographically most concentrated to residents of Brazil (26%), Taiwan (16%), and Argentina (11%).

Segment Financial Information. A summary of financial information for the Company's segments is as follows:

Notes to Table:

(A) Amounts exclude realized gains and losses on investments, net of taxes.
(B) Amounts exclude other unallocated assets.

Additional information concerning these industry segments is included in Note 13, Segment and Other Operating Information, of the accompanying consolidated financial statements.

Competition

National Western competes with over 1,000 life insurers in the United States, as well as other financial intermediaries such as banks and securities firms who market insurance products. Competitive factors are primarily the breadth and quality of products offered, established positions in niche markets, pricing, relationships with distribution, commission structures, perceived stability of the insurer, quality of underwriting and customer service, and cost efficiency.

In order to compete successfully, life insurers have turned their attention toward distribution, technology, defined end market targets, speed to the market in terms of product development, and customer relationship management as ways of gaining a competitive edge. The Company's management believes that it competes primarily on the basis of its longstanding reputation for commitment in serving international markets, its financial strength and stability, and its ability to attract and retain distribution based upon product and compensation.

Risk Management

The Company's product designs, underwriting standards and risk management techniques are utilized to protect against disintermediation risk and greater than expected mortality and morbidity risk. Disintermediation risk is limited through the use of surrender charges, non-surrenderability provisions, and market value adjustment features. Investment guidelines including duration targets, asset allocation tolerances and return objectives help to ensure that disintermediation risk is managed within the constraints of profitability criteria. Prudent underwriting is applied to select and price insurance risks and the Company regularly monitors mortality experience relative to its product pricing assumptions. Enforcement of disciplined claims management serves to further protect against greater than expected mortality.

Substantially all international products contain a currency clause stating that premium and claim "dollars" refer to lawful currency of the United States. Policy applications submitted by international insurance brokers are generally associated with individuals in upper socioeconomic classes who desire the stability and inflationary hedge of dollar denominated insurance products issued by the Company. The favorable demographics of this group typically results in a higher average policy size, and persistency and claims experience similar to that in the United States. By accepting applications submitted on residents outside the United States, the Company is able to further diversify its revenue, earnings, and insurance risk.

The Company follows the industry practice of reinsuring (ceding) portions of its insurance risks with a variety of reinsurance companies. The use of reinsurance allows the Company to underwrite policies larger than the risk it is willing to retain on any single life and to continue writing a larger volume of new business. The maximum amount of life insurance the Company normally retains is $250,000 on any one life. However, the use of reinsurance does not relieve the Company of its primary liability to pay the full amount of the insurance benefit in the event of the failure of a reinsurer to honor its contractual obligation. Consequently, the Company avoids concentrating reinsurance risk with any one reinsurer and only participates in reinsurance treaties with reputable carriers.

The Company maintains a system of disclosure controls and procedures, including internal controls designed to provide reasonable assurance that assets are safeguarded and transactions properly authorized, executed and recorded. The Company recognizes the importance of full and open presentation of its financial position and operating results and to this end maintains a Disclosure Controls and Procedures Committee comprised of senior executives who possess comprehensive knowledge of the Company's business and operations. This Committee is responsible for evaluating disclosure controls and procedures for adequacy as well as for the completeness and accuracy of the Company's financial disclosures. The Audit Committee of the Company's Board of Directors, composed of independent directors, meets periodically with members of the Disclosure Controls and Procedures Committee to review the effectiveness of their evaluations.

Regulatory and Other Issues

Regulation. The Company's insurance business is subject to comprehensive state regulation in each of the states it is licensed to conduct business. The laws enforced by the various state insurance departments provide broad administrative powers with respect to licensing to transact business, licensing and appointing agents, approving policy forms, regulating premium rates, regulating unfair trade and claims practices, establishing solvency standards, fixing minimum interest rates for the accumulation of surrender values, and regulating the type, amounts, and valuations of permitted investments, among other things. The Company is required to file detailed annual statements with each of the state insurance supervisory departments in which it does business. The Company's operations and financial records are subject to examination by these departments at regular intervals. Statutory financial statements are prepared in accordance with accounting practices prescribed or permitted by the Colorado Divisi on of Insurance, the Company's principal insurance regulator. Prescribed statutory accounting practices are largely dictated by the Codification of Statutory Accounting Principles ("Codification") adopted by the National Association of Insurance Commissioners ("NAIC"), which were effective January 1, 2001.

The NAIC, as well as state regulators, continually evaluates existing laws and regulations pertaining to the operations of life insurers. To the extent that initiatives result as a part of this process, they may be adopted in the various states in which the Company is licensed to do business. It is not possible to predict the ultimate content and timing of new statutes and regulations adopted by state insurance departments and the related impact upon the Company's operations although it is conceivable that they may be more restrictive.

Although the federal government does not directly regulate the life insurance industry, federal measures previously considered or enacted by Congress, if revisited, could affect the insurance industry and the Company's business. These measures include the tax treatment of life insurance companies and life insurance products, as well as changes in individual income tax structures and rates. Even though the ultimate impact of any of these changes, if implemented, is uncertain, the persistency of the Company's existing products and the ability to sell products could be materially affected.

Risk-Based Capital Requirements. The NAIC established risk-based capital ("RBC") requirements to help state regulators monitor the financial strength and stability of life insurers by identifying those companies that may be inadequately capitalized. Under the NAIC's requirements, each insurer must maintain its total capital above a calculated threshold or take corrective measures to achieve the threshold. The threshold of adequate capital is based on a formula that takes into account the amount of risk each company faces on its products and investments. The RBC formula takes into consideration four major areas of risk which are: (i) asset risk which primarily focuses on the quality of investments; (ii) insurance risk which encompasses mortality and morbidity risk; (iii) interest rate risk which involves asset/liability matching issues; and (iv) other business risks. For each category, the RBC requirements are determined by applying specified factors to various assets, premiums, reserves, and other items, with the factor being higher for items with greater underlying risk and lower for items with less risk. The Company's statutory capital and surplus at December 31, 2003, was significantly in excess of the threshold RBC requirements.

Financial Strength Ratings. Ratings with respect to financial strength are an important factor in establishing the competitive position of insurance companies. Ratings are important to maintaining public confidence and impact the ability to market products. The following summarizes the Company's financial strength ratings.

The rating agencies generally review the Company's rating on an annual basis. The Company's "A+" rating from Standard & Poor's was affirmed on December 6, 2002, and will be subject to review again in March 2004. A.M. Best affirmed the Company's "A-" rating on June 9, 2003. There is no assurance that the Company's ratings will continue for a certain period of time or that they will not be changed. In the event the Company's ratings are downgraded, the Company's business may be negatively impacted.

Effects of Inflation. The rate of inflation as measured by the change in the average consumer price index has not had a material effect on the revenues or operating results of the Company during the three most recent fiscal years.

Other Operations

National Western's primary business encompasses its life insurance and annuity operations, but the Company also has small real estate, nursing home, and other investments through wholly owned subsidiaries. These operations are substantially lesser in significance to National Western's consolidated financial operations. Contributions to consolidated earnings from these other operations were $5.1 million, $4.7 million, and $4.3 million for the years 2003, 2002, and 2001, respectively, and the operations are further described in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations.

The Company leases approximately 72,000 square feet of office space in Austin, Texas. This lease expires in 2010 and specifies lease payments that gradually increase over the term of the lease. Currently, lease payments are $550,800 per year plus taxes, insurance, maintenance, and other operating costs. Additionally, the Company's wholly owned subsidiary, The Westcap Corporation, owns two buildings adjacent to the Company's principal office space totaling approximately 21,000 square feet that are leased and utilized by the Company. The Company's affiliate, Regent Care Building, Limited Partnership, owns a 46,000 square foot building in Reno, Nevada, which is leased and utilized by another of the Company's affiliates, Regent Care Operations, Limited Partnership, for use in its nursing home operations. Lease costs and related operating expenses for facilities of the Company's subsidiaries are currently not significant in relation to the Company's consolidated financial statements. The intercompany lease costs related to The Westcap Corporation and the nursing home have been eliminated for consolidated reporting purposes.

The Company reached a class wide settlement agreement with a class of plaintiffs who had challenged bonus interest rates on certain Company annuity products. The Company vigorously defended the case and denied liability for the claims asserted by the plaintiff in reaching the settlement. The fairness of the settlement agreement was granted final approval by the Court on February 18, 2004. There were no objectors and the order approving the settlement is final and non-appealable. The settlement resulted in a $9.7 million pre-tax charge against 2003 earnings from operations, which represented the maximum settlement fund liability.

In the course of an audit of a charitable tax-exempt foundation, the Internal Revenue Service ("IRS") raised an issue under the special provisions of Internal Revenue Code ("IRC") governing tax-exempt private foundations as to certain interest-bearing loans from the Company to another corporation in which the tax-exempt foundation owns stock. The issue is whether such transactions constitute indirect self-dealing by the foundation, the result of which would be excise taxes on the Company by virtue of its participation in such transactions. By letter to the Company dated August 21, 2003, the IRS proposed an initial excise tax liability in the total amount approximating one million dollars as a result of such transactions. The Company disagrees with the IRS analysis. The Company is contesting the matter and expects to prevail on the merits. On October 14, 2003, in response to the IRS letter, the Company requested that this issue instead be referred to the IRS National Office for technical advice. The IRS audit team agreed and the matter was referred in November of 2003 to the IRS National Office. Such technical advise when issued by the IRS National Office will be in the form of a memorandum analyzing the issue which will be binding on the IRS audit team.

The Company is involved or may become involved in various legal actions, in the normal course of business, in which claims for alleged economic and punitive damages have been or may be asserted, some for substantial amounts. Although there can be no assurances, at the present time, the Company does not anticipate that the ultimate liability arising from potential, pending or threatened legal actions, after consideration of amounts provided for in the Company's consolidated financial statements, will have a material adverse effect on the financial condition or operating results of the Company.

No matters were submitted to a vote of the Company's security holders during the fourth quarter of 2003.

Market Information

The principal market on which the common stock of the Company trades is The NASDAQ Stock Market^® under the symbol "NWLIA". The high and low sales prices for the common stock for each quarter during the last two years are shown in the following table.

Equity Security Holders

The number of stockholders of record on March 12, 2004 was as follows:

Dividends

The Company has never paid cash dividends on its common stock. Payment of dividends is within the discretion of the Company's Board of Directors. Presently, the Company's policy is to reinvest earnings internally to finance the development of new business, and there are no plans to pay cash dividends to stockholders in the foreseeable future.

Securities Authorized For Issuance Under Equity Compensation Plans

The Company has one equity compensation plan that was approved by security holders. Under the plan, 159,173 shares of the Company's Class A common stock may be issued upon exercise of the outstanding options at December 31, 2003. The weighted average exercise price of the outstanding options is $82.67 per option. Excluding the outstanding options, 85,507 shares of the common stock remain available for future issuance under the plan at December 31, 2003. The Company has no equity compensation plans that have not been approved by security holders.

The following five-year financial summary includes comparative amounts derived from the audited consolidated financial statements.

Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. Certain information contained herein or in other written or oral statements made by or on behalf of National Western Life Insurance Company or its subsidiaries are or may be viewed as forward-looking. Although the Company has used appropriate care in developing any such information, forward-looking information involves risks and uncertainties that could significantly impact actual results. These risks and uncertainties include, but are not limited to, matters described in the Company's SEC filings such as exposure to market risks, anticipated cash flows 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 financial condition and results of operations ("MD&A") of National Western Life Insurance Company for the three years ended December 31, 2003 follows. This discussion should be read in conjunction with the Company's consolidated financial statements and related notes beginning on page __ of this report.

Overview

The Company provides life insurance products for the savings and protection needs of policyholders and annuity contracts for the asset accumulation and retirement needs of contractholders both domestically and internationally. The Company accepts funds from policyholders or contractholders 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, the underlying economics and relevant factors affecting the life insurance industry include the following:

   -  level of premium revenues collected
   -  persistency of policies and contracts
   -  returns on investments
   -  investment credit quality
   -  levels of policy benefits and costs to acquire business
   -  effect of interest rate changes on revenues and investments including asset and liability matching
   -  adequate levels of capital and surplus

The Company monitors these factors continually as key business indicators. The discussion below includes these indicators and presents information useful to an overall understanding of the Company's business performance in 2003, incorporating required disclosures in accordance with the rules and regulations of the Securities and Exchange Commission.

The Company has experienced record sales both with its annuity products domestically and internationally with its life products over the past several years. The increase in sales has come at a challenging time for the insurance industry with the sluggish economy, low interest rate levels, deterioration in corporate credit quality, and increased regulatory requirements. Despite these obstacles, business levels have increased and the Company has improved investment performance, not by taking on additional risks in the investment portfolio, but with improved overall credit quality of its portfolio of fixed income securities. The Company's financial performance is determined by the execution of its business model, which includes distribution and sale of its products, while maintaining invested values in order to meet future commitments of its policyholders and their beneficiaries.


RESULTS OF OPERATIONS

Consolidated Operations

The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In addition, the Company regularly evaluates operating performance using non-GAAP financial measures which exclude or segregate index options and realized investment gains and losses from operating revenues and earnings. 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 index options 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 cou ld 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.

Revenues. The following details Company 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. The Company's retention of inforce policies and contracts, referred to as persistency, improved substantially year over year from 2001 to 2003 contributing to higher operating earnings. However, revenues decreased from a lower incidence of surrender charges. Surrender charges promote persistency and protect the Company during times of increasing interest rates as these charges discourage policy and contract holders from withdrawing part or all of their funds held by the Company. Surrender charge revenue was $21.6 million in 2003 compared to $23.1 million in 2002 and $26.7 million in 2001.

Traditional life insurance premiums for products such as whole life and term life are recognized as revenues over the premium-paying period. These are product lines that the Company has not put as much emphasis on relative to interest sensitive products, particularly in its international life insurance operations. In addition, traditional life premiums are muted for increases in reinsurance premiums and exchange rate changes associated with policies in Haiti which is the only international country where premiums and benefits may be paid in other than U.S. dollars.

A detail of net investment income is provided below.

Net investable cash flow is primarily invested in investment grade debt securities generating nearly 87% of total investment income in 2003. With the decline in interest rate levels over the past several years, mortgage loan income has declined as prepayments have continued and new loan funding opportunities with interest rates below the Company's required yield levels for this type of investment opportunities have decreased. Other investment income for 2003 includes $3.3 million related to income received on various profit participation arrangements. Despite the drop in interest rate levels, the Company generated comparable higher net investment earnings due to the invested asset balance continuing to increase year to year. In addition, investment expenses have remained relatively level from 2001, 2002, and 2003.

Net investment income performance is summarized as follows:

The yield on average invested assets has declined from 7.47% in 2001 to 7.15% in 2002 and down to 6.85% in 2003, excluding index options. This decline in yield is due to the overall interest rate declines in the market and the Company obtaining lower yields on new invested funds. Net investment income performance is analyzed excluding the index option income which is a common practice in the insurance industry in order to assess underlying profitability and results from ongoing operations.

Other revenue consists primarily of revenues associated with nursing home operations which recorded revenues of $6.9 million, $6.1 million, and $5.2 million in 2003, 2002, and 2001, respectively. In 2001, other revenue included nearly $0.7 million received from the favorable resolution of longstanding litigation against the Company and one of its wholly owned subsidiaries, The Westcap Corporation ("Westcap").

Index Options. Index options are derivative financial instruments used to fully hedge the equity return component of the Company's equity-indexed products, which were first introduced for sale in 1997. In 2002, the Company began selling an equity-indexed universal life product. Any gains or losses from the sale or expiration of the options, as well as period-to-period changes in fair values, are reflected as a component of net investment income. However, increases or decreases in income from these options are substantially offset by corresponding increases or decreases in amounts paid to equity-indexed annuity and life policyholders.

The losses from index options in 2001 and 2002 were due to poor stock market conditions, specifically the performance of the S&P 500 Index^®. Index options are intended to act as hedges to match the returns on the S&P 500 Index^®. With the decline in this index, the index option values likewise declined. While income from index options was lower, the contract interest expense for the Company's equity-indexed annuities was also substantially lower. Conversely, in 2003, the stock market increased and the Company recorded gains from index options and increased contract interest expenses.

Realized Losses on Investments. The losses on investments consist primarily of impairment writedowns for investments in debt securities. The Company records impairment writedowns when a decline in value is considered other than temporary and full recovery of the investment is not expected. In 2003, the Company recorded impairment writedowns totaling $7.2 million on holdings of American Airlines ($3.1 million), Lukens ($0.8 million) and collaterialized bond obligation ("CBO") investments ($3.3 million). Writedowns in 2002 included WorldCom ($9.6 million), United Airlines ($4.0 million) and CBO investments ($3.8 million). Writedowns in 2001 related to Enron ($9.0 million), Lukens ($14.4 million), Federal Mogul ($4.4 million) and CBOs ($4.5 million). Total impairment writedowns in 2003, 2002, and 2001 totaled $7.2 million, $17.4 million, and $32.3 million, respectively.

Benefits and Expenses. The following details benefits and expenses.

The Company's mortality experience over the past five years has generally been consistent with its product pricing assumptions. Policy benefits reflect death claims of $26.8 million, $22.8 million, and $23.6 million for 2003, 2002, and 2001, respectively. The increase in death claims in 2003 is consistent with the Company's substantial increase in business inforce.

Life insurance companies are required to defer certain expenses associated with acquiring new business. The majority of these acquisition expenses consist of commissions paid to agents, underwriting costs, and certain marketing expenses and sales inducements. The Company defers sales inducements in the form of first year interest bonuses on annuity products that are directly related to the production of new business. These charges are commonly deferred and amortized by insurers using the same methodology and assumptions used to amortize other capitalized acquisition costs and the amortization is included in annuity contract interest. Recognition of these deferred policy acquisition costs in the financial statements occurs over future periods in relation to the 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 thes e 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 profit patterns is to be "unlocked" and reset based upon the actual experience.

Amortization of deferred policy acquisition costs increased in 2003 to $53.8 million compared to $35.8 million and $27.4 million in 2002 and 2001, respectively. Increased amortization in the current year is due in part to the deferral of sales inducement costs, as noted above, which results in higher amortization of deferred acquisition costs. In addition to the deferral of sales inducements, an "unlocking" adjustment was made pertaining to the annuity line of business and the expected emergence of future profits which also resulted in increased deferred policy acquisition costs amortization during 2003. No expected changes were made related to the amortization of these costs in 2002. In 2001, the Company analyzed its assumptions regarding the emergence of profits of its business and determined that unlocking was required to incorporate improved persistency with respect to its annuity block of business and as well as to factor in the recent realized investment loss experience. The outcome of these revis ions resulted in the amortization of deferred policy acquisition costs decreasing to $27.4 million in 2001. While the Company is required to evaluate its emergence of profits continually, management believes that the current amortization patterns of deferred policy acquisition costs are reflective of actual experience.

The Company closely monitors its credited interest rates on interest sensitive policies, taking into consideration such factors as profitability goals, policyholder benefits, product marketability, and economic market conditions. Average credited rates, calculated based on policy reserves for the Company's universal life and annuity business, have generally declined over the past several years, which is consistent with declines in market interest rates. As market interest rates fluctuate, the Company's credited interest rates are often adjusted accordingly taking into consideration the factors described above. Raising policy credited rates can typically have an impact sooner than higher market rates on the Company's investment portfolio yield, making it more difficult to maintain the current interest spread. The difference between yields earned over policy credited rates is often referred to as the interest spread.

Contract interest also includes the performance of the equity-index component of the Company's equity-indexed products. As previously noted, the recent market performance of these equity-index features increased contract interest expenses while also increasing the Company's investment income given the hedge nature of the options purchased for these products. Excluding equity-indexed products, the Company's average credited rate on annuity products was approximately 4.3% in 2003. The average credited rate in 2003 for interest sensitive life products approximated 5.0%. With these credited rates, the Company generally realized its targeted interest spread on its products.

Other operating expenses consist of general administrative expenses, licenses and fees, and commissions not subject to deferral and expenses of nursing home operations. Nursing home expenses are included in the amount of $6.0 million, $5.4 million, and $4.8 million in 2003, 2002, and 2001, respectively. The Company's operating expenses in 2002 and 2003 include increases associated with its significant upturn in business. In addition, a charge was recorded during 2003 in the amount of $9.7 million relating to a litigation claim where the Company has reached a settlement agreement that has been approved by the court. The suit involves a class action lawsuit against the Company in the state of Michigan and filed on behalf of purchasers who challenged the bonus interest rate paid by the Company on certain annuity products. This settlement amount is included as a component of other operating expenses in 2003.

Federal Income Taxes. Federal income taxes on earnings from continuing operations for 2003, 2002, and 2001 reflect effective tax rates of 32.9%, 33.1%, and 34.2%, respectively, which are lower than the expected Federal rate of 35% primarily due to tax-exempt investment income related to municipal securities and dividends-received deductions on income from stocks.

Segment Operations

Summary of Segment Earnings

A summary of segment earnings from continuing operations for the years ended December 31, 2003, 2002, and 2001 is provided below. The segment earnings exclude realized gains and losses on investments, net of taxes.

Domestic Life Insurance Operations

A comparative analysis of results of operations for the Company's domestic life insurance segment is detailed below.

Revenues from domestic life insurance operations include life insurance premiums on traditional type products and 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.

The Company's U.S. operations have recently emphasized annuity product sales over life product sales. Consequently, domestic life revenues have been declining for several years. It is the Company's goal to increase domestic life product sales through increased recruiting of new distribution and the development of new life insurance products. To that end, the Company increased its level of contracted agents from 5,200 at the end of 2002 to 11,100 at the end of 2003.

Segment earnings have declined as the block of business has contracted reporting earnings of $1.4 million, $2.6 million, and $5.2 million for the years ended December 31, 2003, 2002, and 2001, respectively. The face amount of domestic life insurance inforce has declined from $2.9 billion at December 31, 2001 to $2.8 billion at December 31, 2002 and to $2.7 billion at December 31, 2003. Absent the growth rates targeted by management, the block of business will continue to contract due to the normal incidence of terminations from death or surrender with lower earnings resulting. Lack of critical mass in this block of business also impacted the expected emergence of future profits which can serve to increase the amortization of deferred policy acquisition costs.

International Life Insurance Operations

A comparative analysis of results of operations for the Company's international life insurance segment is detailed below.

As with domestic operations, revenues from the international life insurance segment include both premiums on traditional type products and revenues from universal life insurance. A comparative detail of premiums and contract revenues is provided below.

International operations have emphasized universal life policies over traditional life insurance products. In accordance with generally accepted accounting principles premiums collected on universal life products are not reflected as revenues in the Company's statements of earnings. Actual universal life premiums collected are detailed below.

The Company's international life operations have been a significant part of the Company's overall business as evidenced by the growth in collected premiums. International sales increased in 2003 and 2002 due to the addition of new agents in several markets who were attracted to National Western given the Company's longstanding reputation for supporting its international life products and the instability of competing companies in international markets.

Policy benefits totaled $17.9 million in 2003 and $15.0 million in 2002 and 2001, which are consistent with Company expectations. Amortization of deferred policy acquisition costs was $12.1 million, $10.5 million, and $10.7 million for 2003, 2002, and 2001, respectively. The increase in amortization in 2003 is a result of a change in expected emergence of profits given the increased sales related to equity-indexed universal life products that are generating higher gross profits due to the surge in the stock market. Collected premiums related to the equity-indexed universal life product were $21.0 million and $10.0 million in 2003 and 2002, respectively. The increase in universal life contract interest is also the result of the increased sales of the equity-indexed universal life product and the associated stock market gains which increased the amounts the Company credits to policyholders on these products. Contract interest expense was $17.8 million, $16.5 million, and $15.9 million in 2003, 2002, and 2 001, respectively.

While the Company experienced a rapid move to a higher sales level in 2002 due to the added markets, the Company did not expect 2003 sales activity to replicate that of 2002. However, 2003 international sales surpassed the Company's expectations and approximated those of 2002. Management expects sales growth internationally to trend at a steadier pace from the level of 2002 and 2003 sales. As the international life insurance inforce continues to grow, the Company anticipates operating earnings to similarly increase. The amount of international life insurance inforce has grown from $7.1 billion at December 31, 2001 to $8.8 billion at December 31, 2002 and to $10.2 billion at December 31, 2003.

Annuity Operations

The Company's annuity operations are almost exclusively in the United States. Although some of the Company's investment contracts are available to international residents, current sales are small relative to total annuity sales. A comparative analysis of results of operations for the Company's annuity segment is detailed below.