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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------------------------
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002 Commission File No. 1-12785
NATIONWIDE FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 31-1486870
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
One Nationwide Plaza
Columbus, Ohio 43215
(614) 249-7111
(Address, including zip code, and telephone number,
including area code, of Registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject
to the filing requirements for at least the past 90 days.
Yes X No
---- -----
The number of shares outstanding of each of the registrant's classes of common
stock on August 2, 2002 was as follows:
CLASS A COMMON STOCK (par value $0.01 per share) - 24,257,042 shares outstanding
(Title of Class)
CLASS B COMMON STOCK (par value $0.01 per share) - 95,643,143 shares outstanding
(Title of Class)
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
PART I FINANCIAL INFORMATION
Item 1 Unaudited Consolidated Financial Statements 3
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 16
Item 3 Quantitative and Qualitative Disclosures About Market Risk 36
PART II OTHER INFORMATION
Item 1 Legal Proceedings 36
Item 2 Changes in Securities 37
Item 3 Defaults Upon Senior Securities 37
Item 4 Submission of Matters to a Vote of Security Holders 38
Item 5 Other Information 38
Item 6 Exhibits and Reports on Form 8-K 38
SIGNATURE 40
2
PART I - FINANCIAL INFORMATION
ITEM 1 UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Unaudited)
(in millions, except per share amounts)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- ---------------------
2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
REVENUES
Policy charges $ 255.9 $ 256.7 $ 512.8 $ 524.6
Life insurance premiums 64.0 66.6 124.7 130.5
Net investment income 452.7 431.5 896.3 857.0
Net realized (losses) gains on investments, hedging instruments
and hedged items (40.8) 3.2 (45.5) (0.8)
Other 24.4 19.6 48.2 39.3
- -----------------------------------------------------------------------------------------------------------------------------------
756.2 777.6 1,536.5 1,550.6
- -----------------------------------------------------------------------------------------------------------------------------------
BENEFITS AND EXPENSES
Interest credited to policyholder account values 305.8 309.7 603.6 611.9
Other benefits and claims 78.3 77.2 150.8 142.2
Policyholder dividends on participating policies 10.2 11.1 21.9 21.6
Amortization of deferred policy acquisition costs 85.0 85.5 169.8 179.7
Interest expense on debt and capital and preferred securities
of subsidiary trusts 16.9 13.4 33.6 27.5
Other operating expenses 156.3 124.0 313.5 257.5
- -----------------------------------------------------------------------------------------------------------------------------------
652.5 620.9 1,293.2 1,240.4
- -----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before federal income tax expense and
cumulative effect of adoption of accounting
principles 103.7 156.7 243.3 310.2
Federal income tax expense 23.3 41.2 59.2 81.8
- -----------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before cumulative effect of
adoption of accounting principles 80.4 115.5 184.1 228.4
Income from discontinued operations, net of tax 1.2 0.7 3.4 0.3
Cumulative effect of adoption of accounting principles, net of -- (2.3) -- (7.1)
tax
- -----------------------------------------------------------------------------------------------------------------------------------
Net income $ 81.6 $ 113.9 $ 187.5 $ 221.6
===================================================================================================================================
INCOME FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF ADOPTION OF
ACCOUNTING PRINCIPLES PER COMMON SHARE
Basic $ 0.62 $ 0.90 $ 1.43 $ 1.78
Diluted $ 0.62 $ 0.90 $ 1.43 $ 1.77
NET INCOME PER COMMON SHARE
Basic $ 0.63 $ 0.88 $ 1.45 $ 1.72
Diluted $ 0.63 $ 0.88 $ 1.45 $ 1.71
WEIGHTED AVERAGE COMMON SHARES OUTSTANDING
Basic 129.0 128.9 128.9 128.8
Diluted 129.3 129.2 129.3 129.2
See accompanying notes to unaudited consolidated financial statements, including
note 9 which describes related party transactions.
3
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in millions, except per share amounts)
JUNE 30, DECEMBER 31,
2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
(UNAUDITED)
ASSETS
Investments:
Securities available-for-sale, at fair value:
Fixed maturity securities (cost $19,942.6 in 2002; $18,135.8 in 2001) $ 20,552.0 $ 18,548.3
Equity securities (cost $118.3 in 2002; $143.2 in 2001) 120.7 150.5
Mortgage loans on real estate, net 7,574.8 7,113.1
Real estate, net 153.2 172.0
Policy loans 624.6 592.7
Other long-term investments 128.5 125.0
Short-term investments, including amounts managed by a related party 1,415.5 1,112.8
- -----------------------------------------------------------------------------------------------------------------------------------
30,569.3 27,814.4
- -----------------------------------------------------------------------------------------------------------------------------------
Cash 44.8 65.0
Accrued investment income 310.9 309.7
Deferred policy acquisition costs 3,332.8 3,213.7
Goodwill 169.0 130.0
Other assets 976.7 781.4
Assets held in separate accounts 54,411.6 59,646.7
- -----------------------------------------------------------------------------------------------------------------------------------
$ 89,815.1 $ 91,960.9
===================================================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Future policy benefits and claims $ 28,003.4 $ 25,491.6
Short-term debt -- 100.0
Long-term debt 896.9 597.0
Other liabilities 2,626.0 2,382.3
Liabilities related to separate accounts 54,411.6 59,646.7
- -----------------------------------------------------------------------------------------------------------------------------------
85,937.9 88,217.6
- -----------------------------------------------------------------------------------------------------------------------------------
NFS-obligated mandatorily redeemable capital and preferred securities of subsidiary
trusts holding solely junior subordinated debentures of NFS 300.0 300.0
- -----------------------------------------------------------------------------------------------------------------------------------
Shareholders' equity:
Preferred stock, $0.01 par value. Authorized 50.0 million shares, no shares
issued and outstanding -- --
Class A common stock, $0.01 par value. Authorized 750.0 million shares, 33.4
million and 24.1 million shares issued, respectively, and 24.3 million and 24.1
million shares outstanding, respectively 0.3 0.2
Class B common stock, $0.01 par value. Authorized 750.0 million shares,
95.6 million and 104.7 million shares issued and outstanding, respectively 1.0 1.0
Additional paid-in capital 761.2 646.5
Retained earnings 2,772.2 2,598.8
Accumulated other comprehensive income 294.8 202.5
Treasury stock (244.9) (0.2)
Other (7.4) (5.5)
- -----------------------------------------------------------------------------------------------------------------------------------
3,577.2 3,443.3
- -----------------------------------------------------------------------------------------------------------------------------------
$ 89,815.1 $ 91,960.9
===================================================================================================================================
See accompanying notes to unaudited consolidated financial statements, including
note 9 which describes related party transactions.
4
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
(Unaudited)
Six Months Ended June 30, 2002 and 2001
(in millions)
ACCUMULATED
CLASS A CLASS B ADDITIONAL OTHER
COMMON COMMON PAID-IN RETAINED COMPREHENSIVE
STOCK STOCK CAPITAL EARNINGS INCOME (LOSS)
======================================================================================================
Balance as of January 1, 2001 $ 0.2 $ 1.0 $ 640.8 $2,245.5 $ 114.5
Comprehensive income:
Net income -- -- 221.6 --
Net unrealized gains on
securities
available-for-sale
arising during the period,
net of tax -- -- -- -- 78.6
Cumulative effect of adoption
of accounting principles, net
of tax -- -- -- -- (1.4)
Accumulated net gains on cash
flow hedges, net of tax -- -- -- -- 0.5
Total comprehensive income
Cash dividends declared -- -- -- (30.9) --
Other, net -- -- 4.9 0.9 --
- ------------------------------------------------------------------------------------------------------
Balance as of June 30, 2001 $ 0.2 $ 1.0 $ 645.7 $2,437.1 $ 192.2
======================================================================================================
BALANCE AS OF JANUARY 1, 2002 $ 0.2 $ 1.0 $ 646.5 $2,598.8 $ 202.5
Comprehensive income:
Net income -- -- -- 187.5 --
Net unrealized gains on
securities available-for-sale
arising during the period,
net of tax -- -- -- -- 82.7
Accumulated net gains on cash
flow hedges, net of tax -- -- -- -- 9.6
Total comprehensive income
Cash dividends declared -- -- -- (31.1) --
Exchange of subsidiaries for
shares of NFS stock held by a
related party 0.1 -- 110.1 -- --
Other, net -- -- 4.6 17.0 --
- ------------------------------------------------------------------------------------------------------
BALANCE AS OF JUNE 30, 2002 $ 0.3 $ 1.0 $ 761.2 $2,772.2 $ 294.8
======================================================================================================
TOTAL
TREASURY SHAREHOLDERS'
STOCK OTHER EQUITY
===========================================================================
Balance as of January 1, 2001 $ (0.3) $ (4.2) $2,997.5
Comprehensive income:
Net income -- -- 221.6
Net unrealized gains on
securities
available-for-sale
arising during the period,
net of tax -- -- 78.6
Cumulative effect of adoption
of accounting principles, net
of tax -- -- (1.4)
Accumulated net gains on cash
flow hedges, net of tax -- -- 0.5
--------
Total comprehensive income 299.3
--------
Cash dividends declared -- -- (30.9)
Other, net 0.1 (2.9) 3.0
- -------------------------------------------------------------------------
Balance as of June 30, 2001 $ (0.2) $ (7.1) $3,268.9
=========================================================================
BALANCE AS OF JANUARY 1, 2002 $ (0.2) $(5.5) $3,443.3
Comprehensive income:
Net income -- -- 187.5
Net unrealized gains on
securities available-for-sale
arising during the period,
net of tax -- -- 82.7
Accumulated net gains on cash
flow hedges, net of tax -- -- 9.6
--------
Total comprehensive income 279.8
--------
Cash dividends declared -- -- (31.1)
Exchange of subsidiaries for
shares of NFS stock held by a
related party (244.7) -- (134.5)
Other, net -- (1.9) 19.7
- -------------------------------------------------------------------------
BALANCE AS OF JUNE 30, 2002 $(244.9) $(7.4) $3,577.2
=========================================================================
See accompanying notes to unaudited consolidated financial statements, including
note 9 which describes related party transactions.
5
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
Six Months Ended June 30, 2002 and 2001
(in millions)
2002 2001
==========================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 187.5 $ 221.6
Adjustments to reconcile net income to net cash provided by operating activities:
Income from discontinued operations (3.4) (0.3)
Interest credited to policyholder account values 603.6 611.9
Capitalization of deferred policy acquisition costs (353.6) (399.3)
Amortization of deferred policy acquisition costs 169.8 179.7
Amortization and depreciation (3.7) (9.8)
Realized losses on investments, hedging instruments and hedged items 45.5 0.8
Cumulative effect of adoption of accounting principles -- 10.9
Increase in accrued investment income (1.2) (33.4)
Increase in other assets (212.0) (84.7)
Increase in policy liabilities 17.6 11.5
Increase in other liabilities 391.7 44.9
Other, net 31.0 0.6
--------------------------------------------------------------------------------------------------------------------------
Net cash provided by continuing operations 872.8 554.4
Net cash provided by (used in) discontinued operations 3.4 (3.9)
--------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 876.2 550.5
--------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity of securities available-for-sale 2,120.2 2,048.2
Proceeds from sale of securities available-for-sale 929.4 131.7
Proceeds from repayments of mortgage loans on real estate 464.4 377.5
Proceeds from sale of real estate 30.9 9.5
Proceeds from repayments of policy loans and sale of other invested assets 29.3 46.2
Cost of securities available-for-sale acquired (4,829.9) (3,134.5)
Cost of mortgage loans on real estate acquired (928.3) (796.7)
Cost of real estate acquired (0.3) (0.2)
Short-term investments, net (310.3) (264.0)
Acquisition of subsidiary, net of cash (36.0) -
Disposal of subsidiaries, net of cash (48.6) -
Collateral - securities lending, net (189.9) -
Other, net (184.2) 120.7
--------------------------------------------------------------------------------------------------------------------------
Net cash used in continuing operations (2,953.3) (1,461.6)
Net cash provided by discontinued operations -- 2.4
--------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (2,953.3) (1,459.2)
--------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in short-term debt (100.0) (4.5)
Proceeds from issuance of long-term debt 296.0 -
Cash dividends paid (31.0) (30.9)
Increase in investment and universal life insurance product account values 3,489.4 3,318.9
Decrease in investment and universal life insurance product account values (1,598.8) (2,376.3)
Other, net 1.3 1.6
--------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 2,056.9 908.8
--------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash (20.2) 0.1
Cash, beginning of period 65.0 62.7
--------------------------------------------------------------------------------------------------------------------------
Cash, end of period $ 44.8 $ 62.8
==========================================================================================================================
See accompanying notes to unaudited consolidated financial statements, including
note 9 which describes related party transactions.
6
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Six Months Ended June 30, 2002
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of
Nationwide Financial Services, Inc. and subsidiaries (NFS or
collectively, the Company) have been prepared in accordance with
accounting principles generally accepted in the United States of
America (GAAP), which differ from statutory accounting practices
prescribed or permitted by regulatory authorities, for interim
financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all
information and footnotes required by GAAP for complete financial
statements. The financial information included herein reflects all
adjustments (all of which are normal and recurring in nature) which
are, in the opinion of management, necessary for a fair presentation of
financial position and results of operations. Operating results for all
periods presented are not necessarily indicative of the results that
may be expected for the full year. All significant intercompany
balances and transactions have been eliminated. The accompanying
unaudited consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and
related notes for the year ended December 31, 2001 included in the
Company's 2001 Annual Report on Form 10-K and Current Report on Form
8-K filed June 20, 2002, which reported revised consolidated financial
statements for discontinued operations (see note 9).
(2) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets (SFAS 142).
SFAS 142 applies to all acquired intangible assets whether acquired
singularly, as part of a group, or in a business combination. SFAS 142
supersedes APB Opinion No. 17, Intangible Assets (APB 17) and carries
forward provisions in APB 17 related to internally developed intangible
assets. SFAS 142 changes the accounting for goodwill and intangible
assets with indefinite lives from an amortization method to an
impairment-only approach.
The Company adopted SFAS 142 on January 1, 2002. The amortization of
goodwill from past business combinations ceased upon adoption of this
statement. At the time of adoption, the Company had unamortized
goodwill of $130.0 million. See note 4 for additional disclosures.
In October 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS 144). SFAS 144 supersedes SFAS 121, Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be
Disposed of, and APB Opinion No. 30, Reporting the Results of
Operations - Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events
and Transactions (APB 30). SFAS 144 was adopted by the Company on
January 1, 2002 and carries forward many of the provisions of SFAS 121
and APB 30 for recognition and measurement of the impairment of
long-lived assets to be held and used, and measurement of long-lived
assets to be disposed of by sale. Under SFAS 144, if a long-lived asset
is part of a group that includes other assets and liabilities, then the
provisions of SFAS 144 apply to the entire group. In addition, SFAS 144
does not apply to goodwill and other intangible assets that are not
amortized. The adoption of SFAS 144 did not have a material impact on
the results of operations or financial position of the Company.
In April 2002, the FASB issued Statement of Financial Accounting
Standards No. 145, Rescission of FASB Statements No. 4, 44 and 64,
Amendment of FASB Statement No. 13 and Technical Corrections (SFAS
145). The adoption of SFAS 145 did not have any impact on the financial
position or results of operations of the Company.
In June 2002, the FASB issued Statement of Financial Accounting
Standards No. 146, Accounting for Costs Associated with Exit of
Disposal Activities (SFAS 146). Adoption of SFAS 146 is not expected to
have any impact on the financial position or results of operations of
the Company.
7
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
(3) EARNINGS PER SHARE
Basic earnings per share is the amount of earnings for the period
available to each share of common stock outstanding during the
reporting period. Diluted earnings per share is the amount of earnings
for the period available to each share of common stock outstanding
during the reporting period adjusted for the potential issuance of
common shares for stock options.
The calculations of basic and diluted earnings per share are as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------------------
(in millions, except per share amounts) 2002 2001 2002 2001
=================================================================================================================
Income from continuing operations before cumulative
effect of adoption of accounting principles $ 80.4 $ 115.5 $ 184.1 $ 228.4
Income from discontinued operations, net of tax 1.2 0.7 3.4 0.3
Cumulative effect of adoption of accounting principles,
net of tax -- (2.3) -- (7.1)
-----------------------------------------------------------------------------------------------------------------
Net income $ 81.6 $ 113.9 $ 187.5 $ 221.6
=================================================================================================================
Weighted average common shares outstanding - basic 129.0 128.9 128.9 128.8
Dilutive effect of stock options 0.3 0.3 0.4 0.4
-----------------------------------------------------------------------------------------------------------------
Weighted average common shares outstanding - diluted 129.3 129.2 129.3 129.2
=================================================================================================================
Income from continuing operations before cumulative
effect of adoption of accounting principles per
common share:
Basic $ 0.62 $ 0.90 $ 1.43 $ 1.78
Diluted $ 0.62 $ 0.90 $ 1.43 $ 1.77
Income from discontinued operations per common share,
net of tax:
Basic $ 0.01 $ -- $ 0.02 $ --
Diluted $ 0.01 $ -- $ 0.02 $ --
Cumulative effect of adoption of accounting principles
per common share, net of tax:
Basic $ -- $ (0.02) $ -- $ (0.06)
Diluted $ -- $ (0.02) $ -- $ (0.06)
-------------------------------------------------------------------------------------------------------------------
Net income per common share:
Basic $ 0.63 $ 0.88 $ 1.45 $ 1.72
Diluted $ 0.63 $ 0.88 $ 1.45 $ 1.71
=================================================================================================================
8
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
(4) GOODWILL
Changes in the carrying amount of goodwill by reportable segment for
the six months ended June 30, 2002 were as follows:
INDIVIDUAL INSTITUTIONAL LIFE
(in millions) ANNUITY PRODUCTS INSURANCE CORPORATE(1) TOTAL
===============================================================================================================
Balance as of January 1, 2002 $ -- $ 35.8 $ 70.3 $ 23.9 $ 130.0
Acquisitions (see note 9) -- 2.9 60.0 -- 62.9
Disposals (see note 9) -- -- -- (23.9) (23.9)
---------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2002 $ -- $ 38.7 $ 130.3 $ -- $ 169.0
===============================================================================================================
----------
(1) Amount was previously reported in the Asset Management segment, which
the Company no longer reports due to the transactions described in note
9.
During the second quarter of 2002 the Company completed its
transitional impairment testing and concluded that, as of January 1,
2002, there were no impairment losses on existing goodwill.
Below is a calculation of reported net income, basic earnings per share
and diluted earnings per share adjusted for the effect of amortization
expense for the three and six months ended June 30, 2001.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------------------
(in millions, except per share amounts) 2002 2001 2002 2001
==================================================================================================================
Net income, as originally reported $ 81.6 $ 113.9 $ 187.5 $ 221.6
Exclude goodwill amortization expense, net of tax -- 2.8 -- 5.6
------------------------------------------------------------------------------------------------------------------
Adjusted net income $ 81.6 $ 116.7 $ 187.5 $ 227.2
==================================================================================================================
BASIC EARNINGS PER SHARE:
As originally reported $ 0.63 $ 0.88 $ 1.45 $ 1.72
Exclude goodwill amortization expense -- 0.02 -- 0.04
------------------------------------------------------------------------------------------------------------------
As adjusted $ 0.63 $ 0.90 $ 1.45 $ 1.76
==================================================================================================================
DILUTED EARNINGS PER SHARE:
As originally reported $ 0.63 $ 0.88 $ 1.45 $ 1.71
Exclude goodwill amortization expense -- 0.02 -- 0.04
------------------------------------------------------------------------------------------------------------------
As adjusted $ 0.63 $ 0.90 $ 1.45 $ 1.75
==================================================================================================================
Basic income from continuing operations before cumulative effect of
adoption of accounting principles per common share, excluding goodwill
amortization expense, net of tax, for the three and six months ended
June 30, 2001 was $0.92 and $1.81, respectively. Diluted income from
continuing operations per common share, excluding goodwill amortization
expense, net of tax, for the three and six months ended June 30, 2001
was $0.92 and $1.80, respectively.
9
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
(5) COMPREHENSIVE INCOME (LOSS)
Comprehensive income (loss) includes net income as well as certain
items that are reported directly within a separate component of
shareholders' equity that bypass net income. Other comprehensive income
(loss) is comprised of unrealized gains (losses) on securities
available-for-sale and accumulated net gains (losses) on cash flow
hedges. The related before and after federal income tax amounts are as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------------------------------------------
(in millions) 2002 2001 2002 2001
===================================================================================================================
Unrealized gains (losses) on securities available-for-sale
arising during the period:
Gross $ 306.9 $ (67.6) $ 149.8 $ 159.2
Adjustment to deferred policy acquisition (99.7) 21.3 (64.7) (43.8)
costs
Related federal income tax (expense) benefit (72.5) 16.2 (29.8) (40.4)
-------------------------------------------------------------------------------------------------------------------
Net 134.7 (30.1) 55.3 75.0
-------------------------------------------------------------------------------------------------------------------
Reclassification adjustment for net losses on securities
available-for-sale realized during the period:
Gross 37.4 1.3 42.2 5.5
Related federal income tax benefit (13.1) (0.4) (14.8) (1.9)
-------------------------------------------------------------------------------------------------------------------
Net 24.3 0.9 27.4 3.6
-------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) on securities
available-for-sale 159.0 (29.2) 82.7 78.6
-------------------------------------------------------------------------------------------------------------------
Accumulated net gain (loss) on cash flow hedges:
Gross 5.7 (0.3) 14.7 0.8
Related federal income tax (expense) benefit (1.9) 0.1 (5.1) (0.3)
-------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) on cash
flow hedges 3.8 (0.2) 9.6 0.5
-------------------------------------------------------------------------------------------------------------------
Accumulated net gain (loss) on transition adjustments:
Transition adjustment - FAS 133 -- -- -- (5.6)
Transition adjustment - EITF 99-20 -- 3.5 -- 3.5
Related federal income tax (expense) benefit -- (1.3) -- 0.7
-------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) on
transition adjustments -- 2.2 -- (1.4)
-------------------------------------------------------------------------------------------------------------------
Total other comprehensive income (loss) $ 162.8 $ (27.2) $ 92.3 $ 77.7
===================================================================================================================
Reclassification adjustments for net realized gains and losses on the
ineffective portion of cash flow hedges were immaterial during the
three and six months ended June 30, 2002 and 2001 and, therefore, are
not reflected in the table above.
10
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
(6) SECURITIZATION TRANSACTION
During the first quarter of 2002, the Company sold a credit enhanced
equity interest in a Low Income Housing Tax Credit Fund (Fund) to an
unrelated third party for $55.3 million. The Company recognized $3.1
million of structuring fee income related to this transaction.
Additionally, $1.6 million of net proceeds were used to establish a
stabilization reserve for certain properties that are not currently
generating the underlying tax credits. This amount is evaluated
regularly and is reduced and recognized in income if and when the
properties begin generating tax credits and the related cash flow
projections no longer require such reserves. There was no change in the
stabilization reserve during second quarter 2002. As part of this
transaction, the Company has provided a cumulative guaranteed 5.25%
return to the third party investor as it relates to the tax credit
flows over the life of the transaction. The Company does not anticipate
making any payments related to the guarantee provision provided by this
transaction.
(7) SEGMENT DISCLOSURES
The Company uses differences in products as the basis for defining its
reportable segments. The Company has historically reported four product
segments: Individual Annuity, Institutional Products, Life Insurance
and Asset Management. During the second quarter of 2002, the Company
completed a transaction with a related party that resulted in the
disposal of a substantial portion of the business that had been
reported in the Asset Management segment (see note 9). As a result, the
Company no longer reports an Asset Management segment, as this business
is considered discontinued operations. Effective in the second quarter
of 2002, structured products transactions previously reported in the
Asset Management segment are reported in the Institutional Products
segment. Amounts reported for prior periods have been revised to
reflect these changes.
The Individual Annuity segment consists of individual The BEST of
AMERICA(R) and private label deferred variable annuity products,
deferred fixed annuity products and income products. Individual
deferred annuity contracts provide the customer with tax-deferred
accumulation of savings and flexible payout options including lump sum,
systematic withdrawal or a stream of payments for life. In addition,
variable annuity contracts provide the customer with access to a wide
range of investment options and asset protection in the event of an
untimely death, while fixed annuity contracts generate a return for the
customer at specified interest rates fixed for prescribed periods.
The Institutional Products segment is comprised of the Company's
private and public sector group retirement plans and medium-term note
program. The private sector includes the 401(k) business generated
through fixed and variable annuities, Nationwide Trust Company, FSB and
The 401(k) Company. The public sector includes the Internal Revenue
Code (IRC) Section 457 business in the form of fixed and variable
annuities as well as administration-only business. Additionally,
structured products transactions are reported in the Institutional
Products segment.
The Life Insurance segment consists of investment life products,
including both individual variable life and corporate-owned life
insurance products (COLI), traditional life insurance products,
universal life insurance and the Company's investment in TBG Insurance
Services Corporation d/b/a TBG Financial (TBG Financial), a leading
COLI producer. Life insurance products provide a death benefit and
generally also allow the customer to build cash value on a
tax-advantaged basis.
In addition to the product segments, the Company reports a Corporate
segment. The Corporate segment includes net investment income not
allocated to the three product segments, unallocated expenses, interest
expense on debt and in 2001, goodwill amortization. In addition to
these operating revenues and expenses, the Company also reports net
realized gains and losses on investments not related to
securitizations, hedging instruments and hedged items in the Corporate
segment, but does not consider them as part of operating income.
11
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
The following table summarizes the financial results of the Company's business
segments for the three months ended June 30, 2002 and 2001.
INDIVIDUAL INSTITUTIONAL LIFE
(in millions) ANNUITY PRODUCTS INSURANCE CORPORATE TOTAL
===================================================================================================================
2002
Net investment income $ 165.8 $ 198.0 $ 81.9 $ 7.0 $ 452.7
Other operating revenue 139.8 67.0 137.8 (0.3) 344.3
- -------------------------------------------------------------------------------------------------------------------
Total operating revenue(1) 305.6 265.0 219.7 6.7 797.0
- -------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder account values 126.0 134.5 45.3 -- 305.8
Amortization of deferred policy acquisition costs 54.5 11.3 19.2 -- 85.0
Interest expense on debt and capital and
preferred securities of subsidiary trusts -- -- -- 16.9 16.9
Other benefits and expenses 70.8 66.2 107.4 0.4 244.8
- -------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 251.3 212.0 171.9 17.3 652.5
- -------------------------------------------------------------------------------------------------------------------
Operating income (loss) before federal income
tax expense(1) 54.3 53.0 47.8 (10.6) 144.5
Net realized losses on investments, hedging
instruments and hedged items -- -- -- (40.8) (40.8)
- --------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
federal income tax expense and cumulative
effect of adoption of accounting principles $ 54.3 $ 53.0 $ 47.8 $(51.4) $ 103.7
====================================================================================================================
2001
Net investment income $ 129.1 $ 211.9 $ 81.2 $ 9.3 $ 431.5
Other operating revenue 144.7 72.1 125.7 0.4 342.9
- -------------------------------------------------------------------------------------------------------------------
Total operating revenue(1) 273.8 284.0 206.9 9.7 774.4
- -------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder account values 106.8 158.7 44.2 -- 309.7
Amortization of deferred policy acquisition costs 53.2 13.0 19.3 -- 85.5
Interest expense on debt and capital and
preferred securities of subsidiary trusts -- -- -- 13.4 13.4
Other benefits and expenses 51.8 58.3 99.3 2.9 212.3
- -------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 211.8 230.0 162.8 16.3 620.9
- -------------------------------------------------------------------------------------------------------------------
Operating income (loss) before federal income
tax expense(1) 62.0 54.0 44.1 (6.6) 153.5
Net realized gains on investments, hedging
instruments and hedged items -- -- -- 3.2 3.2
- -------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
federal income tax expense and cumulative
effect of adoption of accounting principles $ 62.0 $ 54.0 $ 44.1 $ (3.4) $ 156.7
====================================================================================================================
- --------------
(1) Excludes net realized gains and losses on investments not related to
securitizations, hedging instruments and hedged items, discontinued
operations and cumulative effect of adoption of accounting principles.
12
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
The following table summarizes the financial results of the Company's
business segments for the six months ended June 30, 2002 and 2001.
Individual Institutional Life
(in millions) Annuity Products Insurance Corporate Total
========================================================================================================================
2002
Net investment income $ 321.3 $ 394.4 $ 161.9 $ 18.7 $ 896.3
Other operating revenue 272.6 140.7 272.6 (0.2) 685.7
- -------------------------------------------------------------------------------------------------------------------------
Total operating revenue(1) 593.9 535.1 434.5 18.5 1,582.0
- -------------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder account values 244.9 267.7 91.0 -- 603.6
Amortization of deferred policy acquisition costs 108.2 21.5 40.1 -- 169.8
Interest expense on debt and capital and
preferred securities of subsidiary trusts -- -- -- 33.6 33.6
Other benefits and expenses 133.2 134.4 214.9 3.7 486.2
- -------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 486.3 423.6 346.0 37.3 1,293.2
- -------------------------------------------------------------------------------------------------------------------------
Operating income (loss) before federal income
tax expense(1) 107.6 111.5 88.5 (18.8) 288.8
Net realized losses on investments, hedging
instruments and hedged items -- -- -- (45.5) (45.5)
- -------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
federal income tax expense and cumulative
effect of adoption of accounting principles $ 107.6 $ 111.5 $ 88.5 $ (64.3) $ 243.3
=========================================================================================================================
Assets as of period end $ 42,815.1 $ 32,637.3 $9,567.5 $ 4,795.2 $89,815.1
=========================================================================================================================
2001
Net investment income $ 254.8 $ 423.7 $ 161.1 $ 17.4 $ 857.0
Other operating revenue 288.9 146.0 258.7 0.8 694.4
- -------------------------------------------------------------------------------------------------------------------------
Total operating revenue(1) 543.7 569.7 419.8 18.2 1,551.4
- -------------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder account values 208.1 316.8 87.0 -- 611.9
Amortization of deferred policy acquisition costs 110.9 25.8 43.0 -- 179.7
Interest expense on debt and capital and
preferred securities of subsidiary trusts -- -- -- 27.5 27.5
Other benefits and expenses 102.2 118.8 193.6 6.7 421.3
- -------------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 421.2 461.4 323.6 34.2 1,240.4
- -------------------------------------------------------------------------------------------------------------------------
Operating income (loss) before federal income
tax expense(1) 122.5 108.3 96.2 (16.0) 311.0
Net realized losses on investments, hedging
instruments and hedged items -- -- -- (0.8) (0.8)
- -------------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing operations before
federal income tax expense and cumulative
effect of adoption of accounting principles $ 122.5 $ 108.3 $ 96.2 $ (16.8) $ 310.2
=========================================================================================================================
Assets as of period end $ 44,019.4 $ 36,076.5 $8,707.9 $ 3,277.4(2) $92,081.2
=========================================================================================================================
- ----------
(1) Excludes net realized gains and losses on investments not related to
securitizations, hedging instruments and hedged items, discontinued
operations and cumulative effect of adoption of accounting principles.
(2) Includes $167.0 million of assets related to discontinued operations
(see note 9).
13
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
(8) CONTINGENCIES
On October 29, 1998, the Company was named in a lawsuit filed in Ohio
state court related to the sale of deferred annuity products for use as
investments in tax-deferred contributory retirement plans (Mercedes
Castillo v. Nationwide Financial Services, Inc., Nationwide Life
Insurance Company and Nationwide Life and Annuity Insurance Company).
On May 3, 1999, the complaint was amended to, among other things, add
Marcus Shore as a second plaintiff. The amended complaint is brought as
a class action on behalf of all persons who purchased individual
deferred annuity contracts or participated in group annuity contracts
sold by the Company and the other named Company affiliates which were
used to fund certain tax-deferred retirement plans. The amended
complaint seeks unspecified compensatory and punitive damages. On June
11, 1999, the Company and the other named defendants filed a motion to
dismiss the amended complaint. On March 8, 2000, the court denied the
motion to dismiss the amended complaint filed by the Company and the
other named defendants. On January 25, 2002, the plaintiffs filed a
motion for leave to amend their complaint to add three new named
plaintiffs. On February 9, 2002, the plaintiffs filed a motion for
class certification, which has not been granted. The Company is
opposing this motion. On February 9, 2002, Marcus Shore withdrew as a
named plaintiff in the lawsuit. On April 16, 2002, the Company filed a
motion for summary judgement on the individual claims of plaintiff
Mercedes Castillo. On May 28, 2002, the Court denied plaintiffs' motion
to add new persons as named plaintiffs, so the action is now proceeding
with Mercedes Castillo as the only named plaintiff. The Company intends
to defend this lawsuit vigorously.
On August 15, 2001, the Company was named in a lawsuit filed in
Connecticut federal court titled Lou Haddock, as trustee of the Flyte
Tool & Die, Incorporated Deferred Compensation Plan, et al v.
Nationwide Financial Services, Inc. and Nationwide Life Insurance
Company. On September 6, 2001, the plaintiffs amended their complaint
to include class action allegations. The plaintiffs seek to represent a
class of retirement plans that purchased variable annuities from
Nationwide Life Insurance Company to fund qualified ERISA retirement
plans. The amended complaint alleges that the retirement plans
purchased variable annuity contracts from the Company that allowed plan
participants to invest in funds that were offered by separate mutual
fund companies; that the Company was a fiduciary under ERISA and that
the Company breached its fiduciary duty when it accepted certain fees
from the mutual fund companies that purportedly were never disclosed by
the Company; and that the Company violated ERISA by replacing many of
the funds originally included in the plaintiffs' annuities with
"inferior" funds because the new funds purportedly paid higher fees to
the Company. The amended complaint seeks disgorgement of the fees
allegedly received by the Company and other unspecified compensatory
damages, declaratory and injunctive relief and attorney's fees. On
November 15, 2001, the Company filed a motion to dismiss the amended
complaint, which has not been decided. On December 3, 2001, the
plaintiffs filed a motion for class certification. On January 15, 2002,
the plaintiffs filed a response to the Company's motion to dismiss the
amended complaint. On February 22, 2002, the Company filed a reply
memorandum in support of its motion to dismiss. On March 12, 2002, the
plaintiffs filed a response to the Company's reply memorandum. On March
19, 2002, the Company filed a supplemental memorandum in support of its
motion to dismiss. The court heard oral argument on the motion to
dismiss on August 6, 2002. The class has not been certified. The
Company intends to defend this lawsuit vigorously.
There can be no assurance that any such litigation will not have a
material adverse effect on the Company in the future.
(9) RELATED PARTY TRANSACTIONS
The Company has entered into significant, recurring transactions and
agreements with Nationwide Mutual Insurance Company (NMIC) and other
affiliates as a part of its ongoing operations. The nature of the
transactions and agreements includes: annuity and life insurance
contracts, a tax sharing agreement, reinsurance agreements, cost
sharing agreements, administration services, marketing agreements,
office space leases, intercompany repurchase agreements and cash
management services. The transactions and agreements are described more
fully in note 16 to the consolidated financial statements included in
the Company's 2001 Annual Report on Form 10-K. During 2002, there have
been no material changes to the nature and terms of these transactions
and agreements.
Effective June 28, 2002, the Company entered into a Marketing and
Support Services Agreement with Gartmore Global Investments, Inc.
(GGI). Under this agreement, the Company receives quarterly payments of
$1 million in exchange for certain specified marketing and support of
GGI product offerings.
14
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
Amounts on deposit with a related party in cash management were $551.7
million and $85.6 million as of June 30, 2002 and December 31, 2001,
respectively.
On February 5, 2002 NFS purchased the remaining 10% of The 401(k)
Companies, Inc. for $3.9 million from existing shareholders. The
shareholders primarily consisted of management and employees of The
401(k) Companies, Inc.
On May 31, 2002 NFS purchased an additional interest in TBG Financial
for $40.7 million from existing shareholders. The shareholders
primarily consisted of management and employees of TBG Financial. This
additional investment increased NFS' ownership of TBG Financial to 63%.
The results of TBG Financial are included in the consolidated financial
statements of the Company effective May 31, 2002.
In June 2002, NFS exchanged all of its shares of common stock of GGI, a
majority owned subsidiary, and Nationwide Securities, Inc. (NSI), an
indirect wholly owned subsidiary, for approximately 9.1 million shares
of NFS common stock held by Nationwide Corporation. The transactions
valued NFS' interest in GGI and NSI at approximately $362.8 million. As
required by NFS' Restated Certificate of Incorporation, the shares
Nationwide Corporation exchanged were automatically converted from
Class B common stock to Class A common stock upon return to NFS.
NFS has retained these Class A shares in treasury for future issuance.
The GGI and NSI transactions are between related parties and therefore
will be recorded at carrying value of the underlying components of the
transactions rather than fair value. As a result, NFS recorded the NFS
shares received as treasury stock at Nationwide Corporation's carrying
value of these shares. NFS recorded the excess of Nationwide
Corporation's carrying value of NFS shares exchanged over the carrying
value of GGI and NSI, net of transaction costs, $110.1 million, as a
credit to additional paid-in-capital upon closing. These transactions
are intended to qualify as tax-free exchanges.
The results of the operations of GGI and NSI are reflected as
discontinued operations for all periods presented.
(10) PENDING TRANSACTION
On August 8, 2001, NFS announced the signing of an agreement and plan
of merger, whereby through a sponsored demutualization it will acquire
Provident Mutual Life Insurance Company (Provident). The purchase
price, which is to be paid in a combination of NFS Class A common
stock, cash and policy credits, is expected to be approximately $1.527
billion, assuming the NFS Final Stock Price - as defined in the
merger agreement - is within a range of $36.86 and $47.71. If the NFS
Final Stock Price is less than $36.86 or greater than $47.71,
the purchase price will be reduced or increased accordingly. On July
31, 2002, the Insurance Commissioner of the Commonwealth of
Pennsylvania approved the Sponsored Demutualization Application
previously filed by NFS and Provident, subject to certain conditions.
The NFS shareholders and Provident members will vote on matters
related to the proposed transaction at separate meetings scheduled for
September 13, 2002 and September 24, 2002, respectively. In addition
to these votes, the closing of the transaction, which is expected to
occur on or about October 1, 2002, is subject to various regulatory
requirements and satisfaction of conditions set forth in the merger
agreement.
(11) SENIOR NOTES
On June 24, 2002, NFS issued $300.0 million of 5.90% senior notes due
July 1, 2012 at an all-in rate of 6.09%. The senior notes are not
subject to any sinking fund payments. The terms of the senior notes
contain various restrictive covenants including limitations on the
disposition of subsidiaries. The senior notes are redeemable in whole
or in part, at the option of NFS, at any time or from time to time at a
redemption price equal to the greater of: (i) 100% of the aggregate
principal amount of the notes to be redeemed; or (ii) the sum of the
present value of the remaining scheduled payments of principal and
interest on the notes, discounted to the redemption date on a
semi-annual basis at the treasury rate plus 20 basis points, together
in each case with accrued interest payments to the redemption date. The
Company is scheduled to make interest payments on January 1 and July 1
of each year commencing January 1, 2003.
(12) RECLASSIFICATION
Certain items in the 2001 unaudited consolidated financial statements
and related footnotes have been reclassified to conform to the 2002
presentation.
15
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
The following analysis of unaudited consolidated results of
operations and financial condition of the Company should be read
in conjunction with the unaudited consolidated financial
statements and related notes included elsewhere herein.
NFS is the holding company for Nationwide Life Insurance Company
(NLIC) and other companies that comprise the domestic life
insurance and retirement savings operations of the Nationwide
group of companies (Nationwide). The Company is a leading provider
of long-term savings and retirement products in the United States
of America. The Company develops and sells a diverse range of
products including individual annuities, private and public sector
pension plans and other investment products sold to institutions,
and life insurance. The Company sells its products through a
diverse distribution network, including independent
broker/dealers, wirehouse and regional firms, financial
institutions, pension plan administrators, life insurance
specialists, Nationwide Retirement Solutions, The 401(k) Company,
Nationwide agents and Provident agents.
Management's discussion and analysis (MD&A) contains certain
forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995 with respect to the
results of operations and businesses of the Company. These
forward-looking statements involve certain risks and
uncertainties. Factors that may cause actual results to differ
materially from those contemplated or projected, forecast,
estimated or budgeted in such forward-looking statements include,
among others, the following possibilities: (i) change in
Nationwide's control of the Company through its beneficial
ownership of approximately 97.5% of the combined voting power of
all the outstanding common stock and approximately 79.8% of the
economic interest in the Company other than through the Provident
transaction; (ii) the Company's primary reliance, as a holding
company, on dividends from its subsidiaries to meet debt payment
obligations and the applicable regulatory restrictions on the
ability of the Company's subsidiaries to pay such dividends; (iii)
the potential impact on the Company's reported net income that
could result from the adoption of certain accounting standards
issued by the Financial Accounting Standards Board or other
standard-setting bodies; (iv) tax law changes impacting the tax
treatment of life insurance and investment products; (v) repeal of
the federal estate tax; (vi) heightened competition, including
specifically the intensification of price competition, the entry
of new competitors and the development of new products by new and
existing competitors; (vii) adverse state and federal legislation
and regulation, including limitations on premium levels, increases
in minimum capital and reserves, and other financial viability
requirements; (viii) failure to expand distribution channels in
order to obtain new customers or failure to retain existing
customers; (ix) inability to carry out marketing and sales plans,
including, among others, development of new products and/or
changes to certain existing products and acceptance of the new
and/or revised products in the market; (x) changes in interest
rates and the stock markets causing a reduction of investment
income and/or asset fees, an acceleration of the amortization of
deferred policy acquisition costs, reduction in the value of the
Company's investment portfolio or separate account assets or a
reduction in the demand for the Company's products; (xi) general
economic and business conditions which are less favorable than
expected; (xii) competitive, regulatory or tax changes that affect
the cost of, or demand for the Company's products; (xiii)
unanticipated changes in industry trends and ratings assigned by
nationally recognized rating organizations; (xiv) inaccuracies in
assumptions regarding future persistency, mortality, morbidity and
interest rates used in calculating reserve amounts; and (xv)
adverse litigation results or resolution of litigation and
arbitration.
BUSINESS OUTLOOK
As part of the Company's disclosure procedures, the Company has
incorporated a business outlook section as a permanent part of its
quarterly earnings release, conference call and MD&A. As such, the
following statements, which were published on July 29, 2002 as
part of the Company's earnings release, are forward-looking, based
on business conditions that existed as of June 30, 2002 and do not
consider any potential financial impact from the proposed
transaction with Provident. Due to the inherent difficulty in
forecasting the short-term performance of the equity markets, as
measured by the S&P 500 Index, and the related performance of the
Company's separate account values, the information provided below
incorporates a range of possible results that are intended to
illustrate the sensitivity of the Company's revenue and earnings
to the ultimate performance of the equity markets. To the extent
that actual equity market performance varies from that assumed in
the illustration below, our results will vary accordingly.
16
- For the full year 2002, should the equity markets and the
related performance of our separate account assets achieve a
return of 0 to 2 percent per quarter for the balance of the
year, operating earnings per share should be within a range
of $3.25 to $3.40.
- Utilizing the same equity market assumptions noted above,
revenue growth would be within a range of 4 to 6 percent and
return on equity would be within a range of 12 to 13 percent
for the full year 2002.
- In light of the recent market turmoil and considering the
sharp decline in the equity market since the end of the
quarter, should the equity market remain at this level (as
of July 26, 2002) for the balance of the year, earnings per
share would be within a range of $3.15 to $3.20 per share.
The information above does not reflect any potential impact
related to acceleration of deferred policy acquisition costs (DAC)
amortization that may result from continued depressed equity
market levels. For further discussion of this topic see Part I,
Item 2 - Individual Annuity, beginning on page 24.
The Company's ability to meet the indicated outlook and
expectations is subject to the factors described in the
introduction section immediately above. Following the end of each
quarter, the Company has a "quiet period" when it no longer
publishes or updates its current expectations and forecasts and
Company representatives will not comment concerning the Company's
financial results or expectations. The quiet period will extend
until the day when the Company's next earnings release is
published. Prior to the start of the next quiet period (October 7,
2002), investors can continue to rely on the earnings release and
web site as still being the Company's current expectations on
matters covered, unless the Company publishes a notice stating
otherwise.
CRITICAL ACCOUNTING POLICIES AND RECENTLY ISSUED ACCOUNTING
PRONOUNCEMENTS
In preparing the unaudited consolidated financial statements,
management is required to make estimates and assumptions that
affect the reported amounts of assets and liabilities and the
disclosures of contingent assets and liabilities as of the date of
the unaudited consolidated financial statements and the reported
amounts of revenues and expenses for the reporting period. Actual
results could differ significantly from those estimates.
The most critical estimates include those used in determining
impairment losses on investments, valuation allowances for
mortgage loans on real estate, deferred policy acquisition costs
for investment products and universal life insurance products and
federal income taxes.
Impairment Losses on Investments
Management regularly reviews its fixed maturity and equity
securities portfolio to evaluate the necessity of recording
impairment losses for other-than-temporary declines in the fair
value of investments. A number of criteria are considered during
this process including, but not limited to, the current fair value
as compared to amortized cost or cost, as appropriate, of the
security, the length of time the security's fair value has been
below amortized cost/cost, and by how much, specific credit issues
related to the issuer and current economic conditions.
Other-than-temporary impairment losses result in a reduction of
the cost basis of the underlying investment.
Impairment losses are recorded on long-lived assets used in
operations when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets
are less than the assets' carrying amount.
Significant changes in the factors the Company considers when
evaluating investments for impairment losses could result in a
significant change in impairment losses reported in the unaudited
consolidated financial statements.
17
Valuation Allowances on Mortgage Loans on Real Estate
The Company provides valuation allowances for impairments of
mortgage loans on real estate based on a review by portfolio
managers. Mortgage loans on real estate are considered impaired
when, based on current information and events, it is probable that
the Company will be unable to collect all amounts due according to
the contractual terms of the loan agreement. When the Company
determines that a loan is impaired, a provision for loss is
established equal to the difference between the carrying value and
the estimated value of the mortgage loan. Estimated value is based
on the present value of expected future cash flows discounted at
the loan's effective interest rate, or the fair value of the
collateral, if the loan is collateral dependent. Loans in
foreclosure and loans considered impaired are placed on
non-accrual status. Interest received on non-accrual status
mortgage loans on real estate is included in net investment income
in the period received.
The valuation allowance account for mortgage loans on real estate
is maintained at a level believed adequate by the Company to
absorb estimated credit losses. The Company's periodic evaluation
of the adequacy of the allowance for losses is based on past loan
loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrower's ability to
repay, the estimated value of the underlying collateral,
composition of the loan portfolio, current economic conditions and
other relevant factors. Significant changes in the factors the
Company considers in determining the valuation allowance on
mortgage loans on real estate could result in a significant change
in the provision for valuation allowance reported in the unaudited
consolidated financial statements.
Deferred Policy Acquisition Costs For Investment Products and
Universal Life Insurance Products
The costs of acquiring new and renewal business, principally
commissions, certain expenses of the policy issue and underwriting
department and certain variable sales expenses that relate to and
vary with the production of new or renewal business have been
deferred. DAC is subject to recoverability testing at the time of
policy issuance and loss recognition testing at the end of each
reporting period.
For investment products and universal life insurance products, DAC
is being amortized with interest over the lives of the policies in
relation to the present value of estimated future gross profits
from projected interest spreads, asset fees, cost of insurance,
policy administration and surrender charges. For years in which
gross profits are negative, DAC is amortized based on the present
value of gross revenues. The Company regularly reviews the
estimated future gross profits and revises such estimates when
appropriate. The cumulative change in amortization as a result of
changes in estimates to reflect current best estimates is recorded
as a charge or credit to amortization expense. The most
significant assumptions that are involved in the estimation of
future gross profits include future investment performance and
surrender/lapse rates. In the event actual experience differs
significantly from assumptions or assumptions are significantly
revised, the Company may be required to record a significant
charge or credit to amortization expense. DAC is adjusted to
reflect the impact of unrealized gains and losses on fixed
maturity securities available-for-sale.
Federal Income Taxes
The Company provides for federal income taxes based on amounts the
Company believes it will ultimately owe. Inherent in the provision
for federal income taxes are estimates regarding the deductibility
of certain expenses and the realization of certain tax credits. In
the event the ultimate deductibility of certain expenses or the
realization of certain tax credits differ from estimates, the
Company may be required to significantly change the provision for
federal income taxes recorded in the unaudited consolidated
financial statements.
Recently Issued Accounting Pronouncements
See note 2 to the unaudited consolidated financial statements for
a discussion of recently issued accounting pronouncements.
18
RESULTS OF OPERATIONS
Revenues
Total operating revenues, which excludes net realized gains and
losses on investments, hedging instruments and hedged items for
second quarter 2002 increased to $797.0 million compared to $774.4
million for the same period in 2001. For the first six months of
2002 and 2001, total operating revenues were $1.58 billion and
$1.55 billion, respectively.
Policy charges include asset fees, which are primarily earned from
separate account values generated from sales of individual and
group variable annuities and investment life insurance products;
cost of insurance charges earned on universal life insurance
products; administrative fees, which include fees charged per
contract on a variety of the Company's products and premium loads
on universal life insurance products; and surrender fees, which
are charged as a percentage of premiums withdrawn during a
specified period of annuity and certain life insurance contracts.
Policy charges for the comparable periods of 2002 and 2001 were as
follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------------------
(in millions) 2002 2001 2002 2001
=========================================================================================================
Asset fees $ 145.3 $ 157.6 $ 293.0 $ 317.3
Cost of insurance charges 58.3 49.6 113.7 96.2
Administrative fees 30.4 31.1 68.2 72.4
Surrender fees 21.9 18.4 37.9 38.7
---------------------------------------------------------------------------------------------------------
Total policy charges $ 255.9 $ 256.7 $ 512.8 $ 524.6
=========================================================================================================
The decline in asset fees reflects a decrease in total average
separate account values, of $4.40 billion (7%) in the first six
months of 2002 compared to a year ago. Market depreciation on
investment options underlying variable annuity and investment life
insurance products as a result of the sharp declines in the equity
markets, partially offset by net flows into these products,
resulted in the decrease in average separate account values.
Cost of insurance charges are assessed on the net amount at risk
on universal life insurance policies. The net amount at risk is
equal to a policy's death benefit minus the related policyholder
account value. The amount charged is based on the insured's age
and other underwriting factors. The increase in cost of insurance
charges is due primarily to growth in the net amount at risk as a
result of new sales of corporate and individual investment life
insurance products and favorable persistency of in-force business.
The net amount at risk related to corporate and individual
investment life insurance grew to $35.43 billion as of June 30,
2002 compared to $30.62 billion a year ago.
The decline in administrative fees in the three and six months
ended June 30, 2002 compared to the same periods a year ago is
primarily attributable to lower administration fees from public
sector pension case terminations and lower premium loads due to a
decline in life insurance premiums.
Net investment income includes the investment income earned on
investments supporting fixed annuities and certain life insurance
products as well as invested assets not allocated to product
segments, net of related investment expenses. Net investment
income grew from $431.5 million in the second quarter of 2001 to
$452.7 million in the second quarter of 2002 and from $857.0
million in the first half of 2001 to $896.3 million in the first
half of 2002. These increases were primarily due to increased
invested assets to support growth in individual fixed annuity, the
medium-term note program and life insurance policy reserves,
partially offset by lower yields due to declining market interest
rates. General account assets supporting insurance products are
closely correlated to the underlying reserves on these products.
General account reserves grew by $4.19 billion to $28.00 billion
as of the end of second quarter 2002 compared to $23.81 billion a
year ago.
19
Realized gains and losses on investments not related to
securitizations, hedging instruments and hedged items are not
considered by the Company to be recurring components of earnings.
The Company makes decisions concerning the sale of invested assets
based on a variety of market, business, tax and other factors. In
addition, charges related to other-than-temporary impairments of
available-for-sale securities and other investments and valuation
allowances on mortgage loans on real estate are included in this
caption. Also included are changes in the fair value of
derivatives qualifying as fair value hedges and the change in the
fair value of the hedged items, the ineffective portion of cash
flow hedges and changes in the fair value of free-standing
derivatives, all of which are considered non-recurring components
of earnings.
Net realized losses on investments, hedging instruments and hedged
items totaled $12.7 million in second quarter 2002 compared to
$6.9 million gains in the same period a year ago. For the first
half of 2002, net realized losses on investments, hedging
instruments and hedged items totaled $12.9 million compared to
$6.9 million gains for the first half of 2001. Also, during second
quarter 2002, the Company recorded realized losses related to
other-than-temporary impairments on securities available-for-sale
of $28.1 million, compared to $3.7 million a year ago, while
year-to-date 2002 realized losses related to other-than-temporary
impairments on securities available-for-sale totaled $32.6 million
compared to $7.7 million for the same period a year ago. In the
second quarter of 2002, the Company recorded net realized losses
on investments of $22.5 million, pre-tax, related to WorldCom,
Inc.
Other income includes management fees, commissions and other
income earned by subsidiaries of the Company that provide
administration, marketing and distribution services. The increase
in other income in 2002 reflects an increase in the number of
private sector pension plans sold through Nationwide Trust
Company, FSB.
Benefits and Expenses
Interest credited to policyholder account values totaled $305.8
million in second quarter 2002 compared to $309.7 million in
second quarter 2001, while year-to-date 2002 interest credited
totaled $603.6 million compared to $611.9 million a year ago and
principally relates to fixed annuities, both individual and
institutional, funding agreements backing the Company's
medium-term note program and certain life insurance products. The
decline in interest credited reflects lower crediting rates in the
Individual Annuity and Institutional Products segments, partially
offset by an increase in average assets.
Amortization of DAC declined to $85.0 million in the second
quarter of 2002 compared to $85.5 million in the second quarter of
2001. On a year-to-date basis, DAC amortization totaled $169.8
million in 2002 compared to $179.7 million in 2001. The decline in
amortization expense is primarily attributable to an increase in
amortization in 2001 related to an increase in public sector
pension case terminations and lower gross profits from individual
variable annuities, which have been adversely impacted by lower
equity markets.
Operating expenses increased 26% to $156.3 million in second
quarter 2002 compared to $124.0 million in second quarter 2001.
For the first half of 2001, operating expenses were $313.5
million, up 22% from $257.5 million for the first half of 2001.
The increase reflects a growing customer base, an increase in
employee benefit costs and spending on projects focused on
improving producer and customer service and increasing sales.
The additional interest expense in 2002 reflects the November 2001
and June 2002 senior note offerings, offset by lower utilization
of commercial paper borrowings.
Federal income tax expense was $23.3 million and $41.2 million,
representing effective tax rates of 22.5% and 26.3% for second
quarter 2002 and 2001, respectively. For the first six months of
2002 and 2001, federal income tax expense was $59.2 million and
$81.8 million, representing effective tax rates of 24.3% and
26.4%, respectively. An increase in tax credits from affordable
housing partnership investments and the elimination of
non-deductible goodwill amortization expense in 2002, partially
offset by lower tax exempt income drove the decreases in effective
rates.
20
Discontinued Operations
On June 28, 2002 NFS completed a transaction with Nationwide
Corporation to exchange all of the shares of common stock of GGI,
a majority owned subsidiary, that NFS held for shares of NFS
common stock held by Nationwide Corporation. GGI comprised NFS'
asset management operations. NFS also exchanged all of the shares
of common stock of NSI, an indirect wholly owned broker/dealer
subsidiary, for shares of NFS' common stock held by Nationwide
Corporation.
As a result of these transactions, the Company is no longer
engaged in asset management operations and the results of GGI and
NSI have been reported as discontinued operations. Also, the
Company no longer reports an Asset Management segment and
structured products transactions previously reported in the Asset
Management segment are now reported in the Institutional Products
segment. All periods presented have been revised to reflect these
changes.
Income from discontinued operations, net of tax, for second
quarter 2002 and 2001 was $1.2 million and $0.7 million,
respectively. For the first six months of 2002 and 2001, income
from discontinued operations, net of tax, was $3.4 million and
$0.3 million, respectively.
Other Data
The Company analyzes operating performance using a non-GAAP
measure called net operating income. The Company calculates net
operating income by adjusting net income to exclude all net
realized gains and losses on investments not related to
securitizations, hedging instruments and hedged items,
discontinued operations and cumulative effect of adoption of
accounting principles, all net of tax. Net operating income or
similar measures are commonly used in the insurance industry as a
measure of ongoing earnings performance.
The excluded items are important in understanding the Company's
overall results of operations. Net operating income should not be
viewed as a substitute for net income determined in accordance
with GAAP, and it should be noted that the Company's definition of
net operating income may differ from that used by other companies.
However, the Company believes that the presentation of net
operating income as it is measured for management purposes
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 net realized gains and losses on investments not
related to securitizations, hedging instruments and hedged items,
net of tax, from net operating income because such items are often
the result of a single non-recurring event which may or may not be
at the Company's discretion. Including the fluctuating effects of
these transactions could distort trends in the underlying
profitability of the Company's business. The Company also excludes
discontinued operations and the cumulative effect of adoption of
accounting principles, both net of tax, from net operating income
as such adjustments are not reflective of the ongoing operations
of the Company's business.
The following table reconciles the Company's reported net income
to net operating income for the periods indicated.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------
(in millions) 2002 2001 2002 2001
==================================================================================================
Net income $ 81.6 $ 113.9 $ 187.5 $ 221.6
Net realized losses (gains) on investments, hedging
instruments and hedged items, net of tax(1) 26.5 (2.1) 29.6 0.5
Discontinued operations, net of tax (1.2) (0.7) (3.4) (0.3)
Cumulative effect of adoption of accounting
principles, net of tax - 2.3 - 7.1
--------------------------------------------------------------------------------------------------
Net operating income $ 106.9 $ 113.4 $ 213.7 $ 228.9
==================================================================================================
----------
(1) Excludes net realized gains and losses related to
securitizations.
21
Sales Information
The Company regularly monitors and reports a non-GAAP measure
titled sales. Sales or similar measures are commonly used in the
insurance industry as a measure of business generated in the
period.
Sales should not be viewed as a substitute for revenues determined
in accordance with GAAP and the Company's definition of sales
might differ from that used by other companies. Sales generate
customer funds managed and administered, which ultimately drive
revenues. Sales are primarily comprised of statutory premiums and
deposits on individual and group annuities and life insurance
products sold to a diverse customer base. Statutory premiums and
deposits are calculated in accordance with accounting practices
prescribed or permitted by regulatory authorities and then
adjusted to arrive at sales. Sales also include deposits on
administration-only group pension plans.
Sales are stated net of internal replacements, which in the
Company's opinion provides a more meaningful disclosure of sales.
In addition, sales exclude: funding agreements issued under the
Company's medium-term note program; large case bank-owned life
insurance (BOLI); large case pension plan acquisitions; and
deposits into Nationwide employee and agent benefit plans.
Although these products contribute to asset and earnings growth,
they do not produce steady production flow that lends itself to
meaningful comparisons and are therefore excluded from sales.
The Company believes that the presentation of sales as measured
for management purposes enhances the understanding of the
Company's business and helps depict trends that may not be
apparent in the results of operations due to differences between
the timing of sales and revenue recognition.
The Company's flagship products are marketed under The BEST of
AMERICA brand and include individual variable and group annuities,
group private sector pension plans sold through Nationwide Trust
Company, FSB and variable life insurance. The BEST of AMERICA
products allow customers to choose from investment options managed
by premier mutual fund managers. The Company has also developed
private label variable and fixed annuity products in conjunction
with other financial services providers that allow those providers
to sell products to their own customer bases under their own brand
name.
The Company also markets group deferred compensation retirement
plans to employees of state and local governments for use under
IRC Section 457. The Company utilizes its sponsorship by the
National Association of Counties and The United States Conference
of Mayors when marketing IRC Section 457 products.
22
Sales by product and segment for the comparable periods of 2002
and 2001 are summarized as follows.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------------------------------
(in millions) 2002 2001 2002 2001
======================================================================================================
The BEST of AMERICA products $ 968.7 $ 1,091.3 $ 1,943.3 $ 2,152.7
Private label annuities 208.1 535.5 429.1 757.0
Other -- 0.3 -- 2.8
------------------------------------------------------------------------------------------------------
Total individual variable annuity sales 1,176.8 1,627.1 2,372.4 2,912.5
------------------------------------------------------------------------------------------------------
Deferred fixed annuities 661.9 442.8 1,199.9 761.3
Income products 32.6 34.0 58.1 73.1
------------------------------------------------------------------------------------------------------
Total individual fixed annuity sales 694.5 476.8 1,258.0 834.4
------------------------------------------------------------------------------------------------------
Total individual annuity sales $ 1,871.3 $ 2,103.9 $ 3,630.4 $ 3,746.9
======================================================================================================
The BEST of AMERICA annuity products $ 684.6 $ 770.6 $ 1,475.2 $ 1,708.6
The BEST of AMERICA trust products 358.6 170.5 925.2 406.5
The 401(k) Company 116.2 103.1 246.2 214.6
Other 22.7 13.4 33.2 27.3
------------------------------------------------------------------------------------------------------
Total private sector pension plan sales 1,182.1 1,057.6 2,679.8 2,357.0
------------------------------------------------------------------------------------------------------
IRC Section 457 annuities 351.1 388.0 685.9 790.1
Administration-only agreements 277.1 266.0 547.3 526.9
------------------------------------------------------------------------------------------------------
Total public sector pension plan sales 628.2 654.0 1,233.2 1,317.0
------------------------------------------------------------------------------------------------------
Total institutional products sales $ 1,810.3 $ 1,711.6 $ 3,913.0 $ 3,674.0
======================================================================================================
The BEST of AMERICA variable life series $ 139.7 $ 148.9 $ 266.3 $ 289.5
Corporate-owned life insurance 139.9 137.9 454.5 515.7
Traditional/Universal life insurance 61.9 63.4 121.7 122.2
------------------------------------------------------------------------------------------------------
Total life insurance sales $ 341.5 $ 350.2 $ 842.5 $ 927.4
======================================================================================================
The Company sells its products through a diverse distribution
network. Unaffiliated entities that sell the Company's products to
their own customer base include independent broker/dealers,
wirehouse and regional firms, financial institutions, pension plan
administrators, life insurance specialists and Provident agents.
Representatives of the Company who market products directly to a
customer base include Nationwide Retirement Solutions and The
401(k) Company. The Company also distributes retirement savings
products through the agency distribution force of its ultimate
parent company, NMIC.
Sales by distribution channel are summarized as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------------------
(in millions) 2002 2001 2002 2001
=========================================================================================================
Independent broker/dealers $ 1,142.3 $ 1,171.5 $ 2,524.1 $ 2,525.0
Financial institutions 1,045.4 902.4 2,068.5 1,685.6
Nationwide Retirement Solutions 649.7 670.9 1,262.2 1,364.1
Wirehouse and regional firms 516.7 719.3 1,019.3 1,086.9
Pension plan administrators 205.1 266.9 432.7 593.9
Nationwide agents 186.8 193.7 348.5 362.5
Life insurance specialists 139.9 137.9 454.5 515.7
The 401(k) Company 116.2 103.1 246.2 214.6
Provident agents 21.0 -- 29.9 --
---------------------------------------------------------------------------------------------------------
Total $ 4,023.1 $ 4,165.7 $ 8,385.9 $ 8,348.3
=========================================================================================================
23
Sales through financial institutions grew 16% in second quarter
2002 compared to a year ago, driven mainly by increased fixed
annuity and pension sales. Year-to-date 2002 sales through this
channel increased 23% compared to the same period a year ago.
Sales through Nationwide Retirement Solutions declined 3% in
second quarter 2002 and 7% year-to-date compared to 2001,
reflecting the impact of case terminations in 2001 and 2002.
Sales through wirehouse and regional firms decreased 28% in the
second quarter of 2002 to $516.7 million compared to sales of
$719.3 million in second quarter 2001 due primarily to a spike in
sales in second quarter of 2001 from the launch of the Waddell &
Reed Financial, Inc. relationship. For the first six months of
2002, sales through this channel decreased 6% to $1.02 billion
compared to $1.09 billion in the same period a year ago,
reflecting lower sales from the Waddell & Reed Financial, Inc.
relationship.
Sales through pension plan administrators dropped 23% and 27% in
second quarter 2002 and the first six months of 2002 compared to
the same periods a year ago, respectively. As the Company's
private sector pension business model continues to evolve, direct
production through this channel is not expected to grow, with more
new business opportunities being created in conjunction or
partnership with the independent broker/dealer, wirehouse and
financial institutions relationships.
BUSINESS SEGMENTS
The Company has three product segments: Individual Annuity,
Institutional Products and Life Insurance. In addition, the
Company reports certain other revenues and expenses in a Corporate
segment.
The following table summarizes operating income (loss) before
federal income tax expense for the Company's business segments for
the periods indicated.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------------------------------
(in millions) 2002 2001 2002 2001
=====================================================================================================================
Individual Annuity $ 54.3 $ 62.0 $ 107.6 $ 122.5
Institutional Products 53.0 54.0 111.5 108.3
Life Insurance 47.8 44.1 88.5 96.2
Corporate(1) (10.6) (6.6) (18.8) (16.0)
---------------------------------------------------------------------------------------------------------------------
Operating income before federal income tax expense(1) $ 144.5 $ 153.5 $ 288.8 $ 311.0
=====================================================================================================================
----------
(1) Excludes net realized gains and losses on investments not
related to securitizations, hedging instruments and hedged
items, discontinued operations and cumulative effect of
adoption of accounting principles.
Individual Annuity
The Individual Annuity segment consists of individual The BEST of
AMERICA and private label deferred variable annuity products,
deferred fixed annuity products and income products. Individual
deferred annuity contracts provide the customer with tax-deferred
accumulation of savings and flexible payout options including lump
sum, systematic withdrawal or a stream of payments for life. In
addition, variable annuity contracts provide the customer with
access to a wide range of investment options and asset protection
in the event of an untimely death, while fixed annuity contracts
generate a return for the customer at specified interest rates
fixed for prescribed periods.
24
The following table summarizes certain selected financial data
for the Company's Individual Annuity segment for the periods
indicated.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------------------------------
(in millions) 2002 2001 2002 2001
===================================================================================================================
INCOME STATEMENT DATA
Revenues:
Policy charges $ 123.6 $ 127.0 $ 243.2 $ 255.2
Net investment income 165.8 129.1 321.3 254.8
Premiums on immediate annuities 16.2 17.7 29.4 33.7
-------------------------------------------------------------------------------------------------------------------
$ 305.6 273.8 593.9 543.7
-------------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account values 126.0 106.8 244.9 208.1
Other benefits 21.4 20.1 37.8 35.8
Amortization of deferred policy acquisition costs 54.5 53.2 108.2 110.9
Other operating expenses 49.4 31.7 95.4 66.4
-------------------------------------------------------------------------------------------------------------------
251.3 211.8 486.3 421.2
-------------------------------------------------------------------------------------------------------------------
Operating income before federal income tax expense $ 54.3 $ 62.0 $ 107.6 $ 122.5
===================================================================================================================
OTHER DATA
Sales:
Individual variable annuities $ 1,176.8 $ 1,627.1 $ 2,372.4 $ 2,912.5
Individual fixed annuities 694.5 476.8 1,258.0 834.4
-------------------------------------------------------------------------------------------------------------------
Total individual annuity sales $ 1,871.3 $ 2,103.9 $ 3,630.4 $ 3,746.9
===================================================================================================================
Average account values:
General account $ 9,919.3 $ 7,340.7 $ 9,602.0 $ 7,152.0
Separate account 31,869.0 34,176.5 32,319.0 34,745.7
-------------------------------------------------------------------------------------------------------------------
Total average account values $ 41,788.3 $ 41,517.2 $ 41,921.0 $ 41,897.7
===================================================================================================================
Account values as of period end:
Individual variable annuities $ 33,566.0 $ 37,343.8
Individual fixed annuities 6,923.8 4,691.7
-------------------------------------------------------------------------------------------------------------------
Total account values $ 40,489.8 $ 42,035.5
===================================================================================================================
Return on average allocated capital 10.2% 15.1% 10.5% 15.6%
Pre-tax operating income to average account values 0.52% 0.60% 0.51% 0.58%
-------------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings totaled $54.3 million in second quarter
2002, down 12% compared to $62.0 million a year ago. For the first
six months of 2002 pre-tax operating earnings were $107.6 million
compared to $122.5 million for the first six months of 2001. An
increase in interest spread income was offset by lower asset fees
and higher operating expenses.
Asset fees decreased to $100.9 million in the second quarter of
2002, down 6% from $107.7 million in the same period a year ago.
For the first half of 2002, asset fees totaled $203.2 million,
down 6% from the first half of 2001 total of $216.1 million. Asset
fees are calculated daily and charged as a percentage of separate
account values. The fluctuations in asset fees are primarily due
to changes in the market value of investment options underlying
the account values, which have followed the general trends of the
equity markets. Average separate account values decreased 7% to
$32.32 billion as of June 30, 2002 compared to $34.75 billion a
year ago.
25
Operating expenses were $49.4 million in second quarter 2002, an
increase of 56% over second quarter 2001. During the first half of
2002, operating expenses totaled $95.4 million, an increase of 44%
over the first half of 2001 total of $66.4 million. The increase
in general operating expenses compared to a year ago is the result
of a growing customer base, an increase in employee benefit costs,
an increase in trail commissions and projects focused on improving
producer and customer service and increasing sales.
Interest spread income is net investment income less interest
credited to policyholder account values. Interest spread income
can vary depending on crediting rates offered by the Company,
performance of the investment portfolio, including the rate of
prepayments, changes in market interest rates, the competitive
environment and other factors.
The following table depicts the interest spread on average general
account values in the Individual Annuity segment for the periods
indicated.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------------------
2002 2001 2002 2001
=================================================================================================================
Net investment income 7.03% 7.61% 7.09% 7.76%
Interest credited 5.08 5.82 5.10 5.82
-----------------------------------------------------------------------------------------------------------------
Interest spread on average general account values 1.95% 1.79% 1.99% 1.94%
=================================================================================================================
Interest spread on average general account values increased 16
basis points in second quarter 2002 compared to a year ago. The
increase is primarily due to a reduction in interest crediting
rates in response to declining market rates.
The Company regularly reviews its DAC balances and underlying
assumptions. Recent declines in the stock market may reduce the
Company's assumptions for future gross profits which could result
in an adjustment to the DAC balance and an acceleration of
amortization expense. Should the equity markets remain at end of
July levels for the remainder of this year, the Company would
likely record an adjustment to the DAC balance in the fourth
quarter of 2002 or first quarter of 2003. Under those assumptions,
the increase in amortization expense would be approximately $175
million to $200 million, after tax. Should the equity markets
rebound in the coming months, the likelihood of an adjustment to
the DAC balance will be reduced.
Individual Annuity sales, which exclude internal replacements,
during second quarter 2002 were $1.87 billion, down 11% from $2.10
billion in the year ago quarter. For the first six months of 2002,
sales were $3.63 billion compared to $3.75 billion for the first
six months of 2001. The appeal of fixed products to consumers
remained very strong, as sales of fixed annuities reached $694.5
million in second quarter 2002, a 46% increase from the $476.8
million reported in the second quarter a year ago. Sales of fixed
annuities for the first half of 2002 were $1.26 billion compared
to $834.4 million for the first half of 2001.
Individual Annuity segment deposits in second quarter 2002 of
$1.99 billion offset by withdrawals and surrenders totaling $1.48
billion generated net flows of $509.4 million compared to the
$1.05 billion achieved a year ago. The decrease in net flows is
attributable to the decline in sales combined with an increase in
variable annuity surrenders due to the implementation of
short-term trading fees and a change in procedures which now allow
customers quicker access to their funds.
The decrease in pre-tax operating income to average account values
in second quarter and the first half of 2002 compared to 2001 is
primarily a result of lower asset fees and higher expenses,
partially offset by increased spread income of general account
assets. The decrease in return on average allocated capital to
10.2% in the current quarter reflects the decrease in operating
income coupled with an increase in allocated capital as a result
of the significant growth in fixed annuities.
26
Institutional Products
The Institutional Products segment is comprised of the Company's
private and public sector group retirement plans, medium-term note
program and structured products initiatives. The private sector
includes the 401(k) business generated through fixed and variable
annuities, Nationwide Trust Company, FSB and The 401(k) Company.
The public sector includes the IRC Section 457 business in the
form of fixed and variable annuities as well as
administration-only business.
Sales results do not include business generated through the
Company's medium-term note program, large case pension plan
acquisitions and Nationwide employee and agent benefit plans,
however the income statement data does reflect this business.
The following table summarizes certain selected financial data for
the Company's Institutional Products segment for the periods
indicated.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------------------------------
(in millions) 2002 2001 2002 2001
===================================================================================================================
INCOME STATEMENT DATA
Revenues:
Policy charges $ 44.7 $ 54.2 $ 94.7 $ 111.2
Net investment income 198.0 211.9 394.4 423.7
Other 22.3 17.9 46.0 34.8
-------------------------------------------------------------------------------------------------------------------
265.0 284.0 535.1 569.7
-------------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account values 134.5 158.7 267.7 316.8
Other operating expenses 77.5 71.3 155.9 144.6
-------------------------------------------------------------------------------------------------------------------
212.0 230.0 423.6 461.4
-------------------------------------------------------------------------------------------------------------------
Operating income before federal income tax expense $ 53.0 $ 54.0 $ 111.5 $ 108.3
===================================================================================================================
OTHER DATA
Sales:
Private sector pension plans $ 1,182.1 $ 1,057.6 $ 2,679.8 $ 2,357.0
Public sector pension plans 628.2 654.0 1,233.2 1,317.0
-------------------------------------------------------------------------------------------------------------------
Total institutional products sales $ 1,810.3 $ 1,711.6 $ 3,913.0 $ 3,674.0
===================================================================================================================
Average account values:
General account $ 12,424.3 $ 11,505.4 $ 12,253.4 $ 11,257.0
Separate account 20,643.0 23,737.1 21,065.5 24,181.4
Administration-only 16,911.1 14,670.1 16,805.7 13,438.9
-------------------------------------------------------------------------------------------------------------------
Total average account values $ 49,978.4 $ 49,912.6 $ 50,124.6 $ 48,877.3
===================================================================================================================
Account values as of period end:
Private sector pension plans $ 20,601.3 $ 20,991.1
Public sector pension plans 24,165.1 27,277.9
Funding agreements backing medium-term notes 4,104.8 2,569.5
-------------------------------------------------------------------------------------------------------------------
Total account values $ 48,871.2 $ 50,838.5
===================================================================================================================
Return on average allocated capital 21.2% 21.5% 22.4% 21.7%
Pre-tax operating income to average account values 0.42% 0.43% 0.44% 0.44%
-------------------------------------------------------------------------------------------------------------------
27
Pre-tax operating income totaled $53.0 million in the quarter
ended June 30, 2002, down 2% compared to the pre-tax operating
income of $54.0 million reported a year ago. Pre-tax operating
income increased 3% to $111.5 million in the first six months of
2002 compared to the same period a year ago. Significant growth in
interest spread income and income from trust products was offset
by lower policy charges and higher operating expenses.
Asset fees declined 13% to $39.6 million in the quarter ended June
30, 2002 compared to $45.7 million a year ago, while year-to-date
2002 asset fees were $80.5 million compared to $93.0 million in
2001. The decline was driven by a 13% drop in average separate
account values in both the quarter and first half of 2002 compared
to the same periods a year ago, attributable to market
depreciation on assets and public sector pension case
terminations.
Other income, which includes fees for administration-only cases,
Nationwide Trust Company, FSB products and structured products,
increased 25% in second quarter 2002 from a year ago due to growth
in trust sold private sector pension plans, which now account for
30% of private sector pension plan sales compared to 16% a year
ago. Other income increased 32% in the first half of 2002 compared
to the same period a year ago.
Interest spread income is net investment income less interest
credited to policyholder account values. Interest spread income
can vary depending on crediting rates offered by the Company,
performance of the investment portfolio, including the rate of
prepayments, changes in market interest rates, the competitive
environment and other factors. Interest spread income was $10.3
million higher in the second quarter of 2002 compared to the
second quarter of 2001 and $19.8 million higher on a year-to-date
basis driven by both higher average general account values and
improved interest spread. The increase in average general account
values was led by growth in the medium-term note program, where we
issued $400.0 million of notes during the quarter and $975.0
million during the first six months of 2002.
The following table depicts the interest spread on average general
account values in the Institutional Products segment for the
periods indicated.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------------------
2002 2001 2002 2001
===============================================================================================================
Net investment income 6.37% 7.37% 6.44% 7.53%
Interest credited 4.33 5.52 4.37 5.63
---------------------------------------------------------------------------------------------------------------
Interest spread on average general account values 2.04% 1.85% 2.07% 1.90%
===============================================================================================================
Interest spread improved to 204 basis points in the second quarter
of 2002 compared to 185 basis points a year ago as effective
crediting rate management more than offset lower investment income
yields on account values.
Institutional Products sales during second quarter 2002 reached
$1.81 billion compared to sales of $1.71 billion in second quarter
2001. For the first six months of 2002, sales reached $3.91
billion compared to sales of $3.67 billion for the same period a
year ago. Private Sector pension sales, aided by new selling
relationships and the sale of two large plans in first quarter
2002, were the key driver to growth, posting a strong quarter with
sales 12% ahead of a year ago. Sales in the Public Sector declined
slightly from a year ago reflecting the impact of case
terminations in 2001 and 2002 on recurring deposits.
Institutional Products segment deposits in second quarter 2002 of
$1.85 billion offset by participant withdrawals and surrenders
totaling $1.50 billion generated net flows from participant
activity of $351.3 million, an 8% decrease over second quarter
2001. Year-to-date 2002 net flows decreased 12% to $716.7 million
compared to year-to-date 2001 net flows of $818.9 million. In the
Private Sector, increased competition and a slow-down in new plan
creation is increasing the level of take-over business. In the
Public Sector, the increase reflects participants taking advantage
of the new portability provisions created as part of the tax
reforms enacted a year ago and the decrease in sales.
28
Life Insurance
The Life Insurance segment consists of investment life products,
including both individual variable life and COLI products,
traditional life insurance products, universal life insurance and
the Company's investment in TBG Financial, a leading COLI
producer. Effective May 31, 2002, the Company increased its
ownership in TBG Financial to 63%. The results of TBG Financial
are included in the consolidated results of the Company effective
May 31, 2002. Life insurance products provide a death benefit and
generally also allow the customer to build cash value on a
tax-advantaged basis.
The following table summarizes certain selected financial data for
the Company's Life Insurance segment for the periods indicated.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------------------------------------
(in millions) 2002 2001 2002 2001
===================================================================================================================
INCOME STATEMENT DATA
Revenues:
Total policy charges $ 87.6 $ 75.5 $ 174.9 $ 158.2
Net investment income 81.9 81.2 161.9 161.1
Other 50.2 50.2 97.7 100.5
-------------------------------------------------------------------------------------------------------------------
219.7 206.9 434.5 419.8
-------------------------------------------------------------------------------------------------------------------
Benefits 112.4 112.4 225.9 215.0
Operating expenses 59.5 50.4 120.1 108.6
-------------------------------------------------------------------------------------------------------------------
171.9 162.8 346.0 323.6
-------------------------------------------------------------------------------------------------------------------
Operating income before federal income tax expense $ 47.8 $ 44.1 $ 88.5 $ 96.2
===================================================================================================================
OTHER DATA
Sales:
The BEST of AMERICA variable life series $ 139.7 $ 148.9 $ 266.3 $ 289.5
Corporate-owned life insurance 139.9 137.9 454.5 515.7
Traditional/Universal life insurance 61.9 63.4 121.7 122.2
-------------------------------------------------------------------------------------------------------------------
Total life insurance sales $ 341.5 $ 350.2 $ 842.5 $ 927.4
===================================================================================================================
Policy reserves as of period end:
Individual investment life insurance $ 2,160.5 $ 2,139.0
Corporate investment life insurance 3,530.3 2,987.3
Traditional life insurance 1,905.1 1,837.7
Universal life insurance 816.0 774.2
-------------------------------------------------------------------------------------------------------------------
Total policy reserves $ 8,411.9 $ 7,738.2
===================================================================================================================
Life insurance in-force as of period end:
Individual investment life insurance $ 32,721.2 $ 28,673.0
Corporate investment life insurance 8,402.3 7,072.9
Traditional life insurance 24,966.1 24,222.2
Universal life insurance 7,763.9 7,904.5
-------------------------------------------------------------------------------------------------------------------
Total insurance in-force $ 73,853.5 $ 67,872.6
===================================================================================================================
Return on average allocated capital 11.8% 11.0% 11.2% 12.2%
-------------------------------------------------------------------------------------------------------------------
Life Insurance segment earnings increased 8% to $47.8 million for
the second quarter 2002, up from $44.1 million a year ago. An
increase in policy charges and improved mortality experience
offset the increase in operating expenses. On a year-to-date basis
segment earnings decreased 8% to $88.5 million in 2002 from $96.2
million in 2001. Lower income from TBG Financial, adverse
mortality early in 2002 and higher operating expenses contributed
to the decline.
29
Driven by increased policy charges, revenues from investment life
products increased to $110.4 million in second quarter 2002
compared to $97.8 million in second quarter 2001, while
year-to-date revenues increased to $217.4 million for 2002
compared to $203.0 million for 2001. The increase in policy
charges is attributable to a growing block of investment life
business, as insurance in-force increased 15% to $41.12 billion as
of second quarter 2002, compared to $35.75 billion in second
quarter 2001, which offset the impact of lower premium loads due
to a decline in life insurance premiums.
Pre-tax earnings from investment life products totaled $29.4
million in second quarter 2002, a 24% increase from $23.8 million
in second quarter 2001, while the first six months of 2002 reached
$51.0 million compared to $56.0 million a year ago, a 9% decrease.
The growth in current quarter pre-tax earnings is due to the
increase in policy charges mentioned above, offset by increased
general operating expenses. Adverse mortality reduced year-to-date
earnings, as higher than normal frequency of death claims were
reported in the first quarter of 2002. Also contributing to the
year-to-date decline in earnings in investment life were lower
investment income and reduced earnings from TBG Financial.
Fixed life pre-tax earnings decreased 9% to $18.4 million in
second quarter 2002 compared to $20.3 million in the same period a
year ago. For the first six months of 2002, pre-tax earnings
decreased 7% to $37.5 million compared to $40.2 million for the
first six months of 2001. Increases in policy benefit costs and
operating expenses contributed to the declines.
Total life insurance sales, excluding all BOLI and Nationwide
employee and agent benefit plan sales, decreased 2% to $341.5
million in second quarter 2002 compared to $350.2 million during
the same period in 2001. For the first six months of 2002, total
life insurance sales, excluding all BOLI and Nationwide employee
and agent benefit plan sales, decreased $84.9 million compared to
2001 and totaled $842.5 million. Individual variable universal
life sales have been adversely impacted by the phase out of the
estate tax, uncertainty surrounding the taxation of split dollar
plans, and the volatile stock market. Sales of new COLI cases were
down in second quarter 2002 compared to sales in second quarter
2001 due to the depressed economic conditions as corporations are
less inclined to form new executive benefit plans and existing
plans are being funded at lower levels.
Corporate
The Corporate segment consists of net investment income not
allocated to the three product segments, unallocated expenses,
interest expense on debt and, in 2001, goodwill amortization.
The following table summarizes certain selected financial data for
the Company's Corporate segment for the periods indicated.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------------------
(in millions) 2002 2001 2002 2001
==============================================================================================================
INCOME STATEMENT DATA
Operating revenues(1) $ 6.7 $ 9.7 $ 18.5 $ 18.2
Interest expense on debt and capital and preferred
securities of subsidiary trusts (16.9) (13.4) (33.6) (27.5)
Other operating expenses (0.4) (2.9) (3.7) (6.7)
--------------------------------------------------------------------------------------------------------------
Operating loss before federal income tax expense1 $ (10.6) $ (6.6) $ (18.8) $ (16.0)
==============================================================================================================
----------
(1) Excludes net realized gains and losses on investments not
related to securitizations, hedging instruments and hedged
items, discontinued operations and cumulative effect of
adoption of accounting principles.
30
The increase in revenues reflects an increase in net investment
income primarily attributable to income earned on the proceeds
from the $300.0 million November 2001 senior note offering. Second
quarter 2002 investment income was adversely impacted by lower
earnings from real estate investments. The additional interest
expense in second quarter 2002 and the first six months of 2002
primarily reflects the $300.0 million November 2001 senior note
offering, offset by lower utilization of commercial paper
borrowings. Other operating expenses include $2.9 million and $5.8
million of goodwill amortization expense in second quarter 2001
and the first six months of 2001, respectively.
In addition to these operating revenues and expenses, the Company
also reports net realized gains and losses on investments not
related to securitizations, hedging instruments and hedged items
in the Corporate segment. Net realized losses on investments,
hedging instruments and hedged items totaled $12.7 million in
second quarter 2002 compared to $6.9 million gains in the same
period a year ago. For the first half of 2002, net realized losses
on investments, hedging instruments and hedged items totaled $12.9
million compared to $6.9 million gains for the first half of 2001.
Also, during second quarter 2002, the Company recorded realized
losses related to other-than-temporary impairments on securities
available-for-sale of $28.1 million, compared to $3.7 million a
year ago, while year-to-date 2002 realized losses related to
other-than-temporary impairments on securities available-for-sale
totaled $32.6 million compared to $7.7 million for the same period
a year ago. In the second quarter of 2002, the Company recorded
net realized losses on investments of $22.5 million, pre-tax,
related to WorldCom, Inc.
RELATED PARTY TRANSACTIONS
See note 9 to the unaudited consolidated financial statements for
a discussion of related party transactions.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity and capital resources demonstrate the overall financial
strength of the Company and its ability to generate strong cash
flows from its operations and borrow funds at competitive rates to
meet operating and growth needs. The Company's capital structure
consists of long-term debt, capital and preferred securities of
subsidiary trusts and equity, summarized in the following table.
AS OF
----------------------------------------------------
JUNE 30, DECEMBER 31, JUNE 30,
(in millions) 2002 2001 2001
===============================================================================================================
Long-term debt $ 896.9 $ 597.0 $ 298.4
Capital and preferred securities of subsidiary trusts 300.0 300.0 300.0
---------------------------------------------------------------------------------------------------------------
Total long-term debt and capital and preferred
securities 1,196.9 897.0 598.4
---------------------------------------------------------------------------------------------------------------
Shareholders' equity, excluding accumulated other
comprehensive income 3,282.4 3,240.8 3,076.7
Accumulated other comprehensive income 294.8 202.5 192.2
---------------------------------------------------------------------------------------------------------------
Total shareholders' equity 3,577.2 3,443.3 3,268.9
---------------------------------------------------------------------------------------------------------------
Total capital $ 4,774.1 $ 4,340.3 $ 3,867.3
===============================================================================================================
31
Long-term debt is comprised of senior issues, none of which is
subject to any sinking fund payments. The terms of the senior
notes contain various restrictive covenants including limitations
on the disposition of subsidiaries. As of June 30, 2002, the
Company was in compliance with all such covenants. The $300.0
million principal of 8.00% senior notes, due March 1, 2027, are
redeemable in whole or in part, at the option of NFS, at any time
on or after March 1, 2007 at scheduled redemption premiums through
March 1, 2016, and, thereafter, at 100% of the principal amount
thereof plus, in each case, accrued and unpaid interest. The
$300.0 million principal of 6.25% senior notes, due November 15,
2011, are not redeemable prior to their maturity date. The $300.0
million principal of 5.90% senior notes, due July 1, 2012, were
issued on June 24, 2002 and are redeemable in whole or in part, at
the option of NFS, at any time or from time to time at a
redemption price equal to the greater of: (i) 100% of the
aggregate principal amount of the notes to be redeemed; or (ii)
the sum of the present value of the remaining scheduled payments
of principal and interest on the notes, discounted to the
redemption date on a semi-annual basis at the treasury rate plus
20 basis points, together in each case with accrued interest
payments to the redemption date.
The capital and preferred securities of subsidiary trusts include
$100.0 million of capital securities that are due March 1, 2037
and pay a distribution rate of 7.899% and $200.0 million of
preferred securities of subsidiary trusts that are due October 31,
2028 and pay a distribution rate of 7.10%. The 7.899% Junior
Subordinated Debentures are redeemable by NFS in whole at any time
or in part from time to time at par plus an applicable make-whole
premium. The 7.10% Junior Subordinated Debentures are the sole
assets of Nationwide Financial Services Capital Trust II (NFSCTII)
and are redeemable, in whole or in part, on or after October 19,
2003 at a redemption price equal to the principal amount to be
redeemed plus any accrued and unpaid interest. The Preferred
Securities have a liquidation value of $25 per security and must
be redeemed by NFSCTII when the 7.10% Junior Subordinated
Debentures mature or are redeemed by NFS. There are no sinking
fund requirements related to the capital and preferred securities
of subsidiary trusts.
NFS is a holding company whose principal asset is the common stock
of NLIC. The principal sources of funds for NFS to pay interest,
dividends and operating expenses are existing cash and investments
and dividends from NLIC and other subsidiaries.
State insurance laws generally restrict the ability of insurance
companies to pay cash dividends in excess of certain prescribed
limitations without prior approval. The ability of NLIC to pay
dividends is subject to restrictions set forth in the insurance
laws and regulations of the State of Ohio, its domiciliary state.
State of Ohio insurance laws require life insurance companies to
seek prior regulatory approval to pay a dividend if the fair
market value of the dividend, together with that of other
dividends made within the preceding 12 months, exceeds the greater
of (i) 10% of statutory-basis policyholders' surplus as of the
prior December 31 or (ii) the statutory-basis net income of the
insurer for the prior year. NLIC's statutory-basis policyholders'
surplus as of December 31, 2001 was $1.76 billion and
statutory-basis net income for 2001 was $83.1 million. Dividends
of $70.0 million and dividends in the form of return of capital of
$475.0 million were paid in the preceding twelve months as of June
30, 2002. The State of Ohio insurance laws also require insurers
to seek prior regulatory approval for any dividend paid from other
than earned surplus. NLIC sought and obtained prior regulatory
approval from the Ohio Department of Insurance to return this
$475.0 million of capital to NFS during 2002. The payment of
dividends by NLIC may also be subject to restrictions set forth in
the insurance laws of the State of New York that limit the amount
of statutory profits on NLIC's participating policies (measured
before dividends to policyholders) that can inure to the benefit
of NFS and its stockholders. NFS currently does not expect such
regulatory requirements to impair its ability to pay interest,
dividends, operating expenses and principal in the future.
Also available as a source of funds to the Company is a $1 billion
revolving credit facility entered into by NFS, NLIC and NMIC with
a group of national financial institutions. The facility provides
for several, and not joint, liability with respect to any amount
drawn by any party. The facility provides covenants, including,
but not limited to, requirements that the Company maintain
consolidated tangible net worth, as defined, in excess of $1.69
billion and NLIC maintain statutory surplus in excess of $935
million. The Company had no amounts outstanding under this
agreement as of June 30, 2002. NLIC also has a $500 million
commercial paper program that is 50% backed by the credit facility
described above. Therefore borrowing capacity under this facility
is reduced by one-half of any amounts outstanding under the
commercial paper program. There was no outstanding commercial
paper as of June 30, 2002.
32
OFF-BALANCE SHEET TRANSACTIONS
Under the medium-term note program, the Company issues funding
agreements, which are insurance obligations, to an unrelated third
party trust to secure notes issued to investors by the trust. The
funding agreements are recorded as a component of future policy
benefits and claims on the Company's consolidated balance sheets.
Because the Company has no ownership interest in, or control over,
the third party trust that issues the notes, the Company does not
include the trust in its consolidated financial statements and
therefore, such notes are not reflected in the consolidated
financial statements of the Company. As the notes issued by the
trust have a secured interest in the funding agreement issued by
the Company, Moody's Investors Service, Inc. (Moody's) and
Standard & Poor's, A Division of The McGraw-Hill Companies, Inc.,
(S&P) assign the same ratings to the notes as the insurance
financial strength ratings of the Company.
During the first quarter of 2002, the Company sold a credit
enhanced equity interest in a Fund to a third party. The
transaction provides a cumulative guaranteed return to the third
party investor as it relates to the tax credits flows over the
life of the transaction. The Company does not anticipate making
any payments related to the guarantee provision provided by this
transaction due to the diversity of and stabilization of the
majority of the underlying properties and underlying reserves.
Also see note 6 to the unaudited financial statemtents.
INVESTMENTS
General
The Company's assets are divided between separate account and
general account assets. As of June 30, 2002, $54.41 billion (61%)
of the Company's total assets were held in separate accounts and
$35.41 billion (39%) were held in the Company's general account,
including $30.57 billion of general account investments.
Separate account assets consist primarily of deposits from the
Company's variable annuity business. Most separate account assets
are invested in various mutual funds. All of the investment risk
in the Company's separate account assets is borne by the Company's
customers, with the exception of $1.63 billion of policy reserves
as of June 30, 2002 ($1.39 billion as of December 31, 2001) for
which the Company bears the investment risk.
Fixed Maturity Securities
The following table summarizes the composition of the Company's
general account fixed maturity securities by category.
AS OF JUNE 30, 2002 AS OF DECEMBER 31, 2001
-------------------------------------------------------
CARRYING % OF CARRYING % OF
($ in millions) VALUE TOTAL VALUE TOTAL
=======================================================================================================
U.S. government/agencies $ 569.3 2.8 $ 289.6 1.6
Foreign governments 42.7 0.2 44.4 0.3
State and political subdivisions 9.9 -- 7.9 --
Corporate:
Public 7,092.9 34.5 6,188.6 33.4
Private 6,363.1 31.0 6,033.4 32.5
Mortgage-backed securities -
U.S. Government backed 2,976.7 14.5 2,082.1 11.2
Asset-backed securities 3,497.4 17.0 3,902.3 21.0
-------------------------------------------------------------------------------------------------------
Total $ 20,552.0 100.0 $ 18,548.3 100.0
=======================================================================================================
33
The National Association of Insurance Commissioners (NAIC) assigns
securities quality ratings and uniform valuations called "NAIC
Designations" which are used by insurers when preparing their
annual statements. The NAIC assigns designations to publicly
traded as well as privately placed securities. The designations
assigned by the NAIC range from class 1 to class 6, with a
designation in class 1 being of the highest quality. Of the
Company's general account fixed maturity securities, 95% were in
the highest two NAIC Designations as of June 30, 2002.
The following table sets forth an analysis of credit quality, as
determined by NAIC Designation, of the Company's general account
fixed maturity securities portfolio.
AS OF JUNE 30, 2002 AS OF DECEMBER 31, 2001
---------------------------------------------------------
NAIC RATING AGENCY CARRYING % OF CARRYING % OF
DESIGNATION(1) EQUIVALENT DESIGNATION(2) VALUE TOTAL VALUE TOTAL
============================================================================================================
($ in millions)
1 Aaa/Aa/A $ 11,896.6 57.9 $ 11,061.5 59.6
2 Baa 7,521.2 36.6 6,607.4 35.6
3 Ba 797.9 3.9 659.1 3.6
4 B 221.9 1.1 127.3 0.7
5 Caa and lower 61.6 0.3 33.8 0.2
6 In or near default 52.8 0.2 59.2 0.3
------------------------------------------------------------------------------------------------------------
Total $ 20,552.0 100.0 $ 18,548.3 100.0
============================================================================================================
----------
(1) NAIC Designations are assigned no less frequently than
annually. Some designations for securities shown have been
assigned to securities not yet assigned an NAIC Designation
in a manner approximating equivalent public rating
categories.
(2) Comparison's between NAIC and Moody's designations are
published by the NAIC. In the event no Moody's rating is
available, the Company has assigned internal ratings
corresponding to the public rating.
The Company's general account mortgage-backed security (MBS)
investments include residential MBSs and multi-family mortgage
pass-through certificates. As of June 30, 2002, MBSs were $2.98
billion (15%) of the carrying value of the general account fixed
maturity securities available-for-sale, all of which were
guaranteed by the U.S. Government or an agency of the U.S.
Government.
The Company believes that general account MBS investments add
diversification, liquidity, credit quality and additional yield to
its general account fixed maturity securities portfolio. The
objective of the Company's general account MBS investments is to
provide reasonable cash flow stability and increased yield.
General account MBS investments include collateralized mortgage
obligations (CMOs), Real Estate Mortgage Investment Conduits
(REMICs) and mortgage-backed pass-through securities. The
Company's general account MBS investments do not include
interest-only securities or principal-only securities or other
MBSs, which may exhibit extreme market volatility.
Prepayment risk is an inherent risk of holding MBSs. However, the
degree of prepayment risk is particular to the type of MBS held.
The Company limits its exposure to prepayments by purchasing less
volatile types of MBSs. As of June 30, 2002, $1.33 billion (45%)
of the carrying value of the general account MBS portfolio was
invested in planned amortization class CMOs/REMICs (PACs). PACs
are securities whose cash flows are designed to remain constant
over a variety of mortgage prepayment environments. Other classes
in the CMO/REMIC security are structured to accept the volatility
of mortgage prepayment changes, thereby insulating the PAC class.
34
The following table sets forth the distribution by investment type
of the Company's general account MBS portfolio as of June 30, 2002
and December 31, 2001.
AS OF JUNE 30, 2002 AS OF DECEMBER 31, 2001
--------------------------------------------------------
CARRYING % OF CARRYING % OF
($ in millions) VALUE TOTAL VALUE TOTAL
============================================================================================================
Planned Amortization Class $ 1,329.0 44.7 $ 800.9 38.5
Very Accurately Defined Maturity 492.0 16.5 360.2 17.3
Sequential 196.4 6.6 135.9 6.5
Targeted Amortization Class 90.9 3.1 117.0 5.6
Accrual 213.8 7.2 115.5 5.5
Scheduled 78.8 2.6 94.0 4.5
Multi-family Mortgage Pass-through Certificates 108.1 3.6 63.4 3.1
Non-Accelerating Security Class 238.0 8.0 54.6 2.6
Other 229.7 7.7 340.6 16.4
------------------------------------------------------------------------------------------------------------
Total $ 2,976.7 100.0 $2,082.1 100.0
============================================================================================================
The Company's general account asset-backed security (ABS)
investments include home equity/improvement ABSs, credit
tenant/card backed ABSs and CBO/CLO ABSs, among others. As of June
30, 2002, ABSs were $3.50 billion (17%) of the carrying value of
the general account fixed maturity securities available-for-sale.
The Company believes that general account ABS investments add
diversification, liquidity, credit quality and additional yield to
its general account fixed maturity securities portfolio. The
objective of the Company's general account ABS investments is to
provide reasonable cash flow stability and increased yield. The
Company's general account ABS investments do not include
interest-only securities or principal-only securities or other
ABSs, which may exhibit extreme market volatility.
The following table sets forth the distribution by investment type
of the Company's general account ABS portfolio.
AS OF JUNE 30, 2002 AS OF DECEMBER 31, 2001
-------------------------------------------------------------
CARRYING % OF CARRYING % OF
($ in millions) VALUE TOTAL VALUE TOTAL
=================================================================================================================
Home Equity/Improvement $1,048.0 30.0 $1,314.2 33.7
Credit Tenant/Card Backed 548.5 15.7 363.8 9.3
CBO/CLO 442.9 12.7 619.7 15.9
Equity Trust Certificates/Enhanced Equity Trust
Certificates 205.7 5.9 202.7 5.2
Auto Loan Backed 162.5 4.6 186.2 4.8
Pass Through Certificate 194.3 5.6 181.6 4.7
Miscellaneous Asset Backed 144.5 4.1 149.5 3.8
Manufactured Housing Backed 127.9 3.7 247.6 6.3
Franchise/Business Loan 148.5 4.2 160.0 4.1
Equipment Leases 107.6 3.1 136.1 3.5
All Other 367.0 10.4 340.9 8.7
-----------------------------------------------------------------------------------------------------------------
Total $ 3,497.4 100.0 $3,902.3 100.0
=================================================================================================================
Mortgage Loans
As of June 30, 2002, general account mortgage loans were $7.57
billion (25%) of the carrying value of consolidated general
account invested assets.
35
As of June 30, 2002, 0.02% of the Company's mortgage loans were
classified as delinquent, including loans in foreclosure, compared
to none a year ago and 0.42% as of December 31, 2001. Foreclosed
and restructured loans totaled 0.14% and 0.34% of the Company's
mortgage loans as of June 30, 2002, respectively, compared to
0.08% and 0.39% as of June 30, 2001, respectively.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in market risk exposures that
affect the quantitative and qualitative disclosures presented in
NFS' Annual Report on Form 10-K for the year ended December 31,
2001.
PART II - OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
The Company is a party to litigation and arbitration proceedings
in the ordinary course of its business, none of which is expected
to have a material adverse effect on the Company.
In recent years, life insurance companies have been named as
defendants in lawsuits, including class action lawsuits relating
to life insurance and annuity pricing and sales practices. A
number of these lawsuits have resulted in substantial jury awards
or settlements.
On October 29, 1998, the Company was named in a lawsuit filed in
Ohio state court related to the sale of deferred annuity products
for use as investments in tax-deferred contributory retirement
plans (Mercedes Castillo v. Nationwide Financial Services, Inc.,
Nationwide Life Insurance Company and Nationwide Life and Annuity
Insurance Company). On May 3, 1999, the complaint was amended to,
among other things, add Marcus Shore as a second plaintiff. The
amended complaint is brought as a class action on behalf of all
persons who purchased individual deferred annuity contracts or
participated in group annuity contracts sold by the Company and
the other named Company affiliates which were used to fund certain
tax-deferred retirement plans. The amended complaint seeks
unspecified compensatory and punitive damages. On June 11, 1999,
the Company and the other named defendants filed a motion to
dismiss the amended complaint. On March 8, 2000, the court denied
the motion to dismiss the amended complaint filed by the Company
and the other named defendants. On January 25, 2002, the
plaintiffs filed a motion for leave to amend their complaint to
add three new named plaintiffs. On February 9, 2002, the
plaintiffs filed a motion for class certification, which has not
been granted. The Company is opposing this motion. On February 9,
2002, Marcus Shore withdrew as a named plaintiff in the lawsuit.
On April 16, 2002, the Company filed a motion for summary
judgement on the individual claims of plaintiff Mercedes Castillo.
On May 28, 2002, the Court denied plaintiffs' motion to add new
persons as named plaintiffs, so the action is now proceeding with
Mercedes Castillo as the only named plaintiff. The Company intends
to defend this lawsuit vigorously.
36
On August 15, 2001, the Company was named in a lawsuit filed in
Connecticut federal court titled Lou Haddock, as trustee of the
Flyte Tool & Die, Incorporated Deferred Compensation Plan, et al
v. Nationwide Financial Services, Inc. and Nationwide Life
Insurance Company. On September 6, 2001, the plaintiffs amended
their complaint to include class action allegations. The
plaintiffs seek to represent a class of retirement plans that
purchased variable annuities from Nationwide Life Insurance
Company to fund qualified ERISA retirement plans. The amended
complaint alleges that the retirement plans purchased variable
annuity contracts from the Company that allowed plan participants
to invest in funds that were offered by separate mutual fund
companies; that the Company was a fiduciary under ERISA and that
the Company breached its fiduciary duty when it accepted certain
fees from the mutual fund companies that purportedly were never
disclosed by the Company; and that the Company violated ERISA by
replacing many of the funds originally included in the plaintiffs'
annuities with "inferior" funds because the new funds purportedly
paid higher fees to the Company. The amended complaint seeks
disgorgement of the fees allegedly received by the Company and
other unspecified compensatory damages, declaratory and injunctive
relief and attorney's fees. On November 15, 2001, the Company
filed a motion to dismiss the amended complaint, which has not
been decided. On December 3, 2001, the plaintiffs filed a motion
for class certification. On January 15, 2002, the plaintiffs filed
a response to the Company's motion to dismiss the amended
complaint. On February 22, 2002, the Company filed a reply
memorandum in support of its motion to dismiss. On March 12, 2002,
the plaintiffs filed a response to the Company's reply memorandum.
On March 19, 2002, the Company filed a supplemental memorandum in
support of its motion to dismiss. The court heard oral argument on
the motion to dismiss on August 6, 2002. The class has not been
certified. The Company intends to defend this lawsuit vigorously.
There can be no assurance that any such litigation will not have a
material adverse effect on the Company in the future.
ITEM 2 CHANGES IN SECURITIES
Pursuant to the Stock Retainer Plan for Non-Employee Directors,
1,619 shares of Class A Common Stock were issued by NFS during the
second quarter of 2002, at an average price of $40.75 per share to
NFS' directors as partial payment of the $50,000 annual retainer
paid by NFS to the directors in consideration of serving as
directors of the Company. The issuance of such shares is exempt
from registration under the Securities Act of 1933, as amended,
pursuant to section 4(2) promulgated thereunder.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None.
37
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NFS held its Annual Meeting of stockholders on May 8, 2002. At
that meeting, stockholders voted on the following proposals:
1. Election of directors to serve as Class II Directors
until the year 2005 Annual Meeting of stockholders
as follows:
For Withheld
------------------ ------------------
Joseph A. Alutto 1,068,924,706 137,816
Donald L. McWhorter 1,068,905,304 157,218
Arden L. Shisler 1,068,927,058 135,464
Alex Shumate 1,068,924,256 138,266
The terms of office of the Directors, James G
Brocksmith, Henry S. Holloway, Joseph J. Gasper,
W.G. "Jerry" Jurgensen, Lydia Micheaux Marshall,
David O. Miller, James F. Patterson and Gerald D.
Prothro continued after the meeting.
For Against Abstain
------------------ ------------------ -------------------
2. Approval of the Second Amended and Restated
Nationwide Financial Services, Inc. 1996 Long-Term
Equity Compensation Plan as set out in the Proxy 1,058,396,224 7,755,297 136,561
Statement dated March 29, 2002.
3. Approval of a shareholder proposal for the
establishment of a policy relating to a Board of 1,598,733 1,064,189,462 499,887
Directors' committee.
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
2.1 Agreement and Plan of Merger dated as of August 7,
2001 as amended and restated on July 8, 2002
(previously filed as Annex A to the Company's
Registration Statement on Form S-4/A, Commission
File Number 333-90200 filed on August 2, 2002, and
incorporated herein by reference).
10.39 Form of Exchange Agreement between Nationwide
Financial Services, Inc. and Nationwide Corporation
dated as of May 22, 2002.
10.40 Form of Marketing and Support Services Agreement
between Nationwide Financial Services, Inc. and
Gartmore Global Investments, Inc. dated as of
June 28, 2002.
(b) Reports on Form 8-K:
On May 22, 2002, NFS filed a Current Report on Form 8-K
announcing the definitive agreement with Nationwide Corp.
to exchange the shares of GGI and NSI owned by NFS for
shares of NFS' common stock owned by Nationwide Corp.
On June 20, 2002, NFS filed a Current Report on Form 8-K
which provides the transition disclosures required by SFAS
142 and revised consolidated financial statements to
reflect discontinued operations as a result of the
transactions announced on May 22, 2002.
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On June 24, 2002, NFS filed a Current Report on Form 8-K in
connection with the $300.0 million senior note offering.
On July 1, 2002, NFS filed a Current Report on Form 8-K in
connection with the completion of the exchange of shares of
GGI and NSI.
On July 30, 2002, NFS filed a Current Report on Form 8-K in
connection with the release of quarterly earnings results.
On August 2, 2002, NFS filed a Current Report on Form 8-K
in connection with matters related to the proposed
Provident sponsored demutualization.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATIONWIDE FINANCIAL SERVICES, INC.
-----------------------------------
(Registrant)
Date: August 14, 2002 /s/Mark R. Thresher
-------------------------------------------------
Mark R. Thresher, Senior Vice President - Finance
(Chief Accounting Officer)
40