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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. 2-28596
NATIONWIDE LIFE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
OHIO 31-4156830
(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
--- ---
All voting stock was held by affiliates of the Registrant on August 2, 2002.
COMMON STOCK (par value $1 per share) - 3,814,779 shares issued and outstanding
as of August 2, 2002 (Title of Class)
THE REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION
H(1)(a) AND (b) OF FORM 10-Q AND IS THEREFORE FILING THIS FORM WITH THE
REDUCED DISCLOSURE FORMAT.
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
FORM 10-Q
INDEX
PART I FINANCIAL INFORMATION
Item 1 Unaudited Consolidated Financial Statements 3
Item 2 Management's Narrative Analysis of the Results of Operations 14
Item 3 Quantitative and Qualitative Disclosures About Market Risk 28
PART II OTHER INFORMATION
Item 1 Legal Proceedings 28
Item 2 Changes in Securities 29
Item 3 Defaults Upon Senior Securities 29
Item 4 Submission of Matters to a Vote of Security Holders 29
Item 5 Other Information 29
Item 6 Exhibits and Reports on Form 8-K 29
SIGNATURE 30
2
PART I - FINANCIAL INFORMATION
ITEM 1 UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Consolidated Statements of Income
(Unaudited)
(in millions)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
---------------------------------------------------------
2002 2001 2002 2001
==============================================================================================================================
REVENUES
Policy charges $ 254.8 $ 256.4 $ 511.3 $ 524.1
Life insurance premiums 64.0 66.5 124.7 130.4
Net investment income 447.0 428.8 886.2 851.7
Net realized (losses) gains on investments, hedging instruments
and hedged items (41.4) 2.1 (45.5) (1.8)
Other 0.4 2.0 4.0 6.0
- ------------------------------------------------------------------------------------------------------------------------------
724.8 755.8 1,480.7 1,510.4
- ------------------------------------------------------------------------------------------------------------------------------
BENEFITS AND EXPENSES
Interest credited to policyholder account values 301.9 307.9 595.8 609.1
Other benefits and claims 78.1 77.2 150.6 142.2
Policyholder dividends on participating policies 10.2 11.1 21.9 21.6
Amortization of deferred policy acquisition costs 84.3 87.1 167.8 180.0
Interest expense on debt, primarily with a related party 6.0 1.6 11.7 3.9
Other operating expenses 128.0 100.7 265.1 214.9
- ------------------------------------------------------------------------------------------------------------------------------
608.5 585.6 1,212.9 1,171.7
- ------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before federal income tax
expense and cumulative effect of adoption of accounting
principles 116.3 170.2 267.8 338.7
Federal income tax expense 27.8 44.6 68.0 89.0
- ------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before cumulative effect of
adoption of accounting principles 88.5 125.6 199.8 249.7
Income from discontinued operations, net of tax 0.4 0.2 0.7 0.5
Cumulative effect of adoption of accounting principles, net of tax - (2.3) - (7.1)
- ------------------------------------------------------------------------------------------------------------------------------
Net income $ 88.9 $ 123.5 $ 200.5 $ 243.1
==============================================================================================================================
See accompanying notes to unaudited consolidated financial statements, including
note 7 which describes related party transactions.
3
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES (a wholly
owned subsidiary of Nationwide Financial Services, Inc.)
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 $19,586.9 in 2002; $17,961.6 in 2001) $ 20,190.7 $ 18,370.8
Equity securities (cost $87.1 in 2002; $83.0 in 2001) 92.2 94.0
Mortgage loans on real estate, net 7,574.8 7,113.1
Real estate, net 153.2 172.0
Policy loans 620.0 591.1
Other long-term investments 128.5 125.0
Short-term investments, including amounts managed by a related party 972.4 1,011.3
- ------------------------------------------------------------------------------------------------------------------------------
29,731.8 27,477.3
- ------------------------------------------------------------------------------------------------------------------------------
Cash 5.3 22.6
Accrued investment income 304.8 306.7
Deferred policy acquisition costs 3,293.4 3,189.0
Other assets 888.9 646.0
Assets held in separate accounts 54,224.2 59,513.0
- ------------------------------------------------------------------------------------------------------------------------------
$ 88,448.4 $ 91,154.6
==============================================================================================================================
LIABILITIES AND SHAREHOLDER'S EQUITY
Future policy benefits and claims $ 27,580.1 $ 25,216.0
Short-term debt - 100.0
Long-term debt, payable to Nationwide Financial Services, Inc. (NFS) 600.0 300.0
Other liabilities 2,555.3 2,307.9
Liabilities related to separate accounts 54,224.2 59,513.0
- ------------------------------------------------------------------------------------------------------------------------------
84,959.6 87,436.9
- ------------------------------------------------------------------------------------------------------------------------------
Shareholder's equity:
Capital shares, $1 par value. Authorized 5.0 million shares; 3.8 million shares
issued and outstanding 3.8 3.8
Additional paid-in capital 171.1 646.1
Retained earnings 3,018.6 2,863.1
Accumulated other comprehensive income 295.3 204.7
- ------------------------------------------------------------------------------------------------------------------------------
3,488.8 3,717.7
- ------------------------------------------------------------------------------------------------------------------------------
$ 88,448.4 $ 91,154.6
==============================================================================================================================
See accompanying notes to unaudited consolidated financial statements, including
note 7 which describes related party transactions.
4
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES (a wholly
owned subsidiary of Nationwide Financial Services, Inc.)
Consolidated Statements of Shareholder's Equity
(Unaudited)
Six Months Ended June 30, 2002 and 2001
(in millions)
ACCUMULATED
ADDITIONAL OTHER TOTAL
COMMON PAID-IN RETAINED COMPREHENSIVE SHAREHOLDER'S
STOCK CAPITAL EARNINGS INCOME (LOSS) EQUITY
==================================================================================================================================
Balance as of January 1, 2001 $ 3.8 $ 646.1 $ 2,436.3 $ 116.7 $ 3,202.9
Comprehensive income:
Net income - - 243.1 - 243.1
Net unrealized gains on securities available-for-
sale arising during the period, net of tax - - - 81.0 81.0
Cumulative effect of adoption of accounting
principles, net of tax - - - (1.4) (1.4)
Accumulated net gains on cash flow hedges,
net of tax - - - 0.5 0.5
-----------------
Total comprehensive income 323.2
- ----------------------------------------------------------------------------------------------------------------------------------
Balance as of June 30, 2001 $ 3.8 $ 646.1 $ 2,679.4 $ 196.8 $ 3,526.1
==================================================================================================================================
BALANCE AS OF JANUARY 1, 2002 $ 3.8 $ 646.1 $ 2,863.1 $ 204.7 $ 3,717.7
Comprehensive income:
Net income - - 200.5 - 200.5
Net unrealized gains on securities available-for-
sale arising during the period, net of tax - - - 81.0 81.0
Accumulated net gains on cash flow hedges,
net of tax - - - 9.6 9.6
-----------------
Total comprehensive income 291.1
-----------------
Returns of capital to shareholder - (475.0) - - (475.0)
Dividends to shareholder - - (45.0) - (45.0)
- ----------------------------------------------------------------------------------------------------------------------------------
BALANCE AS OF JUNE 30, 2002 $ 3.8 $ 171.1 $ 3,018.6 $ 295.3 $ 3,488.8
==================================================================================================================================
See accompanying notes to unaudited consolidated financial statements, including
note 7 which describes related party transactions.
5
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES (a wholly
owned subsidiary of Nationwide Financial Services, Inc.)
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 $ 200.5 $ 243.1
Adjustments to reconcile net income to net cash provided by operating activities:
Income from discontinued operations (0.7) (0.5)
Interest credited to policyholder account values 595.8 609.1
Capitalization of deferred policy acquisition costs (336.2) (392.3)
Amortization of deferred policy acquisition costs 167.8 180.0
Amortization and depreciation (5.9) (16.8)
Realized losses on investments, hedging instruments and hedged items 45.5 1.8
Cumulative effect of adoption of accounting principles - 10.9
Decrease (increase) in accrued investment income 1.9 (32.4)
Increase in other assets (235.2) (90.4)
Increase in policy liabilities 17.6 11.5
Increase in other liabilities 401.2 66.7
Other, net 31.0 0.6
----------------------------------------------------------------------------------------------------------------------------
Net cash provided by continuing operations 883.3 591.3
Net cash provided by (used in) discontinued operations 0.7 (1.7)
----------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 884.0 589.6
----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity of securities available-for-sale 2,116.2 2,048.2
Proceeds from sale of securities available-for-sale 917.8 130.7
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 (4,625.3) (3,104.4)
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 38.8 (268.0)
Disposal of subsidiary, net of cash (20.0) -
Collateral - securities lending, net (189.9) -
Other, net (175.6) 120.2
----------------------------------------------------------------------------------------------------------------------------
Net cash used in continuing operations (2,342.0) (1,437.0)
Net cash provided by discontinued operations - 0.5
----------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (2,342.0) (1,436.5)
----------------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net change in short-term debt (100.0) (4.5)
Net proceeds from issuance of long-term debt to NFS 300.0 -
Capital returned to shareholder (475.0) -
Cash dividend paid to shareholder (35.0) -
Increase in investment and universal life insurance product account values 3,268.1 3,220.6
Decrease in investment and universal life insurance product account values (1,517.4) (2,356.3)
----------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 1,440.7 859.8
----------------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash (17.3) 12.9
Cash, beginning of period 22.6 18.4
----------------------------------------------------------------------------------------------------------------------------
Cash, end of period $ 5.3 $ 31.3
============================================================================================================================
See accompanying notes to unaudited consolidated financial statements, including
note 7 which describes related party transactions.
6
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Unaudited Consolidated Financial Statements
Six Months Ended June 30, 2002
(1) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of
Nationwide Life Insurance Company and subsidiaries (NLIC 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 Annual Report on Form 10-K.
(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 no unamortized
goodwill.
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 LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Unaudited Consolidated Financial Statements, Continued
(3) COMPREHENSIVE INCOME (LOSS)
---------------------------
Comprehensive income (loss) includes net income as well as certain
items that are reported directly within a separate component of
shareholder's 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 $299.0 $(68.2) $146.5 $163.5
Adjustment to deferred policy acquisition costs (95.6) 21.0 (64.0) (44.1)
Related federal income tax (expense) benefit (71.2) 16.5 (28.9) (41.8)
- ---------------------------------------------------------------------------------------------------------------------
Net 132.2 (30.7) 53.6 77.6
- ---------------------------------------------------------------------------------------------------------------------
Reclassification adjustment for net losses
on securities available-for-sale
realized during the period:
Gross 37.0 1.1 42.2 5.3
Related federal income tax benefit (13.0) (0.4) (14.8) (1.9)
- ---------------------------------------------------------------------------------------------------------------------
Net 24.0 0.7 27.4 3.4
- ---------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) on securities
available-for-sale 156.2 (30.0) 81.0 81.0
- ---------------------------------------------------------------------------------------------------------------------
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) $160.0 $(28.0) $ 90.6 $ 80.1
=====================================================================================================================
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.
8
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Unaudited Consolidated Financial Statements, Continued
(4) 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.
(5) SEGMENT DISCLOSURES
The Company uses differences in products as the basis for defining its
reportable segments. The Company reports three product segments:
Individual Annuity, Institutional Products and Life Insurance. During
the second quarter of 2002, the Company paid dividend to NFS that
resulted in the disposal of a portion of the business that had been
reported in the Corporate segment (see note 7). As a result, this
business is reported as discontinued operations. Effective in the
second quarter of 2002, structured products transactions previously
reported in the Corporate 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. The public sector includes the
Internal Revenue Code (IRC) Section 457 business in the form of fixed
and variable annuities. 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 (COLI) products, traditional life insurance products and
universal life insurance. 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 and
interest expense on debt. 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 part
of operating income.
9
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
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 $ 160.8 $ 198.0 $ 81.9 $ 6.3 $ 447.0
Other operating revenue 138.8 44.9 135.3 0.2 319.2
- -------------------------------------------------------------------------------------------------------------------
Total operating revenue(1) 299.6 242.9 217.2 6.5 766.2
- -------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder
account values 122.0 134.5 45.4 - 301.9
Amortization of deferred policy
acquisition costs 53.9 11.3 19.1 - 84.3
Interest expense on debt - - - 6.0 6.0
Other benefits and expenses 70.0 43.0 103.5 (0.2) 216.3
- -------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 245.9 188.8 168.0 5.8 608.5
- -------------------------------------------------------------------------------------------------------------------
Operating income before federal
income tax expense(1) 53.7 54.1 49.2 0.7 157.7
Net realized losses on investments,
hedging instruments and hedged
items - - - (41.4) (41.4)
- -------------------------------------------------------------------------------------------------------------------
Income (loss) from continuing
operations before federal income
tax expense and cumulative effect
of adoption of accounting principles $ 53.7 $ 54.1 $ 49.2 $ (40.7) $ 116.3
===================================================================================================================
2001
Net investment income $ 127.2 $ 211.8 $ 81.2 $ 8.6 $ 428.8
Other operating revenue 144.4 54.4 125.7 0.4 324.9
- -------------------------------------------------------------------------------------------------------------------
Total operating revenue(1) 271.6 266.2 206.9 9.0 753.7
- -------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder
account values 105.1 158.7 44.1 - 307.9
Amortization of deferred policy
acquisition costs 54.8 13.0 19.3 - 87.1
Interest expense on debt - - - 1.6 1.6
Other benefits and expenses 50.5 40.0 99.4 (0.9) 189.0
- -------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 210.4 211.7 162.8 0.7 585.6
- -------------------------------------------------------------------------------------------------------------------
Operating income before federal
income tax expense(1) 61.2 54.5 44.1 8.3 168.1
Net realized gains on investments,
hedging instruments and hedged
items - - - 2.1 2.1
- -------------------------------------------------------------------------------------------------------------------
Income from continuing operations
before federal income tax
expense and cumulative effect of
adoption of accounting principles $ 61.2 $ 54.5 $ 44.1 $ 10.4 $ 170.2
===================================================================================================================
- ----------
(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.
10
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
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 $ 312.1 $ 394.3 $ 161.9 $ 17.9 $ 886.2
Other operating revenue 271.4 98.4 269.9 0.3 640.0
-------------------------------------------------------------------------------------------------------------------
Total operating revenue(1) 583.5 492.7 431.8 18.2 1,526.2
-------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder
account values 237.1 267.6 91.0 - 595.8
Amortization of deferred policy
acquisition costs 106.3 21.5 40.1 - 167.8
Interest expense on debt - - - 11.7 11.7
Other benefits and expenses 131.6 93.0 210.9 2.1 437.6
-------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 475.0 382.1 342.0 13.8 1,212.9
-------------------------------------------------------------------------------------------------------------------
Operating income before federal
income tax expense(1) 108.5 110.6 89.8 4.4 313.3
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 $ 108.5 $ 110.6 $ 89.8 $ (41.1) $ 267.8
===================================================================================================================
Assets as of period end $42,136.1 $32,536.4 $ 9,509.3 $4,266.6 $ 88,448.4
===================================================================================================================
2001
Net investment income $ 251.6 $ 423.5 $ 161.1 $ 15.5 $ 851.7
Other operating revenue 288.4 112.5 258.7 0.9 660.5
-------------------------------------------------------------------------------------------------------------------
Total operating revenue(1) 540.0 536.0 419.8 16.4 1,512.2
-------------------------------------------------------------------------------------------------------------------
Interest credited to policyholder
account values 205.4 316.8 86.9 - 609.1
Amortization of deferred policy
acquisition costs 111.2 25.8 43.0 - 180.0
Interest expense on debt - - - 3.9 3.9
Other benefits and expenses 99.7 85.9 193.7 (0.6) 378.7
-------------------------------------------------------------------------------------------------------------------
Total benefits and expenses 416.3 428.5 323.6 3.3 1,171.7
-------------------------------------------------------------------------------------------------------------------
Operating income before federal
income tax expense(1) 123.7 107.5 96.2 13.1 340.5
Net realized losses on investments,
hedging instruments and hedged
items - - - (1.8) (1.8)
-------------------------------------------------------------------------------------------------------------------
Income from continuing operations
before federal income tax
expense and cumulative effect of
adoption of accounting principles $ 123.7 $ 107.5 $ 96.2 $ 11.3 $ 338.7
===================================================================================================================
Assets as of period end $43,766.8 $35,984.5 $ 8,707.9 $2,991.5 $ 91,450.7
===================================================================================================================
----------
(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.
11
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Unaudited Consolidated Financial Statements, Continued
(6) 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 the
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.
(7) 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 13 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.
12
NATIONWIDE LIFE INSURANCE COMPANY AND SUBSIDIARIES
(a wholly owned subsidiary of Nationwide Financial Services, Inc.)
Notes to Unaudited Consolidated Financial Statements, Continued
Amounts on deposit with a related party in cash management were $130.4
million and $54.8 million as of June 30, 2002 and December 31, 2001,
respectively.
During the first six months of 2002, NLIC paid a dividend of $35.0
million and dividends in the form of return of capital of $475.0
million to NFS.
In addition, in June 2002, NLIC paid a dividend to NFS in the form of
all of the shares of common stock of Nationwide Securities, Inc. (NSI),
a wholly owned broker/dealer subsidiary. Therefore, the results of the
operations of NSI have been reflected as discontinued operations for
all periods presented. This was a transaction between related parties
and therefore was recorded at carrying value, $10.0 million, of the
underlying components of the transaction rather than fair value.
(8) LONG-TERM DEBT, PAYABLE TO NFS
------------------------------
On June 27, 2002, NLIC sold an 8.15%, $300.0 million surplus note to
NFS, maturing on June 27, 2032. Principal and interest payments are
subject to prior approval by the superintendent of insurance of the
State of Ohio. NLIC is scheduled to pay interest semi-annually on April
15 and October 15 of each year commencing on October 15, 2002.
(9) RECLASSIFICATION
Certain items in the 2001 unaudited consolidated financial statements
and related footnotes have been reclassified to conform to the 2002
presentation.
13
ITEM 2 MANAGEMENT'S NARRATIVE ANALYSIS OF THE RESULTS OF OPERATIONS
INTRODUCTION
The following analysis of unaudited consolidated results of
operations of the Company should be read in conjunction with the
unaudited consolidated financial statements and related notes
included elsewhere herein.
Management's discussion and analysis 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) 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; (ii) tax law changes impacting the tax treatment of life
insurance and investment products; (iii) repeal of the federal
estate tax; (iv) 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; (v) adverse state and federal legislation
and regulation, including limitations on premium levels, increases
in minimum capital and reserves, and other financial viability
requirements; (vi) failure to expand distribution channels in
order to obtain new customers or failure to retain existing
customers; (vii) 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; (viii) 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; (ix) general
economic and business conditions which are less favorable than
expected; (x) competitive, regulatory or tax changes that affect
the cost of, or demand for the Company's products; (xi)
unanticipated changes in industry trends and ratings assigned by
nationally recognized rating organizations; (xii) inaccuracies in
assumptions regarding future persistency, mortality, morbidity and
interest rates used in calculating reserve amounts; and (xiii)
adverse litigation results or resolution of litigation and
arbitration.
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.
14
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. Deferred policy acquisition costs (DAC) are 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.
15
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 $766.2 million compared to $753.7
million for the same period in 2001. For the first six months of
2002 and 2001, total operating revenues were $1.53 billion and
$1.51 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; administration 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 for 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 $ 144.6 $ 157.4 $ 291.7 $ 316.9
Cost of insurance charges 58.2 49.6 113.5 96.2
Administrative fees 30.5 31.1 68.2 72.4
Surrender fees 21.5 18.3 37.9 38.6
-----------------------------------------------------------------------------------------------------
Total policy charges $ 254.8 $ 256.4 $ 511.3 $ 524.1
=====================================================================================================
The decline in asset fees reflects a decrease in total average
separate account values of $4.48 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 $428.8 million in the second quarter of 2001 to
$447.0 million in the second quarter of 2002 and from $851.7
million in the first half of 2001 to $886.2 million in the first
half of 2002. The 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 $3.91 billion to $27.58 billion
as of the end of second quarter 2002 compared to $23.67 billion a
year ago.
16
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, included in this caption are charges related to
other-than-temporary impairments of available-for-sale securities
and other investments and valuation allowances on mortgage loans
on real estate. 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 $13.3 million in second quarter 2002 compared to
$5.8 million gains in the same period a year ago. For the first
half of 2002, net realized gains on investments, hedging
instruments and hedged items totaled $12.9 million compared to
$5.9 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.
Benefits and Expenses
Interest credited to policyholder account values totaled $301.9
million in second quarter 2002 compared to $307.9 million in
second quarter 2001, while year-to-date 2002 interest credited
totaled $595.8 million compared to $609.1 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 $84.3 million in the second
quarter of 2002 compared to $87.1 million in the second quarter of
2001. On a year-to-date basis, DAC amortization totaled $167.8
million in 2002 compared to $180.0 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 27% to $128.0 million in second
quarter 2002 compared to $100.7 million in second quarter 2001.
For the first half of 2002, operating expenses were $265.1
million, up 23% from $214.9 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 December 2001
and June 2002 surplus note offerings, offset by lower utilization
of commercial paper borrowings.
Federal income tax expense was $27.8 million in second quarter
2002 compared to $44.6 million for the same period a year ago,
representing effective tax rates of 23.9% and 26.2% for second
quarter 2002 and 2001, respectively. For the first six months of
2002 and 2001, federal income tax expense was $68.0 million and
$89.0 million, representing effective tax rates of 25.4% and
26.3%, respectively. An increase in tax credits from affordable
housing partnership investments in 2002, partially offset by lower
tax exempt income drove the decreases in effective rates.
Discontinued Operations
On June 27, 2002, NLIC paid a dividend to NFS consisting of its
shares of common stock of Nationwide Securities, Inc. (NSI), a
wholly owned broker/dealer subsidiary. This is a transaction
between related parties and therefore is recorded at carrying
value, $10.0 million, of the underlying components of the
transaction rather than fair value.
17
As a result of this transaction, the Company is no longer engaged
in asset management operations and the underlying results of NSI
have been reported as discontinued operations. Also, effective in
second quarter 2002, the structured products transactions,
previously reported in the Corporate segment, are 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 $0.4 million and $0.2 million,
respectively. For the first six months of 2002 and 2001, income
from discontinued operations, net of tax, was $0.7 million and
$0.5 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 second quarter of 2002 and 2001.
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------------------
(in millions) 2002 2001 2002 2001
===========================================================================================================
Net income $ 88.9 $ 123.5 $ 200.5 $ 243.1
Net realized losses (gains) on investments,
hedging instruments and hedged items, net of tax(1) 26.9 (1.3) 29.6 1.2
Discontinued operations, net of tax (0.4) (0.2) (0.7) (0.5)
Cumulative effect of adoption of accounting principles,
net of tax - 2.3 - 7.1
-----------------------------------------------------------------------------------------------------------
Net operating income $ 115.4 $ 124.3 $ 229.4 $ 250.9
===========================================================================================================
----------
(1) Excludes net realized gains and losses related to
securitizations.
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.
18
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 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
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.
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 $ 866.5 $ 1,027.6 $ 1,743.2 $ 2,053.2
Private label annuities 208.1 535.5 429.1 757.0
Other - 0.3 - 2.8
------------------------------------------------------------------------------------------------------
Total individual variable annuity sales 1,074.6 1,563.4 2,172.3 2,813.0
------------------------------------------------------------------------------------------------------
Deferred fixed annuities 650.2 437.0 1,164.7 753.2
Income products 32.6 34.0 58.1 73.1
------------------------------------------------------------------------------------------------------
Total individual fixed annuity sales 682.8 471.0 1,222.8 826.3
------------------------------------------------------------------------------------------------------
Total individual annuity sales $ 1,757.4 $ 2,034.4 $ 3,395.1 $ 3,639.3
======================================================================================================
The BEST of AMERICA products $ 684.6 $ 770.6 $ 1,475.2 $ 1,708.6
Other 22.7 13.4 33.2 27.3
------------------------------------------------------------------------------------------------------
Total private sector pension plan sales 707.3 784.0 1,508.4 1,735.9
------------------------------------------------------------------------------------------------------
Total public sector pension plan sales -
IRC Section 457 annuities 351.1 388.0 685.9 790.1
------------------------------------------------------------------------------------------------------
Total institutional products sales $ 1,058.4 $ 1,172.0 $ 2,194.3 $ 2,526.0
======================================================================================================
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
======================================================================================================
19
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 an affiliate who market products directly to a
customer base include Nationwide Retirement Solutions. 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 $ 909.4 $ 1,068.8 $ 1,923.6 $ 2,261.5
Financial institutions 864.3 820.6 1,609.0 1,543.0
Wirehouse and regional firms 475.8 690.4 943.2 1,029.7
Nationwide Retirement Solutions 372.6 404.9 714.9 837.2
Life insurance specialists 139.9 137.9 454.5 515.7
Pension plan administrators 188.6 240.3 410.6 543.1
Nationwide agents 185.7 193.7 346.2 362.5
Provident agents 21.0 - 29.9 -
-----------------------------------------------------------------------------------------------------
Total $ 3,157.3 $ 3,556.6 $ 6,431.9 $ 7,092.7
=====================================================================================================
The decline in sales in the independent broker/dealer channel
reflects primarily lower demand for variable annuities due to
declining and volatile equity markets. Also contributing to the
decline were lower private sector group pension sales of group
annuities, as an increasing percentage of total group pension
sales are sold as trust products offered by an affiliate,
Nationwide Trust Company, FSB.
Sales through financial institutions increased 5% in second
quarter 2002 to $864.3 million compared to sales of $820.6 million
in second quarter 2001 and are up 4% for the first six months of
2002, principally due to strong sales of deferred fixed annuities,
offset by lower variable annuity sales.
Sales through Nationwide Retirement Solutions declined 8% in
second quarter 2002 and 15% year-to-date compared to 2001,
reflecting the impact of case terminations in 2001 and 2002.
Sales through wirehouse and regional firms decreased 31% in the
second quarter of 2002 to $475.8 million compared to sales of
$690.4 million in second quarter 2001 due primarily to a spike in
sales in second quarter of 2001 from the launch of the Waddell and
Reed Financial, Inc. relationship. For the first six months of
2002, sales through this channel decreased 8% to $943.2 million
compared to $1.03 billion in the same period a year ago,
reflecting lower sales from the Waddell & Reed Financial, Inc.
relationship.
Sales through pension plan administrators dropped 22% in second
quarter 2002 over the same period a year ago, while year-to-date
2002 sales decreased 24% compared to the same period a year ago.
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 bank relationships.
BUSINESS SEGMENTS
The Company reports three product segments: Individual Annuity,
Institutional Products and Life Insurance. In addition, the
Company reports certain other revenues and expenses in a Corporate
segment.
20
The following table summarizes operating income 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 $ 53.7 $ 61.2 $108.5 $ 123.7
Institutional Products 54.1 54.5 110.6 107.5
Life Insurance 49.2 44.1 89.8 96.2
Corporate(1) 0.7 8.3 4.4 13.1
-----------------------------------------------------------------------------------------------------------------
Operating income before federal income tax expense(1) $157.7 $ 168.1 $313.3 $ 340.5
=================================================================================================================
- ------------
(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.
21
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 $ 122.6 $ 126.7 $ 242.0 $ 254.7
Net investment income 160.8 127.2 312.1 251.6
Premiums on immediate annuities 16.2 17.7 29.4 33.7
-----------------------------------------------------------------------------------------------------------------
299.6 271.6 583.5 540.0
-----------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account values 122.0 105.1 237.1 205.4
Other benefits 21.4 19.9 37.7 35.6
Amortization of deferred policy acquisition costs 53.9 54.8 106.3 111.2
Other operating expenses 48.6 30.6 93.9 64.1
-----------------------------------------------------------------------------------------------------------------
245.9 210.4 475.0 416.3
-----------------------------------------------------------------------------------------------------------------
Operating income before federal income tax expense $ 53.7 $ 61.2 $ 108.5 $ 123.7
=================================================================================================================
OTHER DATA
Sales:
Individual variable annuities $ 1,074.6 $ 1,563.4 $ 2,172.3 $ 2,813.0
Individual fixed annuities 682.8 471.0 1,222.8 826.3
-----------------------------------------------------------------------------------------------------------------
Total individual annuity sales $ 1,757.4 $ 2,034.4 $ 3,395.1 $ 3,639.3
=================================================================================================================
Average account values:
General account $ 9,536.3 $ 7,285.2 $ 9,254.8 $ 7,099.8
Separate account 31,693.0 34,039.6 32,157.2 34,632.5
-----------------------------------------------------------------------------------------------------------------
Total average account values $ 41,229.3 $ 41,324.8 $ 41,412.0 $ 41,732.3
=================================================================================================================
Account values as of period end:
Individual variable annuities $ 33,055.4 $ 37,170.8
Individual fixed annuities 6,825.0 4,633.0
-----------------------------------------------------------------------------------------------------------------
Total account values $ 39,880.4 $ 41,803.8
=================================================================================================================
Return on average allocated capital 10.4% 14.4% 10.8% 15.4%
Pre-tax operating income to average account values 0.52% 0.59% 0.52% 0.59%
-----------------------------------------------------------------------------------------------------------------
Pre-tax operating earnings totaled $53.7 million in second quarter
2002, down 12% compared to second quarter 2001 earnings of $61.2
million. Pre-tax operating earnings for the first half of 2002
also decreased 12% compared to the first half of 2001. An increase
in interest spread income was offset by lower asset fees and
higher operating expenses.
Asset fees decreased to $100.2 million in the second quarter of
2002, down 7% from $107.4 million in the same period a year ago.
Assets fees for the first half of 2002 decreased 6% to $202.0
million compared to $215.7 million in the same period a year ago.
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 $32.16 billion as of June 30, 2002 compared to
$34.63 billion a year ago.
22
Operating expenses were $48.6 million in second quarter 2002, an
increase of 59% over second quarter 2001. During the first half of
2002, operating expenses totaled $93.9 million, an increase of 46%
over the first half of 2001 total of $64.1 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 7.10% 7.57% 7.16% 7.73%
Interest credited 5.12 5.77 5.12 5.79
------------------------------------------------------------------------------------------------------------
Interest spread on average general account values 1.98% 1.80% 2.04% 1.94%
============================================================================================================
Interest spread on average general account values increased 18
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 $1.76 billion, down 13% from $2.03
billion in the year ago quarter. For the first half of 2002, sales
totaled $3.40 billion compared to $3.64 billion in the first half
of 2001. The appeal of fixed products to consumers remained very
strong, as sales of fixed annuities reached $682.8 million in
second quarter 2002, a 45% increase from the quarter ended a year
ago. Fixed annuity sales for the first half of 2002 totaled $1.22
billion compared to $826.3 million in the first half of 2001.
Individual Annuity segment deposits in second quarter 2002 of
$1.87 billion offset by withdrawals and surrenders totaling $1.47
billion generated net flows of $399.5 million compared to the
$987.0 million 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 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
10.4% 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.
23
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. The public sector includes the IRC Section
457 business in the form of fixed and variable annuities.
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 $ 111.1
Net investment income 198.0 211.8 394.3 423.5
Other 0.2 0.2 3.7 1.4
- ------------------------------------------------------------------------------------------------------------------
242.9 266.2 492.7 536.0
- ------------------------------------------------------------------------------------------------------------------
Benefits and expenses:
Interest credited to policyholder account values 134.5 158.7 267.6 316.8
Other benefits and expenses 54.3 53.0 114.5 111.7
- ------------------------------------------------------------------------------------------------------------------
188.8 211.7 382.1 428.5
- ------------------------------------------------------------------------------------------------------------------
Operating income before federal income tax expense $ 54.1 $ 54.5 $ 110.6 $ 107.5
==================================================================================================================
OTHER DATA
Sales:
Private sector pension plans $ 707.3 $ 784.0 $ 1,508.4 $ 1,735.9
Public sector pension plans 351.1 388.0 685.9 790.1
- ------------------------------------------------------------------------------------------------------------------
Total institutional products sales $ 1,058.4 $ 1,172.0 $ 2,194.3 $ 2,526.0
==================================================================================================================
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
- ------------------------------------------------------------------------------------------------------------------
Total average account values $ 33,067.3 $ 35,242.5 $ 33,318.9 $ 35,438.4
==================================================================================================================
Account values as of period end:
Private sector pension plans $ 15,020.0 $ 17,079.2
Public sector pension plans 13,100.1 16,034.5
Funding agreements backing medium-term notes 4,104.8 2,569.5
- ------------------------------------------------------------------------------------------------------------------
Total account values $ 32,224.9 $ 35,683.2
==================================================================================================================
Return on average allocated capital 23.5% 23.3% 24.0% 23.9%
Pre-tax operating income to average account values 0.65% 0.62% 0.66% 0.61%
==================================================================================================================
Pre-tax operating income totaled $54.1 million in the quarter ended June 30,
2002, down slightly compared to the pre-tax operating income of $54.5 million
reported a year ago. Pre-tax operating income increased 3% to $110.6 million in
the first six months of 2002 compared to the same period a year ago. Significant
growth in interest spread income was offset by lower policy charges and higher
operating expenses.
24
Asset fees declined 13% to $39.6 million in the second quarter of
2002 compared to $45.7 million in the quarter a year ago. Asset
fees totaled $80.5 million for the first half of 2002 compared to
$92.9 million for the first half of 2001. The decline was driven
by a 13% decrease 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.
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 $10.4
million higher in the second quarter of 2002 compared to the
second quarter of 2001 and $20.0 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 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% 7.36% 6.44% 7.52%
Interest credited 4.33 5.52 4.37 5.63
--------------------------------------------------------------------------------------------------------------
Interest spread on average general account values 2.04% 1.84% 2.07% 1.89%
==============================================================================================================
Interest spread improved to 204 basis points in the second quarter
of 2002 compared to 184 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
$1.06 billion compared to sales of $1.17 billion in second quarter
2001. For the first six months of 2002, sales reached $2.19
billion compared to $2.53 billion for the same period a year ago.
Private sector pension plan sales of group annuities have
decreased, as an increasing percentage of pension sales are sold
as trust products offered by an affiliate, Nationwide Trust
Company, FSB. Sales in the Public Sector declined from a year ago
reflecting the impact of case terminations in 2001 and 2002 on
recurring deposits. In addition, an increasing number of sales of
new plan sales are administration-only products offered by
Nationwide Retirement Solutions, an affiliate of the Company,
rather than annuities offered by the Company.
Institutional Products segment deposits in second quarter 2002 of
$1.10 billion, offset by participant withdrawals and surrenders
totaling $1.11 billion, generated net flows from participant
activity of $(13.2) million, compared to second quarter 2001 net
flows of $109.5 million. Year-to-date 2002 net flows decreased
183% to $(175.5) million compared to year-to-date 2001 net flows
of $211.8 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.
Life Insurance
The Life Insurance segment consists of investment life products,
including both individual variable life and COLI products,
traditional life insurance products and universal life insurance.
Life insurance products provide a death benefit and generally also
allow the customer to build cash value on a tax-advantaged basis.
25
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 $ 87.5 $ 75.5 $ 174.6 $ 158.2
Net investment income 81.9 81.2 161.9 161.1
Other 47.8 50.2 95.3 100.5
- -----------------------------------------------------------------------------------------------------
217.2 419.8 206.9 431.8
- -----------------------------------------------------------------------------------------------------
Benefits 112.3 112.4 225.8 215.0
Operating expenses 55.7 50.4 116.2 108.6
- -----------------------------------------------------------------------------------------------------
168.0 162.8 342.0 323.6
- -----------------------------------------------------------------------------------------------------
Operating income before federal income tax expense $ 49.2 $ 44.1 $ 89.8 $ 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 13.4% 11.0% 12.5% 12.2%
=====================================================================================================
Life Insurance segment earnings increased 12% to $49.2 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 7% to $89.8 million in 2001 from
$96.2 million in 2001. Adverse mortality early in 2002 and higher operating
expenses contributed to the decline.
Driven by increased policy charges, revenues from investment life products
increased to $107.9 million in second quarter 2002 compared to $97.8 million in
second quarter 2001, while year-to-date revenues increased to $214.7 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.
26
Pre-tax earnings from investment life products totaled $30.8
million in second quarter 2002 a 29% increase from $23.8 million
in second quarter 2001, while the first six months of 2002 reached
$52.3 million compared to $56.0 million a year ago, a 7% 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.
Fixed life pre-tax earnings decreased slightly 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 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 in
second quarter 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 over 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 are down in
2002 compared to 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 and
interest expense on debt.
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) $ 6.5 $ 9.0 $ 18.2 $ 16.4
Interest expense on debt, primarily with a related party (6.0) (1.6) (11.7) (3.9)
Other operating expenses 0.2 0.9 (2.1) 0.6
-----------------------------------------------------------------------------------------------------------------
Operating income before federal income tax expense(1) $ 0.7 $ 8.3 $ 4.4 $ 13.1
=================================================================================================================
----------
(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.
The decline in second quarter 2002 revenues reflects a decrease in
investment income from real estate investments. The additional
interest expense in 2002 reflects the December 2001 and June 2002
surplus note offerings, offset by lower utilization of commercial
paper borrowings.
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 $13.3 million in
second quarter 2002 compared to $5.8 million gains in the same
period a year ago. For the first half of 2002, net realized gains
on investments, hedging instruments and hedged items totaled $12.9
million compared to $5.9 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.
27
RELATED PARTY TRANSACTIONS
See note 7 to the unaudited consolidated financial statements for
a discussion of related party transactions.
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 4 to the unaudited financial statemtents.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Omitted due to reduced disclosure format.
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.
28
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 the 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
Omitted due to reduced disclosure format.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
Omitted due to reduced disclosure format.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Omitted due to reduced disclosure format.
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
None.
(b) Reports on Form 8-K:
On July 30, 2002, the Company filed a Current Report on Form
8-K reporting the condensed consolidated balance sheets as of
June 30, 2002 and December 31, 2001 and the condensed
consolidated income statements for the three and six month
periods ended June 30, 2002 and 2001.
29
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 LIFE INSURANCE COMPANY
(Registrant)
Date: August 14, 2002 /s/Mark R. Thresher
------------------------------------------
Mark R. Thresher
Senior Vice President - Finance -
Nationwide Financial
(Chief Accounting Officer)
30