<PAGE> 1
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 SEPTEMBER 30, 1998 COMMISSION FILE NO. 1-12785
NATIONWIDE FINANCIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 31-1486870
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
ONE NATIONWIDE PLAZA
COLUMBUS, OHIO 43215
(614) 249-7111
(Address, including zip code, and telephone number,
including area code, of Registrant's principal executive offices)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to the filing
requirements for at least the past 90 days.
YES X NO
--- ---
The number of shares outstanding of each of the registrant's classes of common
stock on November 1, 1998 was as follows:
CLASS A COMMON STOCK (par value $0.01 per share) - 23,788,702 shares
issued and outstanding (Title of Class)
CLASS B COMMON STOCK (par value $0.01 per share) - 104,745,000 shares
issued and outstanding (Title of Class)
<PAGE> 2
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
FORM 10-Q
INDEX
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION
<S> <C> <C>
Item 1 Unaudited Consolidated Financial Statements 3
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 14
Item 3 Quantitative and Qualitative Disclosures About Market Risk 30
PART II OTHER INFORMATION
Item 1 Legal Proceedings 31
Item 2 Changes in Securities and Use of Proceeds 32
Item 3 Defaults Upon Senior Securities 32
Item 4 Submission of Matters to a Vote of Security Holders 32
Item 5 Other Information 32
Item 6 Exhibits and Reports on Form 8-K 32
SIGNATURE 33
</TABLE>
2
<PAGE> 3
PART I - FINANCIAL INFORMATION
ITEM 1 UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(Unaudited)
(in millions of dollars, except per share amounts)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- --------------------------
1998 1997 1998 1997
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES
Policy charges $ 180.6 $ 143.3 $ 514.6 $ 393.4
Life insurance premiums 48.4 50.2 153.6 155.9
Net investment income 375.7 356.8 1,109.3 1,050.9
Realized gains (losses) on investments (5.0) (4.8) 16.6 4.3
Other 30.2 16.4 75.5 49.6
--------- --------- --------- ---------
629.9 561.9 1,869.6 1,654.1
--------- --------- --------- ---------
BENEFITS AND EXPENSES
Interest credited to policyholder account balances 269.0 256.0 795.6 756.9
Other benefits and claims 47.5 41.8 134.4 134.3
Policyholder dividends on participating policies 8.6 9.1 30.9 31.3
Amortization of deferred policy acquisition costs 57.5 43.7 159.3 126.7
Interest expense on debt and capital securities of
subsidiary trust 8.0 8.0 24.0 18.0
Other operating expenses 120.7 103.0 348.2 295.6
--------- --------- --------- ---------
511.3 461.6 1,492.4 1,362.8
--------- --------- --------- ---------
Income before federal tax expense 118.6 100.3 377.2 291.3
Federal tax expense 40.7 34.9 129.6 101.8
--------- --------- --------- ---------
Net income $ 77.9 $ 65.4 $ 247.6 $ 189.5
========= ========= ========= =========
NET INCOME PER COMMON SHARE
Basic $ 0.61 $ 0.51 $ 1.93 $ 1.55
Diluted $ 0.61 $ 0.51 $ 1.92 $ 1.55
Weighted average number of common shares
outstanding (in millions) 128.5 128.5 128.5 122.5
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
3
<PAGE> 4
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in millions of dollars, except per share amounts)
<TABLE>
<CAPTION>
(UNAUDITED)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------- ------------
<S> <C> <C>
ASSETS
Investments:
Securities available-for-sale, at fair value:
Fixed maturity securities (cost $13,243.8 in 1998; $12,732.9 in 1997) $13,979.6 $13,204.1
Equity securities (cost $113.5 in 1998; $67.8 in 1997) 128.3 80.4
Fixed maturity securities held-to-maturity, at amortized cost (fair value
$6.0 in 1997) - 6.0
Mortgage loans on real estate, net 5,187.0 5,181.6
Real estate, net 263.5 311.4
Policy loans 452.6 415.3
Other long-term investments 22.2 25.2
Short-term investments 295.4 449.2
--------- ---------
20,328.6 19,673.2
--------- ---------
Cash 17.3 180.9
Accrued investment income 228.1 211.2
Deferred policy acquisition costs 1,870.8 1,665.4
Other assets 501.4 437.8
Assets held in Separate Accounts 42,679.5 37,724.4
--------- ---------
$65,625.7 $59,892.9
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Future policy benefits and claims $19,234.9 $18,702.8
Long-term debt 298.4 298.4
Other liabilities 842.8 943.1
Liabilities related to Separate Accounts 42,679.5 37,724.4
--------- ---------
63,055.6 57,668.7
--------- ---------
NFS-obligated mandatorily redeemable capital securities of subsidiary
trust holding solely junior subordinated debentures of NFS 100.0 100.0
--------- ---------
Shareholders' equity:
Preferred stock, $0.01 par value. Authorized 50.0 million shares; no shares
issued and outstanding - -
Class A common stock, $0.01 par value. Authorized 750.0 million shares,
23.8 million shares issued and outstanding 0.2 0.2
Class B common stock, $0.01 par value. Authorized 750.0 million shares,
104.7 million shares issued and outstanding 1.0 1.0
Additional paid-in capital 629.4 629.2
Retained earnings 1,467.1 1,247.8
Unearned compensation (0.8) (1.1)
Accumulated other comprehensive income 373.2 247.1
--------- ---------
2,470.1 2,124.2
--------- ---------
$65,625.7 $59,892.9
========= =========
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
4
<PAGE> 5
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
(Unaudited)
Nine Months Ended September 30, 1998 and 1997
(in millions of dollars)
<TABLE>
<CAPTION>
ACCUMULATED
CLASS A CLASS B ADDITIONAL OTHER TOTAL
COMMON COMMON PAID-IN RETAINED UNEARNED COMPREHENSIVE SHAREHOLDERS'
STOCK STOCK CAPITAL EARNINGS COMPENSATION INCOME EQUITY
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
1997
BALANCE, JANUARY 1, 1997 $ - $ 1.0 $ 551.4 $ 1,405.7 $ - $ 173.6 $ 2,131.7
Comprehensive income:
Net income - - - 189.5 - - 189.5
Unrealized net gains on
securities available-for-sale
arising during the period - - - - - 39.8 39.8
--------------
Total comprehensive income 229.3
--------------
Issuance of Class A common stock 0.2 - 524.0 - - - 524.2
Dividends to shareholders - - (450.0) (415.4) - - (865.4)
Other, net - - 3.8 - (1.2) - 2.6
------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 1997 $ 0.2 $ 1.0 $ 629.2 $ 1,179.8 $ (1.2) $ 213.4 $ 2,022.4
================================================================================================
1998
BALANCE, JANUARY 1, 1998 $ 0.2 $ 1.0 $ 629.2 $ 1,247.8 $ (1.1) $ 247.1 $ 2,124.2
Comprehensive income:
Net income - - - 247.6 - - 247.6
Unrealized net gains on
securities available-for-sale
arising during the period - - - - - 126.1 126.1
--------------
Total comprehensive income 373.7
--------------
Cash dividends declared - - - (28.3) - - (28.3)
Other, net - - 0.2 - 0.3 - 0.5
------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 1998 $ 0.2 $ 1.0 $ 629.4 $ 1,467.1 $ (0.8) $ 373.2 $ 2,470.1
================================================================================================
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
5
<PAGE> 6
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
Nine Months Ended September 30, 1998 and 1997
(in millions of dollars)
<TABLE>
<CAPTION>
1998 1997
--------------- ---------------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 247.6 $ 189.5
Adjustments to reconcile net income to net cash provided by operating activities:
Interest credited to policyholder account balances 795.6 756.9
Capitalization of deferred policy acquisition costs (437.5) (358.2)
Amortization of deferred policy acquisition costs 159.3 126.7
Amortization and depreciation (4.3) 0.4
Realized gains on investments, net (16.6) (4.3)
Increase in accrued investment income (16.9) (11.1)
(Increase) decrease in other assets (66.1) 5.9
(Decrease) increase in policy liabilities (10.4) 66.2
(Decrease) increase in other liabilities (181.4) 197.5
Other, net (8.2) 1.9
--------------- ---------------
Net cash provided by operating activities 461.1 971.4
--------------- ---------------
CASH FLOWS FROM INVESTING ACTIVITIES
Proceeds from maturity of securities available-for-sale 1,097.7 640.8
Proceeds from sale of securities available-for-sale 550.6 248.7
Proceeds from maturity of securities held to maturity 6.0 -
Proceeds from repayments of mortgage loans on real estate 546.7 296.1
Proceeds from sale of real estate 74.6 23.2
Proceeds from repayments of policy loans and sale of other invested assets 21.1 19.8
Cost of securities available-for-sale acquired (2,187.6) (1,732.1)
Cost of mortgage loans on real estate acquired (556.4) (552.2)
Cost of real estate acquired (0.5) (24.3)
Policy loans issued and other invested assets acquired (51.9) (48.2)
Short-term investments, net 153.8 (514.1)
--------------- ---------------
Net cash used in investing activities (345.9) (1,642.3)
--------------- ---------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net proceeds from issuance of Class A common stock - 524.2
Net proceeds from issuance of NFS-obligated mandatorily redeemable
capital securities of subsidiary trust - 98.3
Net proceeds from issuance of long-term debt - 294.5
Cash dividends paid (25.7) (7.7)
Increase in investment product and universal life insurance product account balances 1,808.5 1,586.2
Decrease in investment product and universal life insurance product account balances (2,061.6) (1,763.0)
--------------- ---------------
Net cash (used in) provided by financing activities (278.8) 732.5
--------------- ---------------
Net (decrease) increase in cash (163.6) 61.6
Cash, beginning of period 180.9 43.2
--------------- ---------------
Cash, end of period $ 17.3 $ 104.8
=============== ===============
</TABLE>
See accompanying notes to unaudited consolidated financial statements.
6
<PAGE> 7
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements
Nine Months Ended September 30, 1998
(1) Basis of Presentation
---------------------
The accompanying unaudited consolidated financial statements of
Nationwide Financial Services, Inc. and subsidiaries (NFS or
collectively the Company) have been prepared in accordance with
generally accepted accounting principles, 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 generally accepted accounting
principles 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,
1997 included in the Company's 1997 Annual Report to Shareholders.
(2) Earnings per Share
------------------
Basic earnings per share is the amount of earnings for the period
available to each share of common stock outstanding during the
reporting period. Diluted earnings per share is the amount of earnings
for the period available to each share of common stock outstanding
during the reporting period adjusted for the potential issuance of
common shares for stock options.
The calculations of basic and diluted earnings per share are as
follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
(in millions, except per share amounts) 1998 1997 1998 1997
----------------------------------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Basic and diluted net income $ 77.9 $ 65.4 $ 247.6 $ 189.5
============= ============= ============= =============
Weighted average number of shares of common
stock outstanding 128.5 128.5 128.5 122.5
Dilutive effect of stock options 0.2 0.1 0.2 0.1
------------- ------------- ------------- -------------
Diluted average number of shares of common
stock outstanding 128.7 128.6 128.7 122.6
============= ============= ============= =============
Net income per common share:
Basic $ 0.61 $ 0.51 $ 1.93 $ 1.55
Diluted $ 0.61 $ 0.51 $ 1.92 $ 1.55
</TABLE>
7
<PAGE> 8
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
(3) Comprehensive Income
--------------------
Pursuant to the Financial Accounting Standards Board (FASB) Statement
No. 130, "Reporting Comprehensive Income", the Consolidated Statements
of Shareholders' Equity include a new measure called "Comprehensive
Income". Comprehensive Income includes net income as well as certain
items that are reported directly within a separate component of
shareholders' equity that bypass net income. Currently, the Company's
only component of Other Comprehensive Income is unrealized gains
(losses) on securities available-for-sale. The related before and after
federal tax amounts are as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
(in millions of dollars) SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------------------------------------------------- -------------------------------
1998 1997 1998 1997
--------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
Unrealized gains on securities available-for-sale
arising during the period:
Gross $ 266.6 $ 152.4 $ 273.7 $ 89.9
Adjustment to deferred policy acquisition costs (73.7) (46.6) (72.8) (28.0)
Related federal tax expense (67.4) (36.9) (70.2) (21.6)
--------------- --------------- --------------- ---------------
Net 125.5 68.9 130.7 40.3
--------------- --------------- --------------- ---------------
Reclassification adjustment for net (gains) losses
on securities available-for-sale realized during
the period:
Gross (3.5) 5.2 (7.0) (0.7)
Related federal tax expense (benefit) 1.2 (1.9) 2.4 0.2
--------------- --------------- --------------- ---------------
Net (2.3) 3.3 (4.6) (0.5)
--------------- --------------- --------------- ---------------
Total Other Comprehensive Income $ 123.2 $ 72.2 $ 126.1 $ 39.8
=============== =============== =============== ===============
</TABLE>
(4) Accounting Pronouncements
-------------------------
On January 1, 1998 the Company adopted FASB Statement No. 131,
"Disclosures about Segments of an Enterprise and Related Information"
(FAS 131). FAS 131 superseded FASB Statement No. 14, "Financial
Reporting for Segments of a Business Enterprise." FAS 131 establishes
standards for public business enterprises to report information about
operating segments in annual financial statements and selected
information about operating segments in interim financial reports. FAS
131 also establishes standards for related disclosures about products
and services, geographic areas, and major customers. The adoption of
FAS 131 did not affect results of operations or financial position, nor
did it affect the manner in which the Company defines its operating
segments. The segment information required for interim periods is
included in note 5.
In March 1998, The American Institute of Certified Public Accountant's
Accounting Standards Executive Committee issued Statement of Position
(SOP) 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use." SOP 98-1 provides guidance intended to
standardize accounting practices for costs incurred to develop or
obtain computer software for internal use. Specifically, SOP 98-1
provides guidance for determining whether computer software is for
internal use and when costs incurred for internal use software are to
be capitalized. SOP 98-1 is effective for financial statements for
fiscal years beginning after December 15, 1998 with earlier application
encouraged. The adoption of SOP 98-1, planned for the first quarter of
1999, is not expected to have a material impact on the Company's
consolidated financial statements.
8
<PAGE> 9
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
In June 1998, the FASB issued Statement No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (FAS 133). FAS 133
establishes accounting and reporting standards for derivative
instruments and for hedging activities. Contracts that contain embedded
derivatives, such as certain insurance contracts, are also addressed by
the Statement. FAS 133 requires that an entity recognize all
derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. The
Statement is effective for all fiscal quarters of fiscal years
beginning after June 15, 1999 with earlier application permitted. The
Company is currently evaluating the impact of this Statement on results
of operations and financial condition.
(5) Segment Disclosures
-------------------
The Company uses differences in products as the basis for defining its
reportable segments. The Company reports three product segments:
Variable Annuities, Fixed Annuities and Life Insurance.
The Variable Annuities segment consists of annuity contracts that
provide the customer with the opportunity to invest in mutual funds
managed by independent investment managers and the Company, with
investment returns accumulating on a tax-deferred basis. The Company's
variable annuity products consist almost entirely of flexible premium
deferred variable annuity contracts.
The Fixed Annuities segment consists of annuity contracts that generate
a return for the customer at a specified interest rate, fixed for a
prescribed period, with returns accumulating on a tax-deferred basis.
Such contracts consist of single premium deferred annuities, flexible
premium deferred annuities and single premium immediate annuities. The
Fixed Annuities segment includes the fixed option under variable
annuity contracts.
The Life Insurance segment consists of insurance products, including
variable universal life insurance and corporate-owned life insurance
products, that provide a death benefit and may also allow the customer
to build cash value on a tax-deferred basis.
In addition to the product segments, the Company reports corporate
revenue and expenses, investments and related investment income
supporting capital not specifically allocated to its product segments,
revenues and expenses of its distribution companies, revenues and
expenses of its investment advisor subsidiaries (other than the portion
allocated to the Variable Annuities and Life Insurance segments),
revenues and expenses related to group annuity contracts sold to
Nationwide Insurance Enterprise employee and agent benefit plans,
interest expense on long-term debt and capital securities and all
realized gains and losses on investments in a Corporate and Other
segment.
9
<PAGE> 10
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
The following table summarizes the financial results of the Company's
business segments for the three months ended September 30, 1998 and
1997.
<TABLE>
<CAPTION>
VARIABLE FIXED LIFE CORPORATE
(in millions of dollars) ANNUITIES ANNUITIES INSURANCE AND OTHER TOTAL
------------------------------------ --------------- --------------- --------------- ------------------------------
<S> <C> <C> <C> <C> <C>
1998
Operating revenue (1) $ 135.3 $ 289.5 $ 142.6 $ 67.5 $ 634.9
Benefits and expenses 80.2 245.7 118.2 67.2 511.3
--------------- --------------- --------------- ---------------- -------------
Operating income before federal
income tax 55.1 43.8 24.4 0.3 123.6
Realized losses on investments - - - (5.0) (5.0)
--------------- --------------- --------------- ---------------- -------------
Consolidated income before
federal tax expense $ 55.1 $ 43.8 $ 24.4 $ (4.7) $ 118.6
=============== =============== =============== ==============================
1997
Operating revenue (1) $ 108.6 $ 286.4 $ 118.6 $ 53.1 $ 566.7
Benefits and expenses 68.6 241.6 97.7 53.7 461.6
--------------- --------------- --------------- ------------------------------
Operating income before federal
income tax 40.0 44.8 20.9 (0.6) 105.1
Realized losses on investments - - - (4.8) (4.8)
--------------- --------------- --------------- ---------------- -------------
Consolidated income before
federal tax expense $ 40.0 $ 44.8 $ 20.9 $ (5.4) $ 100.3
=============== =============== =============== ==============================
</TABLE>
----------
(1) Excludes realized losses on investments.
10
<PAGE> 11
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
The following table summarizes the financial results of the Company's
business segments for the nine months ended September 30, 1998 and
1997.
<TABLE>
<CAPTION>
VARIABLE FIXED LIFE CORPORATE
(in millions of dollars) ANNUITIES ANNUITIES INSURANCE AND OTHER TOTAL
--------------- --------------- --------------- -------------- ---------------
<S> <C> <C> <C> <C> <C>
1998
Operating revenue (1) $ 391.1 $ 865.0 $ 406.6 $ 190.3 $ 1,853.0
Benefits and expenses 231.0 733.1 338.5 189.8 1,492.4
--------------- --------------- --------------- -------------- ---------------
Operating income before federal
income tax 160.1 131.9 68.1 0.5 360.6
Realized gains on investments - - - 16.6 16.6
--------------- --------------- --------------- -------------- ---------------
Consolidated income before
federal tax expense $ 160.1 $ 131.9 $ 68.1 $ 17.1 $ 377.2
=============== =============== =============== ============== ===============
Assets as of period end $ 40,020.7 $ 14,675.0 $ 4,857.7 $ 6,072.3 $ 65,625.7
=============== =============== =============== ============== ===============
1997
Operating revenue (1) $ 289.4 $ 853.4 $ 349.2 $ 157.8 $ 1,649.8
Benefits and expenses 185.2 726.9 297.6 153.1 1,362.8
--------------- --------------- --------------- -------------- ---------------
Operating income before federal
income tax 104.2 126.5 51.6 4.7 287.0
Realized gains on investments - - - 4.3 4.3
--------------- --------------- --------------- -------------- ---------------
Consolidated income before
federal tax expense $ 104.2 $ 126.5 $ 51.6 $ 9.0 $ 291.3
=============== =============== =============== ============== ===============
Assets as of period end $ 34,553.8 $ 14,233.7 $ 3,728.9 $ 5,795.3 $ 58,311.7
=============== =============== =============== ============== ===============
</TABLE>
----------
(1) Excludes realized gains on investments.
(6) Initial Public Offering and Pro Forma Results of Operations
-----------------------------------------------------------
In March 1997, NFS sold 23.6 million shares of its newly-issued Class A
common stock in an initial public offering (the IPO), receiving net
proceeds of $524.2 million. Concurrent with the IPO, NFS sold $300.0
million of senior notes and a subsidiary trust sold $100.0 million of
capital securities in companion public offerings. In anticipation of
the IPO, NFS paid special dividends of $50.0 million in December 1996
and $850.0 million in February 1997 to Nationwide Corporation
(Nationwide Corp.), the 100% owner of NFS prior to the IPO. Subsequent
to the IPO, Nationwide Corp. continues to own all of the outstanding
shares of Class B common stock, which represents approximately 98% of
the combined voting power of the stockholders of NFS.
11
<PAGE> 12
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
The following table compares actual results for the first nine months
of 1998 with unaudited pro forma results for the first nine months of
1997. The 1997 information includes pro forma adjustments to net
investment income and interest expense giving effect to (i) the IPO and
companion offerings of senior notes and capital securities of
subsidiary trust and (ii) the $850.0 million dividend paid by the
Company in February 1997, as if each had been consummated on January 1,
1997. Pro forma results for the three month period ended September 30,
1997 are not presented as they would not differ from actual results.
This pro forma information is not necessarily indicative of what the
Company's results would have been had the above transactions actually
occurred on the date indicated, or of future results of the Company.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------------
1998 1997
(in millions of dollars, except per share amounts) (ACTUAL) (PRO FORMA)
---------------------------------------------------------------------------------------- ---------------
<S> <C> <C>
Revenues $ 1,869.6 $ 1,655.9
Benefits and expenses 1,492.4 1,369.0
--------------- ---------------
Income before federal tax expense 377.2 286.9
Federal tax expense 129.6 100.3
--------------- ---------------
Net income $ 247.6 $ 186.6
=============== ===============
Net income per common share:
Basic $ 1.93 $ 1.45
Diluted $ 1.92 $ 1.45
Weighted average number of shares of common stock
outstanding (in millions) 128.5 128.5
</TABLE>
(7) Acquisitions
------------
In May 1998, NFS acquired all of the outstanding shares of Morley
Financial Services, Inc., an investment management company, for $32.1
million in a transaction accounted for as a purchase.
On July 14, 1998, NFS formed a strategic alliance with National
Deferred Compensation, Inc. (NDC), an administrator of deferred
compensation programs for public employees. The alliance included an
option for NFS to acquire NDC. NFS exercised its option to purchase NDC
on July 31, 1998 with a total purchase price of approximately $24.0
million. The transaction was accounted for as a purchase.
12
<PAGE> 13
NATIONWIDE FINANCIAL SERVICES, INC. AND SUBSIDIARIES
Notes to Unaudited Consolidated Financial Statements, Continued
(8) Subsequent Events
-----------------
On October 19, 1998, Nationwide Financial Services Capital Trust II
(the Trust), a wholly-owned subsidiary trust of NFS, sold, in a public
offering, $200 million of 7.10% Trust Preferred Securities (Preferred
Securities), representing preferred undivided beneficial interests in
the assets of the Trust generating net proceeds of $193.7 million.
Concurrent with the sale of the Preferred Securities, NFS sold to the
Trust $206.2 million of Junior Subordinated Deferrable Interest
Debentures (Junior Subordinated Debentures) due October 31, 2028. The
Junior Subordinated Debentures are the sole assets of the Trust and are
redeemable, in whole or in part, on or after October 19, 2003 at a
redemption price equal to the principal amount to be redeemed plus any
accrued and unpaid interest. The Preferred Securities have a
liquidation amount of $25 per security and must be redeemed by the
Trust when the Junior Subordinated Debentures mature or are redeemed by
NFS.
The Preferred Securities, through obligations of NFS under the Junior
Subordinated Debentures, the Preferred Securities Guarantee Agreement
and the related Amended and Restated Declaration of Trust, are fully
and unconditionally guaranteed by NFS. Distributions on the Preferred
Securities are cumulative and payable quarterly beginning January 31,
1999. Distributions on the Preferred Securities will be classified as
interest expense in the consolidated statements of income.
(9) Contingencies
-------------
On October 29, 1998 the Company and certain of its subsidiaries were
named in a lawsuit filed in the Common Pleas Court of Franklin County,
Ohio 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).
The plaintiff in such lawsuit seeks to represent a national class of
the Company's customers and seeks unspecified compensatory and punitive
damages. The Company is currently evaluating this lawsuit, which is in
an early stage and has not been certified as a class. The Company
intends to defend this lawsuit vigorously.
13
<PAGE> 14
ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
INTRODUCTION
The following analysis of unaudited consolidated results of
operations and financial condition of the Company should be read
in conjunction with the unaudited consolidated financial
statements and related notes included elsewhere herein.
NFS is a holding company for Nationwide Life Insurance Company
(NLIC) and the other companies within the Nationwide Insurance
Enterprise that offer or distribute long-term savings and
retirement products. In March 1997, NFS sold 23.6 million shares
of its newly-issued Class A common stock in an initial public
offering (the IPO), receiving net proceeds of $524.2 million.
Concurrent with the IPO, NFS sold $300.0 million of senior notes
and a subsidiary trust sold $100.0 million of capital securities
in companion public offerings. In addition to actual results, the
Company presents pro forma results for 1997 adjusted for the
public offerings and for the $850.0 million dividend paid in
February 1997 in anticipation of the IPO as if they had occurred
at the beginning of 1997.
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) Nationwide
Corporation's control of the Company through its beneficial
ownership of approximately 97.8% of the combined voting power of
all the outstanding common stock and approximately 81.5% of the
economic interest in the Company; (ii) the Company's primary
reliance, as a holding company, on dividends from its subsidiaries
to meet debt payment obligations and the applicable regulatory
restrictions on the ability of the Company's subsidiaries to pay
such dividends; (iii) the potential impact on the Company's
reported net income that could result from the adoption of certain
accounting standards issued by the FASB; (iv) tax law changes
impacting the tax treatment of life insurance and investment
products; (v) 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; (vi) adverse state and federal legislation and
regulation, including limitations on premium levels, increases in
minimum capital and reserves, and other financial viability
requirements; (vii) failure to expand distribution channels in
order to obtain new customers or failure to retain existing
customers; (viii) inability to carry out marketing and sales
plans, including, among others, changes to certain products and
acceptance of the revised products in the market; (ix) changes in
interest rates and the capital markets causing a reduction of
investment income or asset fees, reduction in the value of the
Company's investment portfolio or a reduction in the demand for
the Company's products; (x) general economic and business
conditions which are less favorable than expected; (xi)
unanticipated changes in industry trends and ratings assigned by
nationally recognized statistical rating organizations or A.M.
Best Company, Inc.; and (xii) inaccuracies in assumptions
regarding future persistency, mortality, morbidity and interest
rates used in calculating reserve amounts.
RESULTS OF OPERATIONS
In addition to net income, the Company reports net operating
income, which excludes realized investment gains and losses. Net
operating income is commonly used in the insurance industry as a
measure of on-going earnings performance.
14
<PAGE> 15
The following table reconciles the Company's reported net income
to net operating income for the three and nine month periods ended
September 30, 1998 and 1997. In addition, net operating income
reflecting pro forma adjustments for the IPO, companion offerings
of senior notes and capital securities, and the $850.0 million
dividend as discussed previously is also presented for 1997. This
pro forma information is not necessarily indicative of what the
Company's results would have been had the above transactions
actually occurred at the beginning of 1997, or of future results
of the Company. All earnings per share amounts are presented on a
diluted basis.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------
(in millions of dollars, except per share amounts) 1998 1997 1998 1997
------------------------------------------------------ ----------- ------------------------ -----------
<S> <C> <C> <C> <C>
Net income $ 77.9 $ 65.4 $ 247.6 $ 189.5
Realized (gains) losses on investments, net of tax 3.3 2.9 (10.8) (3.3)
----------- ------------------------ -----------
Net operating income 81.2 68.3 236.8 186.2
Pro forma adjustments, net of tax - - - (2.9)
----------- ------------------------ -----------
Pro forma net operating income $ 81.2 $ 68.3 $ 236.8 $ 183.3
=========== ======================== ===========
Net operating income per share (pro forma for 1997) $ 0.63 $ 0.53 $ 1.84 $ 1.43
=========== ======================== ===========
</TABLE>
Revenues
Total revenues for third quarter 1998, excluding realized gains
and losses on investments, increased to $634.9 million compared to
$566.7 million for the same period in 1997. For the first nine
months of 1998 and 1997, total revenues excluding realized gains
and losses on investments were $1.85 billion and $1.65 billion,
respectively. Increases in policy charges and net investment
income were the key drivers to revenue growth.
Policy charges include asset fees, which are primarily earned on
variable annuity policy reserves; administration fees, which
include fees charged per contract on a variety of the Company's
products and premium loads on universal life insurance products;
surrender fees, which are charged as a percentage of premiums
withdrawn during a specified period of certain annuity and life
insurance contracts; and cost of insurance charges earned on
universal life insurance products. Policy charges for the
comparable periods of 1998 and 1997 were as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
(in millions of dollars) 1998 1997 1998 1997
--------------------------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Asset fees $ 126.2 $ 105.0 $ 365.4 $ 276.0
Administrative fees 20.0 12.7 54.0 43.0
Surrender fees 11.0 8.3 30.8 24.3
Cost of insurance charges 23.4 17.3 64.4 50.1
------------- ------------- ------------- -------------
Total policy charges $ 180.6 $ 143.3 $ 514.6 $ 393.4
============= ============= ============= =============
</TABLE>
The growth in asset fees reflects a 30% increase in total separate
account assets which reached $42.68 billion as of September 30,
1998 compared to $32.87 billion a year ago. Despite declines in
the equity markets during third quarter 1998, separate account
assets have grown significantly from a year ago due to steady
growth in premiums.
15
<PAGE> 16
Net investment income includes the investment income earned on
investments supporting fixed annuities and certain life insurance
products as well as the yield on the Company's general account
invested assets which are not allocated to product segments. Net
investment income grew from $356.8 million and $1.05 billion in
the third quarter and first nine months of 1997, respectively, to
$375.7 million and $1.11 billion in the comparable periods of 1998
primarily due to increased invested assets to support growth in
fixed annuity and life insurance policy reserves. Fixed annuity
policy reserves, which include the fixed option of variable
annuity contracts, increased to $14.38 billion as of September 30,
1998 compared to $14.19 billion as of December 31, 1997 and $13.97
billion a year ago. Growth in corporate investment life general
account reserves from $74.9 million at the end of third quarter
1997 to $781.3 million as of September 30, 1998 accounted for most
of the increased contribution to net investment income from the
Life Insurance segment.
The Company does not consider realized gains and losses on
investments 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. Net realized
losses on investments were $5.0 million and $4.8 million for third
quarter 1998 and 1997, respectively. For the first nine months of
1998, the Company reported realized gains on investments of $16.6
million compared to $4.3 million of realized gains for the first
nine months of 1997.
During third quarter 1998 NFS entered into a forward agreement for
$300 million of U.S. Treasury securities in an attempt to protect
the Company against the possibility that the coupon rate on an
anticipated $300 million debt issue would rise due to increases in
U.S. Treasury rates. By the end of third quarter, NFS elected to
issue only $200 million of long-term debt as described in Note 8
to the unaudited consolidated financial statements. Upon issuance
of the Preferred Securities, NFS terminated the forward agreement
at a loss of $31.8 million reflecting the substantial decline in
U.S. Treasury rates during third quarter 1998. One third, or $10.6
million, of the loss was recognized in third quarter 1998 and is
included in realized losses on investments. The recognized loss
represents the pro rata share of the loss on the forward agreement
that is attributable to the original amount of the hedge in excess
of the amount of debt ultimately issued by NFS. It is not probable
that NFS will issue an additional $100 million in debt in the near
future. The remaining $21.2 million loss has been deferred and
will be amortized to interest expense over the 30 year life of the
Preferred Securities.
Benefits and Expenses
Interest credited to policyholder account balances principally
relates to fixed annuity products. For the third quarter and first
nine months of 1998 interest credited totaled $269.0 million and
$795.6 million, respectively, compared to $256.0 million and
$756.9 million in the same periods of 1997. The growth in interest
credited reflects the increase in fixed annuity and life insurance
policy reserves previously discussed, partially offset by reduced
average crediting rates. The average crediting rate on fixed
annuity policy reserves was 5.96% during both the third quarter
and first nine months of 1998 compared to 6.10% and 6.12% in the
comparable periods of 1997.
The significant growth in the Variable Annuities segment business
is the primary reason for the increase in amortization of deferred
policy acquisition costs (DAC) which totaled $57.5 million and
$43.7 million in third quarter 1998 and 1997, respectively. On a
year to date basis, amortization of DAC totaled $159.3 million in
1998 compared to $126.7 million in 1997.
Other operating expenses increased 17% to $120.7 million in third
quarter 1998 compared to $103.0 million in third quarter 1997. For
the first nine months of 1998, operating expenses were $348.2
million, up 18% from $295.6 million for the first nine months of
1997. The increases reflect growth in the number of annuity and
life insurance contracts in force and the related increase in
administrative processing costs. Operating expenses also include
costs of certain technology initiatives including projects related
to the Year 2000.
Federal tax expense was $40.7 million and $34.9 million,
representing effective tax rates of 34.3% and 34.8% for third
quarter 1998 and 1997, respectively. For the first nine months of
1998 and 1997 federal tax expense was $129.6 million and $101.8
million, representing effective tax rates of 34.4% and 34.9%,
respectively.
16
<PAGE> 17
Year 2000
The Company has developed and implemented a plan to address issues
related to the Year 2000. The problem relates to many existing
computer systems using only two digits to identify a year in a
date field. These systems were designed and developed without
considering the impact of the upcoming change in the century. If
not corrected, many computer systems could fail or create
erroneous results when processing information dated after December
31, 1999. Like many organizations, the Company is required to
renovate or replace many computer systems so that the systems will
function properly after December 31, 1999. The Company has
completed an inventory and assessment of all computer systems and
has developed a plan to renovate or replace all applications that
were identified as not Year 2000 compliant. The Company has
renovated all applications that required renovation. Testing of
the renovated programs is in process, including running each
application in a Year 2000 environment. The Company expects to
complete the testing of all renovated applications by the end of
1998. For applications being replaced, the Company expects to have
all replacement systems in place and functioning by the end of
1998, with the exception of the policy administration system for
traditional life products which will be in place and functioning
by the end of March 1999. Contingency plans are substantially
completed which identify actions to be taken should the Company's
renovation strategies fall behind schedule.
The Company has completed an inventory and assessment of all
vendor products and is testing and certifying that each vendor
product is Year 2000 compliant. At the end of September 1998, 76%
of vendor products had been tested and certified as Year 2000
compliant. The Company anticipates having all vendor products
tested and certified by the end of 1998. Any vendor products that
can not be certified as Year 2000 compliant will be replaced or
eliminated.
In addition to resolving internal Year 2000 readiness issues, the
Company is surveying significant external organizations (business
partners) to assess if they will be Year 2000 compliant and be in
a position to do business in the Year 2000 and beyond.
Specifically, the Company has contacted mutual fund organizations
that provide funds for our variable annuity and life products. The
same action will be taken with wholesale producers before the end
of 1998.
The Company has also addressed issues associated with the exchange
of electronic data with business partners. The Company has
completed an inventory and assessment of all business partners
including electronic interfaces. Processes have been put in place
and programs initiated to process data irrespective of the format
by converting non-compliant data into a Year 2000 compliant
format.
The Company's assessment of Year 2000 issues has also included
non-information technology systems with embedded computer chips.
The Company's building systems such as fire, security, and
elevators and escalators supporting facilities in Columbus, Ohio
have been tested and are Year 2000 compliant.
The proceeding Year 2000 discussion excludes the three companies
acquired in 1998 (see "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Liquidity and
Capital Resources"). The Company is currently reviewing the
acquired companies' systems, applications, and business partners,
and developing work plans for the acquired companies to become
Year 2000 compliant during 1999.
Operating expenses in the first nine months of 1998 and 1997
include approximately $32.7 million and $33.5 million,
respectively, for technology projects, including costs related to
Year 2000. In the fourth quarter of 1998, the Company anticipates
spending approximately $8 million on technology projects,
including Year 2000. At this time, no significant Year 2000 costs
are anticipated in 1999. Management does not anticipate that the
completion of Year 2000 renovation and replacement activities will
result in a reduction in operating expenses. Rather, personnel and
resources currently allocated to Year 2000 issues will be assigned
to other technology-related projects.
17
<PAGE> 18
Statutory Premiums and Deposits
The Company sells its products through a broad distribution
network comprised of wholesale and retail distribution channels.
Wholesale distributors are unaffiliated entities that sell the
Company's products to their own customer base and include
independent broker/dealers, national and regional wirehouses,
financial institutions, pension plan administrators and life
specialists. The Company has access to over 1,100 independent
broker/dealers and over 30,000 registered representatives who sell
individual and group variable annuities, fixed annuities and
variable life insurance in all 50 states and the District of
Columbia. The Company currently has relationships with 185
financial institutions selling individual variable and fixed
annuities (under the Company's brand name and on a private-label
basis), variable universal life insurance and group pension
products. Over 250 regional pension plan administrators market the
Company's group variable and fixed annuities to employers
sponsoring employee retirement programs.
Retail distributors are representatives of the Company who market
products directly to a customer base identified by the Company and
include exclusive retail sales representatives of the Company's
distribution subsidiaries and Nationwide Insurance Enterprise
insurance agents. The Company markets products on a retail basis
to state and local governments and to teachers through its
subsidiary distribution organizations. Approximately 4,300
Nationwide Insurance Enterprise insurance agents are licensed to
sell life insurance and individual annuities primarily targeting
holders of personal automobile and homeowners' insurance policies
issued by the Nationwide Insurance Enterprise.
Statutory premiums and deposits by distribution channel are
summarized as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED, NINE MONTHS ENDED,
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
(in millions of dollars) 1998 1997 1998 1997
--------------------------------------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
WHOLESALE CHANNELS
Independent broker/dealers $ 925.4 $ 954.8 $ 2,851.3 $ 2,781.9
National and regional wirehouses (1) 78.6 - 253.1 -
Financial institutions 457.2 452.6 1,549.2 1,172.0
Pension plan administrators 730.2 594.8 2,160.9 1,733.6
Life specialists 135.3 5.0 589.8 50.0
------------- ------------- ------------- -------------
Total wholesale channels 2,326.7 2,007.2 7,404.3 5,737.5
------------- ------------- ------------- -------------
RETAIL CHANNELS
Exclusive retail sales representatives 588.4 430.6 1,717.4 1,409.4
Nationwide agents 224.5 150.8 711.1 445.4
------------- ------------- ------------- -------------
Total retail channels 812.9 581.4 2,428.5 1,854.8
------------- ------------- ------------- -------------
Total external premiums and deposits 3,139.6 2,588.6 9,832.8 7,592.3
============= ============= ============= =============
Nationwide Insurance Enterprise employee
and agent benefit plans 88.5 42.9 204.0 113.5
------------- ------------- ------------- -------------
Total statutory premiums and deposits $ 3,228.1 $ 2,631.5 $ 10,036.8 $ 7,705.8
============= ============= ============= =============
</TABLE>
----------
(1) Prior to 1998, national and regional wirehouse sales were
included in independent broker/dealer sales.
18
<PAGE> 19
Excluding Nationwide Insurance Enterprise benefit plan sales, the
Company achieved sales growth of 21% in the third quarter of 1998
compared to the third quarter of 1997. On a year to date basis,
sales have increased 30% in 1998 compared to 1997. The Company
believes it is well positioned to achieve its goal of 20% annual
growth in external sales in 1998.
The Company's flagship products are marketed under The BEST of
AMERICA(R) brand, and include individual and group variable
annuities and variable life insurance. The BEST of AMERICA(R)
products allow customers to choose from among 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 which allow
those providers to sell individual variable and fixed annuities
with substantially the same features as the Company's brand name
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
Internal Revenue Code (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. In addition, the Company utilizes an exclusive
arrangement with the National Education Association (NEA) to
market tax-qualified annuities under IRC 403(b) to NEA members.
Variable annuities developed for the NEA members are sold under
the NEA Valuebuilder brand.
The Company offers corporate-owned life insurance (COLI).
Corporations purchase COLI to provide protection against the death
of selected employees and to fund non-qualified benefit plans.
External statutory premiums and deposits by product are summarized
as follows.
<TABLE>
<CAPTION>
THREE MONTHS ENDED, NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ---------------------------
(in millions of dollars) 1998 1997 1998 1997
----------------------------------------- ------------- -------------- ------------- -------------
<S> <C> <C> <C> <C>
The BEST of AMERICA(R) products:
Individual variable annuities $ 1,141.5 $ 1,131.0 $ 3,640.1 $ 3,152.1
Group variable annuities 709.1 568.5 2,083.3 1,649.4
Variable universal life insurance 89.7 56.2 232.1 154.1
Private label annuities 260.4 274.0 835.3 769.5
IRC Section 457 annuities 551.8 395.2 1,599.9 1,312.1
The NEA Valuebuilder annuities 36.7 35.4 117.6 97.3
Corporate-owned life insurance 135.3 5.0 589.8 50.0
Traditional/Universal life insurance 55.4 57.0 176.8 180.3
Other 159.7 66.3 557.9 227.5
------------- -------------- ------------- -------------
$ 3,139.6 $ 2,588.6 $ 9,832.8 $ 7,592.3
============= ============== ============= =============
</TABLE>
19
<PAGE> 20
BUSINESS SEGMENTS
The Company reports three product segments: Variable Annuities,
Fixed Annuities and Life Insurance. In addition, the Company
reports corporate revenue and expenses, investments and related
investment income supporting capital not specifically allocated to
its product segments, revenues and expenses of its distribution
companies, revenues and expenses of its investment advisor
subsidiaries (other than the portion allocated to the Variable
Annuities and Life Insurance segments), revenues and expenses
related to group annuity contracts sold to Nationwide Insurance
Enterprise employee and agent benefit plans and interest expense
on long-term debt and capital securities in a Corporate and Other
segment. All information set forth below relating to the Variable
Annuities segment excludes the fixed option under variable annuity
contracts. Such information is included in the Fixed Annuities
segment.
The following table summarizes operating income before federal tax
expense for the Company's business segments.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ----------------------------
(in millions of dollars) 1998 1997 1998 1997
------------------------------------ ------------- ------------- -------------- --------------
<S> <C> <C> <C> <C>
Variable Annuities $ 55.1 $ 40.0 $ 160.1 $ 104.2
Fixed Annuities 43.8 44.8 131.9 126.5
Life Insurance 24.4 20.9 68.1 51.6
Corporate and Other 0.3 (0.6) 0.5 4.7
------------- ------------- -------------- --------------
$ 123.6 $ 105.1 $ 360.6 $ 287.0
============= ============= ============== ==============
</TABLE>
Variable Annuities
The Variable Annuities segment consists of annuity contracts that
provide the customer with the opportunity to invest in mutual
funds managed by independent investment managers and the Company,
with investment returns accumulating on a tax-deferred basis. The
Company's variable annuity products consist almost entirely of
flexible premium deferred variable annuity contracts.
20
<PAGE> 21
The following table summarizes certain selected financial data for
the Variable Annuities segment for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ----------------------------
(in millions of dollars) 1998 1997 1998 1997
----------------------------------------------------- ------------- ------------- ------------- --------------
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA (1)
Revenues:
Asset fees $ 122.4 $ 101.1 $ 354.1 $ 264.9
Administrative fees 5.7 4.3 17.7 15.8
Surrender fees 8.0 5.5 21.7 16.4
------------- ------------- ------------- --------------
Total policy charges 136.1 110.9 393.5 297.1
Net investment income and other (2) (0.8) (2.3) (2.4) (7.7)
------------- ------------- ------------- --------------
135.3 108.6 391.1 289.4
Benefits and expenses:
Benefits and claims 0.9 1.6 2.9 4.3
Amortization of DAC 33.2 25.1 90.1 64.6
Other operating expenses 46.1 41.9 138.0 116.3
------------- ------------- ------------- --------------
80.2 68.6 231.0 185.2
------------- ------------- ------------- --------------
Operating income before federal tax expense $ 55.1 $ 40.0 $ 160.1 $ 104.2
============= ============= ============= ==============
OTHER DATA (1)
Statutory premiums and deposits (3) $ 2,477.5 $ 1,900.3 $ 7,493.0 $ 5,667.6
Withdrawals $ 1,022.9 $ 714.9 $ 3,158.4 $ 2,022.2
Policy reserves as of period end $38,814.1 $33,590.2 $38,814.1 $33,590.2
Ratio of policy charges to average policy reserves 1.35% 1.40% 1.34% 1.40%
Pre-tax operating income to average policy reserves 0.55% 0.50% 0.55% 0.49%
</TABLE>
----------
(1) Excludes the fixed option under the variable annuity contracts
which is reported in the Fixed Annuities segment.
(2) The Company's method of allocating net investment income
results in a charge (negative net investment income) to this
segment which is recognized in the Corporate and Other
segment. The charge relates to non-invested assets which
support this segment on a statutory basis.
(3) Statutory data have been derived from the Quarterly Statements
of the Company's life insurance subsidiaries, as filed with
insurance regulatory authorities and prepared in accordance
with statutory accounting practices.
Variable annuity segment results reflect increased asset fee
revenue partially offset by increases in DAC amortization and
other operating expenses. Asset fees increased to $122.4 million
in the third quarter of 1998, up 21% from $101.1 million in the
same period a year ago. For the first nine months of 1998, asset
fees totaled $354.1 million up 34% from the first nine months of
1997. The increase in asset fees reflects higher variable annuity
policy reserve levels. Despite poor third quarter 1998 equity
market performance, variable annuity policy reserves are still up
16% from a year ago due to strong variable annuity sales during
1998.
The Company continues to sustain high sales growth through deeper
penetration of existing distribution channels and expansion into
new sales outlets. Third quarter 1998 premiums grew across all
distribution channels reaching $2.48 billion, 30% above year-ago
third quarter sales of $1.90 billion. During the first nine months
of 1998, variable annuity sales reached $7.49 billion up 32% from
the first nine months of 1997. Included in 1998 sales are $700
million for third quarter and $1.8 billion year-to-date for
America's FUTURE Annuity(R), the Company's lower-fee individual
annuity introduced in November 1997.
Other operating expenses increased 10% and 19% during the third
quarter and first nine months of 1998, respectively, compared to
the same periods of 1997 reflecting growth in the variable annuity
business. The Company has been able to improve its operating
margins by five basis points in third quarter and six basis points
year-to-date compared to 1997 by growing revenues faster than the
increase in expenses. The growth in amortization of DAC reflects
the overall growth in the variable annuity business.
21
<PAGE> 22
Fixed Annuities
The Fixed Annuities segment consists of annuity contracts that
generate a return for the customer at a specified interest rate,
fixed for a prescribed period, with returns accumulating on a
tax-deferred basis. Such contracts consist of single premium
deferred annuities, flexible premium deferred annuities and single
premium immediate annuities. The Fixed Annuities segment includes
the fixed option under variable annuity contracts.
The following table summarizes certain selected financial data for
the Fixed Annuities segment for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------- -------------------------
(in millions of dollars) 1998 1997 1998 1997
----------------------------------------------------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA (1)
Revenues:
Policy charges $ 3.4 $ 2.4 $ 9.6 $ 11.1
Life insurance premiums 5.2 7.1 20.7 23.1
Net investment income 280.9 276.9 834.7 819.2
---------- ---------- ---------- ----------
289.5 286.4 865.0 853.4
---------- ---------- ---------- ----------
Benefits and expenses:
Interest credited to policyholder account balances 207.0 206.1 619.2 612.9
Other benefits and claims 4.6 5.5 18.2 19.2
Amortization of DAC 12.9 8.6 34.6 29.8
Other operating expenses 21.2 21.4 61.1 65.0
---------- ---------- ---------- ----------
245.7 241.6 733.1 726.9
---------- ---------- ---------- ----------
Operating income before federal tax expense $ 43.8 $ 44.8 $ 131.9 $ 126.5
========== ========== ========== ==========
OTHER DATA (1)
Statutory premiums and deposits (2) $ 381.7 $ 570.1 $ 1,341.0 $ 1,540.3
Withdrawals and benefits $ 415.1 $ 365.3 $ 1,425.6 $ 1,299.0
Policy reserves as of period end $ 14,380.0 $ 13,970.4 $ 14,380.0 $ 13,970.4
Net interest spread on general account
policy reserves 2.13% 2.10% 2.07% 2.06%
Pre-tax operating income to average policy reserves 1.22% 1.29% 1.23% 1.23%
</TABLE>
----------
(1) Includes the fixed option under the variable annuity
contracts.
(2) Statutory data have been derived from the Quarterly Statements
of the Company's life insurance subsidiaries, as filed with
insurance regulatory authorities and prepared in accordance
with statutory accounting practices.
22
<PAGE> 23
Fixed annuity segment results reflect an increase in interest
spread income attributable to growth in fixed annuity policy
reserves. Interest spread is the difference between net investment
income and interest credited to policyholder account balances.
Interest spreads vary and are influenced by various factors
including crediting rates offered by competitors, performance of
the investment portfolio, changes in market interest rates and
other factors. The following table depicts the interest spreads on
general account policy reserves in the Fixed Annuities segment for
the third quarter and first nine months of 1998 and 1997.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
1998 1997 1998 1997
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Net investment income 8.09% 8.20% 8.03% 8.18%
Interest credited 5.96 6.10 5.96 6.12
------------- ------------- ------------- -------------
2.13% 2.10% 2.07% 2.06%
============= ============= ============= =============
</TABLE>
Mortgage loan prepayment fees in 1998 accounted for approximately
16 basis points and 10 basis points of the interest spread in the
third quarter and first nine months of 1998, respectively. The
Company anticipates interest spreads in the fourth quarter to be
comparable to third quarter 1998, excluding the impact of mortgage
loan prepayment income. Interest spreads are expected to narrow in
1999.
Fixed annuity policy reserves increased to $14.38 billion as of
September 30, 1998 compared to $14.19 billion as of the end of
1997 and $13.97 billion a year ago.
Third quarter fixed annuity sales decreased to $381.7 million in
1998 compared to $570.1 million in 1997. Third quarter 1997 sales
reflect a sales promotion that offered customers a first-year 7%
crediting rate on several of the Company's variable contracts,
which contributed approximately $200 million to third quarter 1997
sales. Sales for the first nine months of 1998 of $1.34 billion
were also down compared to $1.54 billion in 1997. Most of the
Company's fixed annuity sales are premiums allocated to the fixed
option of variable annuity contracts. Third quarter 1998 fixed
annuity sales include $287.8 million in premiums allocated to the
fixed option under a variable annuity contract, compared to $453.5
million in third quarter 1997.
On October 1, 1998 the Company introduced an 8% first year
crediting rate on individual variable annuities. The cost of this
promotion will be offset by a reduction of renewal rates on
existing contracts. The Company believes these actions will
generate additional sales in the bank and brokerage channels and
be neutral to profitability.
Amortization of DAC increased $4.3 million to $12.9 million in
third quarter 1998 compared to $8.6 million in third quarter 1997
reflecting higher net interest spread.
Life Insurance
The Life Insurance segment consists of insurance products,
including variable universal life insurance and corporate-owned
life insurance products, that provide a death benefit and may also
allow the customer to build cash value on a tax-deferred basis.
23
<PAGE> 24
The following table summarizes certain selected financial data for
the Life Insurance segment for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ------------------------
(in millions of dollars) 1998 1997 1998 1997
----------------------------------------------------------- --------- --------- --------- ---------
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA
Revenues:
Cost of insurance charges $ 23.4 $ 17.3 $ 64.4 $ 50.1
Other policy charges 14.5 9.6 38.2 27.0
--------- --------- --------- ---------
Total policy charges 37.9 26.9 102.6 77.1
Life insurance premiums 43.2 43.1 132.9 132.8
Net investment income 61.2 48.4 170.3 138.9
Other 0.3 0.2 0.8 0.4
--------- --------- --------- ---------
142.6 118.6 406.6 349.2
--------- --------- --------- ---------
Benefits and expenses:
Interest credited to policyholder account balances 30.7 19.5 83.0 56.5
Other benefits and claims 42.0 34.7 113.3 110.8
Policyholder dividends 8.6 9.1 30.9 31.3
Amortization of DAC 11.4 10.0 34.6 32.3
Other operating expenses 25.5 24.4 76.7 66.7
--------- --------- --------- ---------
118.2 97.7 338.5 297.6
--------- --------- --------- ---------
Operating income before federal tax expense $ 24.4 $ 20.9 $ 68.1 $ 51.6
========= ========= ========= =========
OTHER DATA
Statutory premiums (1):
Traditional and universal life insurance $ 55.4 $ 57.0 $ 176.9 $ 180.3
Individual investment life insurance $ 89.7 $ 56.2 $ 232.1 $ 154.1
Corporate investment life insurance $ 135.3 $ 5.0 $ 589.9 $ 50.0
Policy reserves as of period end:
Traditional and universal life insurance $ 2,423.2 $ 2,348.9
Individual investment life insurance $ 1,058.8 $ 852.0
Corporate investment life insurance $ 829.9 $ 74.9
Life insurance in force:
Traditional and universal life insurance $27,238.4 $27,628.5
Individual investment life insurance $14,770.3 $10,486.8
Corporate investment life insurance $ 1,899.6 $ 246.2
</TABLE>
----------
(1) Statutory data have been derived from the Quarterly Statements
of the Company's life insurance subsidiaries, as filed with
insurance regulatory authorities and prepared in accordance
with statutory accounting practices.
Third quarter 1998 Life Insurance segment results compared to
third quarter 1997 reflect continued growth in variable life
policy fees, partially offset by unfavorable mortality.
Year-to-date, Life Insurance segment results reflect increased
revenues driven by growth in investment life insurance in force
and policy reserves coupled with favorable mortality experience.
These trends were partially offset by higher expense levels.
24
<PAGE> 25
Investment life insurance (which includes individual variable
universal life insurance and corporate-owned life insurance
products) policy charges were $25.9 million in the third quarter
of 1998, a 75% increase compared to $14.8 million for the third
quarter of 1997. The growth in investment life insurance policy
charges is attributable to growth in individual investment life
insurance policy reserves which reached $1.89 billion as of the
end of the third quarter 1998 up $961.8 million from a year ago.
Policy reserve growth continues to be driven by strong sales from
both independent broker/dealers and Nationwide Insurance
Enterprise insurance agents. Investment life insurance sales to
individuals during the third quarter of 1998 reached $89.7 million
compared to $56.2 million in the third quarter of 1997. The
Company anticipates continued sales growth in 1998 for investment
life insurance products.
During the first nine months of 1998, the Company continued its
entry into the corporate-owned life insurance market recording
$589.8 million in corporate-owned life insurance premiums compared
to $50.0 million in the nine months of 1997. As of September 30,
1998 the Company had $829.9 million in corporate-owned life
insurance policy reserves.
The increase in operating expenses is due to the increase in
policies in force and continued spending on a new policy
administration system for traditional life insurance policies.
Corporate and Other
The following table summarizes certain selected financial data for
the Corporate and Other segment for the periods indicated.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------ -------------------------
(in millions of dollars) 1998 1997 1998 1997
-------------------------------------------------------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
INCOME STATEMENT DATA
Revenues (1):
Net investment income $ 41.1 $ 38.2 $ 126.9 $ 112.6
Other 26.4 14.9 63.4 45.2
-------- -------- -------- --------
67.5 53.1 190.3 157.8
-------- -------- -------- --------
Benefits and expenses:
Interest credited to policy reserves 31.3 30.4 93.4 87.5
Interest expense on debt and capital securities 8.0 8.0 24.0 18.0
Other operating expenses 27.9 15.3 72.4 47.6
-------- -------- -------- --------
67.2 53.7 189.8 153.1
-------- -------- -------- --------
Operating income before federal tax expense (1) $ 0.3 $ (0.6) $ 0.5 $ 4.7
======== ======== ======== ========
OTHER DATA
Statutory premiums and deposits (2) $ 88.5 $ 42.9 $ 204.0 $ 113.5
Withdrawals $ 50.1 $ 20.6 $ 156.4 $ 126.7
Policy reserves as of period end $3,991.0 $3,719.8 $3,991.0 $3,719.8
Nationwide retail mutual fund assets (3) $2,833.3 $2,562.6 $2,833.3 $2,562.6
</TABLE>
----------
(1) Excludes realized gains and losses on investments.
(2) Statutory data have been derived from the Quarterly Statements
of the Company's life insurance subsidiaries, as filed with
insurance regulatory authorities and prepared in accordance
with statutory accounting practices.
(3) Excludes mutual funds selected as investment options under the
Company's variable annuity and variable universal life
insurance contracts and mutual funds selected as investment
options under Nationwide Insurance Enterprise employee and
agent benefit plans.
25
<PAGE> 26
Revenues in the Corporate and Other segment consist of net
investment income on invested assets not allocated to the three
product segments, investment management fees and other revenues
earned from the Company's investment advisor subsidiaries (other
than the portion allocated to the Variable Annuities and Life
Insurance segments), commissions and other income earned by the
marketing and distribution subsidiaries of the Company and net
investment income and policy charges from group annuity contracts
issued to Nationwide Insurance Enterprise employee and agent
benefit plans.
Growth in interest spread income and other income was driven by
increased policy reserves related to Nationwide Insurance
Enterprise employee and agent benefit plans and strong first nine
months 1998 sales from the Company's investment advisor
subsidiary, respectively.
The 1997 Corporate and Other segment results do not reflect a full
first quarter of interest expense on the senior notes and capital
securities of subsidiary trust which were issued in March 1997.
Stated on a pro forma basis to reflect interest expense for a full
first quarter and to adjust for the impact on net investment
income related to the special dividends paid in anticipation of
the IPO, first nine months 1997 Corporate and Other segment
operating income before federal tax expense was $0.3 million.
In addition to the operating revenues previously presented, the
Company also reports realized gains and losses on investments in
the Corporate and Other segment. The Company realized net
investment losses of $5.0 million and $4.8 million during the
third quarter of 1998 and 1997, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity and capital resources demonstrate the overall financial
strength of the Company and its ability to generate strong cash
flows from its operations and borrow funds at competitive rates to
meet operating and growth needs. The Company's capital structure
consists of long-term debt, capital securities of subsidiary trust
and equity, summarized in the following table.
<TABLE>
<CAPTION>
AS OF
---------------------------------------------------
SEPTEMBER 30, DECEMBER 31, SEPTEMBER 30,
(in millions of dollars) 1998 1997 1997
------------------------------------------------------- ----------------- ---------------- ----------------
<S> <C> <C> <C>
Long-term debt $ 298.4 $ 298.4 $ 298.4
Capital securities of subsidiary trust 100.0 100.0 100.0
----------------- ---------------- ----------------
Total long-term debt and capital securities 398.4 398.4 398.4
----------------- ---------------- ----------------
Shareholders' equity, excluding accumulated other
comprehensive income 2,096.9 1,877.1 1,809.0
Accumulated other comprehensive income 373.2 247.1 213.4
----------------- ---------------- ----------------
Total shareholders' equity 2,470.1 2,124.2 2,022.4
----------------- ---------------- ----------------
Total capital $ 2,868.5 $ 2,522.6 $ 2,420.8
================= ================ ================
Total capital excluding accumulated other
comprehensive income $ 2,495.3 $ 2,275.5 $ 2,207.4
================= ================ ================
Long-term debt and capital securities to total capital 13.9% 15.8% 16.5%
Long-term debt and capital securities to total capital
excluding accumulated other comprehensive income 16.0% 17.5% 18.0%
</TABLE>
The Company's long-term debt bears interest at 8% per annum and
matures March 1, 2027. The capital securities of subsidiary trust
are due March 1, 2037 and pay a distribution rate of 7.899%. There
are no sinking fund requirements related to the debt or capital
securities.
26
<PAGE> 27
On October 14, 1998, Nationwide Financial Services Capital Trust
II (the Trust), a wholly-owned subsidiary trust of NFS, sold, in a
public offering, $200 million of 7.10% Trust Preferred Securities
(Preferred Securities), representing preferred undivided
beneficial interests in the assets of the Trust generating net
proceeds of $193.7 million. Concurrent with the sale of the
Trust's Preferred Securities, NFS sold to the Trust $206.2 million
of Junior Subordinated Deferrable Interest Debentures (Junior
Subordinated Debentures) due October 31, 2028. The Junior
Subordinated Debentures are the sole assets of the Trust and are
redeemable, in whole or in part, on or after October 19, 2003 at a
redemption price equal to the principal amount to be redeemed plus
any accrued and unpaid interest. The Preferred Securities have a
liquidation amount of $25 per security and must be redeemed by the
Trust when the Junior Subordinated Debentures mature or are
redeemed by NFS.
The Preferred Securities, through obligations of NFS under the
Junior Subordinated Debentures, the Preferred Securities Guarantee
Agreement and the related Amended and Restated Declaration of
Trust, are fully and unconditionally guaranteed by NFS.
Distributions on the Preferred Securities are cumulative and
payable quarterly beginning January 31, 1999. Distributions on the
Preferred Securities will be classified as interest expense in the
consolidated statements of income.
NFS is a holding company whose principal asset is the common stock
of NLIC. The principal sources of funds for NFS to pay interest,
dividends and operating expenses are existing cash and
investments, and dividends from NLIC and other subsidiaries.
State insurance laws generally restrict the ability of insurance
companies to pay cash dividends in excess of certain prescribed
limitations without prior approval. The ability of NLIC to pay
dividends is subject to restrictions set forth in the insurance
laws and regulations of Ohio, its domiciliary state. The Ohio
insurance laws require life insurance companies to seek prior
regulatory approval to pay a dividend if the fair market value of
the dividend, together with that of other dividends made within
the preceding 12 months, exceeds the greater of (i) 10% of
statutory-basis policyholders' surplus as of the prior December 31
or (ii) the statutory-basis net income of the insurer for the
prior year. NLIC's statutory-basis policyholders' surplus as of
December 31, 1997 was $1.13 billion and statutory-basis net income
for 1997 was $111.7 million. Total dividends paid in the 12 months
preceding September 30, 1998 were $100.0 million. The Ohio
insurance laws also require insurers to seek prior regulatory
approval for any dividend paid from other than earned surplus. The
payment of dividends by NLIC may also be subject to restrictions
set forth in the insurance laws of New York that limit the amount
of statutory profits on NLIC's participating policies (measured
before dividends to policyholders) that can inure to the benefit
of NFS and its stockholders. NFS currently does not expect such
regulatory requirements to impair its ability to pay interest,
dividends, operating expenses, and principal in the future.
The Company's principal sources of funds are premiums and other
considerations paid, contract charges earned, net investment
income received and proceeds from investments called, redeemed or
sold. The principal uses of these funds are the payment of
benefits on annuity contracts and life insurance policies,
operating expenses and the purchase of investments. Net cash
provided by operating activities (reflecting principally (i)
premiums and contract charges collected, less (ii) benefits paid
on life insurance products, plus (iii) income collected on
invested assets, less (iv) commissions and other general expenses
paid) was $461.1 million and $971.4 million for the first nine
months of 1998 and 1997, respectively. Net cash used in investing
activities (principally reflecting investments purchased less
investments called, redeemed or sold) was $345.9 million and $1.64
billion in the first nine months of 1998 and 1997, respectively.
Net cash (used in) provided by financing activities (principally
reflecting net proceeds from the IPO and the companion offerings
of senior notes and capital securities of subsidiary trust in 1997
only and deposits to investment product and universal life
insurance product account balances less withdrawals from such
account balances) was ($278.8) million and $732.5 million for the
first nine months of 1998 and 1997, respectively.
Also available as a source of funds to the Company is a $600.0
million revolving credit facility entered into by NLIC and
Nationwide Mutual Insurance Company in August 1996 with a five
year term with a group of national financial institutions. In
September 1997, the credit agreement was amended to include NFS as
a party to and borrower under the agreement. The facility provides
for several and not joint liability with respect to any amount
drawn by any party. To date, no amounts have been drawn down on
the facility. The facility provides covenants, including, but not
limited to, requirements that the Company maintain consolidated
tangible net worth, as defined, in excess of $1.23 billion and
NLIC maintain statutory surplus in excess of $875 million.
27
<PAGE> 28
On April 24, 1998 NFS purchased a 32% interest in The 401(k)
Companies, Inc. for $6.5 million. The 401(k) Companies, Inc.
focuses on sales and services to the large case market and will
allow NFS to better penetrate that market.
In May 1998 NFS purchased Morley Financial Services, Inc., an
investment management company, for $32.1 million. Morley Financial
Services, Inc. specializes in stable-value products for qualified
retirement plans.
On July 31, 1998 NFS acquired National Deferred Compensation, Inc.
(NDC) for approximately $24.0 million. NDC is an administrator of
deferred compensation programs for public employees.
INVESTMENTS
General
The Company's assets are divided between separate account and
general account assets. As of September 30, 1998, $42.68 billion
(or 65%) of the Company's total assets were held in separate
accounts and $22.95 billion (or 35%) were held in the Company's
general account, including $20.33 billion of general account
investments.
Separate account assets consist primarily of deposits from the
Company's variable annuity business. Most separate account assets
are invested in various mutual funds. All of the investment risk
in the Company's separate account assets is borne by the Company's
customers, with the exception of $703.9 million of policy reserves
as of September 30, 1998 ($365.5 million as of December 31, 1997)
for which the Company bears all or a portion of the investment
risk.
Fixed Maturity Securities
The following table summarizes the composition of the Company's
general account fixed maturity securities by category.
<TABLE>
<CAPTION>
SEPTEMBER 30, 1998 DECEMBER 31, 1997
--------------------------- ---------------------------
CARRYING % OF CARRYING % OF
(in millions of dollars) VALUE TOTAL VALUE TOTAL
----------------------------------------------- --------------- ----------- --------------- -----------
<S> <C> <C> <C> <C>
U.S. government/agencies $ 264.1 1.9% $ 319.7 2.4%
Foreign governments 99.5 0.7 95.8 0.7
State and political subdivisions 0.9 - 1.6 -
Mortgage-backed securities:
U.S. government/agencies 3,601.7 25.8 3,750.3 28.4
Non-government/agencies - - - -
Corporate:
Public 4,999.4 35.7 4,597.3 34.8
Private 5,014.0 35.9 4,445.4 33.7
--------------- ----------- --------------- -----------
$ 13,979.6 100.0% $ 13,210.1 100.0%
=============== =========== =============== ===========
</TABLE>
The National Association of Insurance Commissioners (NAIC) assigns
securities quality ratings and uniform valuations called "NAIC
Designations" which are used by insurers when preparing their
annual statements. The NAIC assigns designations to publicly
traded as well as privately placed securities. The designations
assigned by the NAIC range from class 1 to class 6, with a
designation in class 1 being of the highest quality. Of the
Company's general account fixed maturity securities, 97% by the
carrying value were in the highest two NAIC Designations as of
September 30, 1998.
28
<PAGE> 29
The following table sets forth an analysis of credit quality, as
determined by NAIC Designation, of the Company's general account
fixed maturity securities portfolio as of September 30, 1998 and
December 31, 1997.
<TABLE>
<CAPTION>
AS OF AS OF
SEPTEMBER 30, 1998 DECEMBER 31, 1997
--------------------------- ----------------------------
NAIC RATING AGENCY CARRYING % OF CARRYING % OF
DESIGNATION (1) EQUIVALENT DESIGNATION (2) VALUE TOTAL VALUE TOTAL
------------------ ----------------------------- --------------------------- --------------- ------------
(in millions of dollars)
<S> <C> <C> <C> <C> <C>
1 Aaa/Aa/A $ 9,287.8 66.5% $ 8,815.3 66.7%
2 Baa 4,323.0 30.9 4,116.6 31.2
3 Ba 362.7 2.6 220.9 1.7
4 B 6.1 - 53.7 0.4
5 Caa and lower - - 3.6 -
6 In or near default - - - -
--------------------------- --------------- ------------
$ 13,979.6 100.0% $ 13,210.1 100.0%
=========================== =============== ============
</TABLE>
----------
(1) NAIC Designations are assigned no less frequently than
annually. Some designations for securities shown have been
assigned to securities not yet assigned an NAIC Designation
in a manner approximating equivalent public rating
categories.
(2) Comparison's between NAIC and Moody's designations are
published by the NAIC. In the event no Moody's rating is
available, the Company has assigned internal ratings
corresponding to the public rating.
The Company's general account mortgage-backed security (MBS)
investments include residential MBSs and multi-family mortgage
pass-through certificates. As of September 30, 1998, MBSs were
$3.60 billion (or 26%) of the carrying value of the general
account fixed maturity securities available-for-sale, all of which
were guaranteed by the U.S. government or an agency of the U.S.
government.
The Company believes that general account MBS investments add
diversification, liquidity, credit quality and additional yield to
its general account fixed maturity securities portfolio. The
objective of the Company's general account MBS investments is to
provide reasonable cash flow stability and increased yield.
General account MBS investments include collateralized mortgage
obligations (CMOs), Real Estate Mortgage Investment Conduits
(REMICs) and mortgage-backed pass-through securities. The
Company's general account MBS investments do not include
interest-only securities or principal-only securities or other
MBSs which may exhibit extreme market volatility.
Prepayment risk is an inherent risk of holding MBSs. However, the
degree of prepayment risk is particular to the type of MBS held.
The Company limits its exposure to prepayments by purchasing less
volatile types of MBSs. As of September 30, 1998, $2.50 billion
(or 70%) of the carrying value of the general account MBS
portfolio was invested in planned amortization class CMOs/REMICs
(PACs). PACs are securities whose cash flows are designed to
remain constant over a variety of mortgage prepayment
environments. Other classes in the CMO/REMIC security are
structured to accept the volatility of mortgage prepayment
changes, thereby insulating the PAC class.
29
<PAGE> 30
The following table sets forth the distribution by investment type
of the Company's general account MBS portfolio as of September 30,
1998 and December 31, 1997.
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1998 AS OF DECEMBER 31, 1997
------------------------------- ------------------------------
CARRYING % OF CARRYING % OF
(in millions of dollars) VALUE TOTAL VALUE TOTAL
------------------------------------ ------------ ------------ ------------ -----------
<S> <C> <C> <C> <C>
Planned Amortization Class $2,501.7 69.5% $2,645.3 70.5%
Very Accurately Defined Maturity 508.1 14.1 550.1 14.7
Multi-family Mortgage Pass-through
Certificates 249.8 6.9 235.2 6.3
Scheduled 150.2 4.2 160.6 4.3
Targeted Amortization Class 93.3 2.6 90.8 2.4
Accrual 42.5 1.2 48.5 1.3
Sequential 27.1 0.7 19.8 0.5
Other 29.0 0.8 - -
------------ ------------ ------------ -----------
$3,601.7 100.0% $3,750.3 100.0%
============ ============ ============ ===========
</TABLE>
The Company has not invested in derivative securities other than
MBSs.
Mortgage Loans
As of September 30, 1998, general account mortgage loans were
$5.19 billion (or 26%) of the carrying value of consolidated
general account invested assets.
The following table sets forth the delinquency, foreclosure and
restructured commercial mortgage loan experience for the Company
and for the life insurers reporting to the American Council of
Life Insurance (ACLI) for the periods indicated.
<TABLE>
<CAPTION>
NINE MONTHS ENDED NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, 1998 SEPTEMBER 30, 1997 DECEMBER 31, 1997
------------------------ ----------------------- ------------------------
COMPANY ACLI (1) COMPANY ACLI (2) COMPANY ACLI (2)
------------ ----------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Delinquent (3) 0.00% - % 0.48% 1.33% 0.19% 0.90%
In foreclosure (4) 0.00 - 0.48 0.82 0.19 0.58
Restructured (5) 0.57 - 1.17 5.64 0.77 4.61
------------ ----------- ----------- ----------- ----------- ------------
Subtotal 0.57 - 1.65 6.97 0.96 5.51
Foreclosed - year to date 0.18 - 0.80 0.65 1.07 0.84
------------ ----------- ----------- ----------- ----------- ------------
Total 0.75% - % 2.45% 7.62% 2.03% 6.35%
============ =========== =========== =========== =========== ============
</TABLE>
----------
(1) ACLI data for the three months ended September 30, 1998 are
not yet available.
(2) Source: ACLI Investment Bulletins entitled "Quarterly Survey
of Mortgage Loan Delinquencies and Foreclosures," numbers
1393 and 1399, dated December 10, 1997 and March 9, 1998,
respectively.
(3) Commercial mortgage loans are classified by the Company and
the ACLI as delinquent when they are 60 days or more past
due.
(4) Delinquent includes loans in foreclosure; therefore,
subtotal and total lines exclude "In foreclosure" amounts.
(5) Commercial mortgage loans are classified by the Company and
the ACLI as restructured when they are in good standing, but
the basic terms have been modified as a result of an actual
or anticipated delinquency.
ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
This information is not required until after the first fiscal year
end in which Item 305 is applicable.
30
<PAGE> 31
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.
In February 1997, NLIC was named as a defendant in a lawsuit filed
in New York Supreme Court related to the sale of whole life
policies on a "vanishing premium" basis (John H. Snyder v.
Nationwide Life Insurance Co.). In April 1998, NLIC was named as a
defendant in a lawsuit filed in Ohio State Court similar to the
Snyder lawsuit (David and Joan Mishler v. Nationwide Life
Insurance Co.). In August 1998, Nationwide Mutual Insurance
Company and NLIC and the plaintiffs executed a stipulation of
settlement and submitted it to the New York Supreme Court for
approval. On August 20, 1998, the Court in the Snyder lawsuit
signed an order preliminarily approving a class for settlement
purposes (which would include the Mishler lawsuit) and scheduled a
fairness hearing for December 17, 1998. At that hearing, the Court
will review the fairness and reasonableness of the proposed
settlement prior to issuing a final order and judgement. The
proposed settlement, which is subject to approval by the Court,
provides policyholders with a potential value of approximately
$100 million in policy adjustments, discounted premiums and
discounted products.
In November 1997, two plaintiffs, one who was the owner of a
variable life insurance contract and the other who was the owner
of a variable annuity contract, commenced a lawsuit in a federal
court in Texas against NLIC and the American Century group of
defendants (Robert Young and David D. Distad v. Nationwide Life
Insurance Company et al.). In this lawsuit, plaintiffs seek to
represent a class of variable life insurance contract owners and
variable annuity contract owners whom they claim were allegedly
misled when purchasing these variable contracts into believing
that the performance of their underlying mutual fund option
managed by American Century, whose shares may only be purchased by
insurance companies, would track the performance of a mutual fund,
also managed by American Century, whose shares are publicly
traded. The amended complaint seeks unspecified compensatory and
punitive damages. On April 27, 1998, the Court denied, in part,
and granted, in part, motions to dismiss the complaint filed by
NLIC and American Century. The remaining claims against NLIC
allege securities fraud, common law fraud, civil conspiracy and
breach of contract. Plaintiffs filed their motion in support of
class certification on August 28, 1998 and NLIC and American
Century filed their separate responses opposing class
certification on October 9, 1998. NLIC intends to defend this case
vigorously.
On October 29, 1998, the Company and certain of its subsidiaries
were named in a lawsuit filed in the Common Pleas Court of
Franklin County, Ohio 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). The plaintiff in such lawsuit
seeks to represent a national class of the Company's customers and
seeks unspecified compensatory and punitive damages. The Company
is currently evaluating this lawsuit, which is in an early stage
and has not been certified as a class. The Company intends to
defend this lawsuit vigorously.
There can be no assurance that any litigation relating to pricing
or sales practices will not have a material adverse effect on the
Company in the future.
31
<PAGE> 32
ITEM 2 CHANGES IN SECURITIES AND USE OF PROCEEDS
NFS reacquired 348, 405 and 410 shares of its Class A Common
Stock, par value $0.01 per share in brokerage transactions on the
last business day of July, August and September, respectively, for
an aggregate purchase price of $18,760.50, $18,762.21 and
$18,762.36, respectively. All amounts include brokers'
commissions. Pursuant to the Stock Retainer Plan for Non-Employee
Directors, 348, 405 and 410 shares of Class A Common Stock were
subsequently reissued by NFS on the last business day of July,
August and September, respectively, at a price of $54.50, $46.188
and $45.625 per share, respectively, to NFS' directors as partial
payment of the $50,000 annual retainer paid by NFS to the
directors in consideration of serving as directors of the Company.
The issuance of such shares is exempt from registration under the
Securities and Exchange Act of 1933, as amended, pursuant to Rule
506 promulgated thereunder.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27 Financial Data Schedule (electronic filing only)
(b) Reports on Form 8-K:
On July 14, 1998, NFS filed a Current Report on Form 8-K
concerning the announcement of NFS's formation of a
strategic alliance with National Deferred Compensation,
Inc.
On September 4, 1998, NFS filed a Current Report on Form
8-K concerning the announcement by Nationwide Mutual
Insurance Company and NLIC of a settlement in a class
action lawsuit related to certain products sold by NLIC.
On September 30, 1998, NFS filed a Current Report on Form
8-K concerning the announcement of NFS's involvement in
discussions with United Asset Management Corporation (UAM)
regarding the possible acquisition of UAM's investment
management affiliate, Pilgrim Baxter & Associates.
On October 15, 1998, NFS filed a Current Report on Form
8-K concerning NFS's announcement of the offering of $200
million of Trust Preferred Securities.
On October 19, 1998, NFS filed a Current Report on Form
8-K concerning NFS's announcement that it had ended
discussions with UAM regarding the possible acquisition of
UAM's investment management affiliate, Pilgrim Baxter &
Associates.
On October 23, 1998, NFS filed a Current Report on Form
8-K to file certain exhibits related to NFS's $200 million
Trust Preferred Securities.
32
<PAGE> 33
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATIONWIDE FINANCIAL SERVICES, INC.
-----------------------------------
(Registrant)
Date: November 16, 1998 /s/Mark R. Thresher
------------------------------------------
Mark R. Thresher, Vice President - Finance
and Treasurer
(Chief Accounting Officer)
33
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<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM NATIONWIDE
FINANCIAL SERVICES, INC.'S QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED
SEPTEMBER 30, 1998, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS.
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